Download Trade Like a Market Maker

How to Take Money From the Market
Maker
Presented by
Andrew Keene
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Andrew Keene
- Floor Trader @ CBOE 10+ Years
- Regular Contributor to CNBC
& Bloomberg
- Taught thousands of students how to become full
time traders
- Turned $50,000 into millions of dollars
Trade Like a Market Maker
-This is the BEST time ever to trade Options: Markets are Tighter, Penny Wide, and More
Liquid that Ever
-There are 8700 stocks and 4200 stocks with options.
-Of the 4200 stocks with options, there are over 320 stocks with listed weekly options
Gives traders 52 expirations to trade instead of 12
Trade Like a Market Maker
What is a Market Maker?
A market maker is someone who is always quoting a bid-ask spread for a given option
contract. The market maker is willing to take either side of the trade and is hoping to
profit from the spread between the bid and offer.
Example: AAPL is trading at $590.00
The market maker makes a market for the Dec 650 calls at 25-25.30 20 up.
This means that at this given time the market maker is willing to buy 20 contracts at $25
and/or sell 20 contracts at $25.30.
Trade Like a Market Maker
We will discuss:
 Who Controls Order flow
 Use Put-Call Ratio to Determine Investor Sentiment
 Use the Market Makers Target for Iron Condors
 Learn Best Time of Day and Week to Trade Credit and Debit Spreads
 Learn when and why to Trade a Credit or Debit Spread
 Learn how to Potentially Profit 600% in Options Using Market Maker Targets
Trade Like a Market Maker
Understanding Who Controls Order Flow:
Does the market maker control order flow?
Absolutely not!
Institutional traders and investors are the ones who really control all of the order flow in
the options market.
But who are these traders?
Institutional Paper
Mutual Funds,
Pension Funds,
Sovereign Wealth
Funds
The “whales” are the ones really in control of order flow
Institutional Paper
Hedge Funds
The more aggressive fish also control order flow. These orders come from hedge
funds and big traders.
Trade Like a Market Maker
Understanding Who Controls Order Flow:
Why are these the people in control?
-
They have MORE capital
-
They have MORE access to information
-
They have BETTER technology
-
They can take on MORE risk
These are the traders we want to follow. These are the traders the market maker watches.
Using the Put-Call Ratio to Determine Investor
Sentiment:
A look at option traders overall sentiment
Using the Put-Call Ratio to Determine Investor Sentiment
The Put-Call Ratio = Number of Puts Traded/Number of Calls Traded
What exactly is the put-call ratio and what does it tell us?
Before we get into that lets talk about why people trade options.
Using the Put-Call Ratio to Determine Investor
Sentiment
•
Trader Buys Calls: Is it a Hedge or Speculation?
•
Trader Sells Calls: Protection against long stock position
or speculation to establish short position.
•
Trader Buys Puts: Protection against long stock position
or speculation to downside?
•
Trader Sells Put: Protection against stock stock position
or speculation to upside?
Using the Put-Call Ratio to Determine Investor
Sentiment
•
Paper Buys Calls : 60% - 40% Bullish / Bearish
•
Paper Sells Calls : 50% - 50% Bullish / Bearish
•
Paper Buys Puts : 65% - 35% Bullish / Bearish
•
*Paper Sells Puts : 80% - 20% Bullish / Bearish
Using the Put-Call Ratio to Determine Investor Sentiment
So why is the put/call ration important to us?
They talk about it all the time on CNBC and other options shows all the time. Why?
Using the Put-Call Ratio to Determine Investor Sentiment
Put/call ratio can be a determinant of investor sentiment. Lets take a look at an example
in Chesapeake Energy Corp (CHK):
A trader BOUGHT 33000 CHK Oct14 35.0 Calls $0.49
This is a HUGE trade that requires this trader to lay out more than $1.3 million in capital.
Remember what we said about call buying. So how can we determine if this is actually a
bullish trade?
Using the Put-Call Ratio to Determine Investor Sentiment
Let’s look at the put/call ratio of CHK on that day.
Put/Call: 11k/171k = 0.06
We can determine a few things by looking at this number:
-
Calls MASSIVELY out traded puts on this day
-
There is clear demand for calls in CHK
-
Options traders are expecting UPSIDE in CHK
While this shows us the action in a single day we can dive even further into these
numbers.
Using the Put-Call Ratio to Determine Investor Sentiment
Where is the open interest sitting?
This can tell us how successful paper has been in the past.
Total open interest put/call ratio:
Put/Call: 155k/267k = 0.58
What does this tell us?
-
Clear trend for CALL BUYERS
-
We have seen this so many times in: VLO, TSO, CHK, MPC, and APC.
-
If these Calls are bought then it tells us the Institutions want to be LONG
See all of the open
interest on the call
side?
Take note as well that the OI
is in ATM and OTM Options
Notice how thin
OI is on the Put
side
Using the Market Makers Targets for Iron Condors
and Iron Butterflies:
Using Smarter Targets For Income Strategies
Using the Market Makers Targets for Iron Condors and Iron
Butterflies
Market Makers Targets:
•
Traders can use the price of the at the money straddle to calculate how much market makers
think the stock can move by expiration.
•
This can be easily calculated using the price of the at the money straddle. Traders can use this
to calculate implied closes for that expiration.
Using the Market Makers Targets for Iron Condors and Iron
Butterflies
The Goldman Sachs Group, Inc (GS) was reporting earnings on 4/17/2014 Before the market
open.
•
I thought that the stock wouldn’t move much so I wanted to set up a short premium
position.
But how do I pick my targets?
•
I use the market makers targets to look for strikes I want to center my trade around. Let’s
break it down on the next slide
Using the Market Makers Targets for Iron Condors and Iron
Butterflies
The GS Apr ATM 157.5 Straddle was trading at $3.70. This tells me that the stock can move up or
down by $3.70 BY EXPIRATION.
Using this straddle price we will calculate our upside and downside targets:
Upside Target = $157.50 + $3.70 = $161.20
Downside Target = $157.50 - $3.70 = $153.80
I now have an implied range that I can use to set up a trade
Using the Market Makers Targets for Iron Condors and Iron
Butterflies
Using the Measured Move Targets to Set Up an Iron Butterfly:
My Trade:
The GS Apr 155-157.5-160 Iron Butterfly for $2.00 Credit
Risk: $50 per 1 lot
Reward: $200 per 1 lot
Breakeven: $155.50 and $159.50
This trade has a GREAT reward/risk set up and has a wide
range of profitability.
Let’s see how it played out…
Using the Market Makers Targets for Iron Condors and Iron
Butterflies
The SPY is currently trading around $186.50 I will look at the weekly 186.50 straddle to get targets.
•
The Weekly 186.50 Straddle is trading at $2.70
•
Upside target = $189.20
•
Downside Target = $183.80
Now let’s look at a trade set up…
Using the Market Makers Targets for Iron Condors and Iron
Butterflies
Trade: The SPY Weekly 183-184-189-190 Iron Condor for a $0.35
Reward: $35 per 1 lot
Risk: $65 per 1 lot
Breakeven: $183.65 and $189.35
This trade makes money if the SPY closes anywhere between $183.65 and $189.35 on expiration.
This trade also sets up well on a risk vs. reward basis
When Is the Best Time to Trade Credit vs. Debit
Spreads?:
Capturing the Most Premium and Avoiding Time Decay
When Is the Best Time to Trade Credit vs. Debit Spreads?
Market makers know the best time of the day and week to trade credit spreads and debit
spreads.
•
On Thursday morning I will begin selling out some of my long premium positions
•
Thursday afternoon is when market makers begin “rolling their date forward”
•
What does this mean?
When Is the Best Time to Trade Credit vs. Debit Spreads?
Thursday afternoon is when premium really starts to come out of options but when do I want to
be putting on debit spreads?
•
I know that I want to be buying debit spreads on Tuesday afternoon
•
This is the best time of the week for me to put on long premium positions
•
Why?
Why Trade a Credit Spread vs. a Debit Spread?:
Know Which Stocks Work Best For Credit vs. Debit Spreads
Why Trade a Credit Spread vs. a Debit Spread?
Changes in a stocks trend and price action can change our considerations when looking to trade
credit or debit spreads.
Some things to think about:
-
Is the stock in a range?
-
Is the stock a trending stock?
-
Is the stock breaking any key levels?
Lets look at some chart examples….
As stock breaks key level here
implied volatility explodes.
Now we are looking for debit
spreads
When inside this range we want to
be trading credit spreads
This type of trend is very strong.
We want to be trading debit
spreads on charts like this.
When AAPL was in the range
highlighted we are looking to be short
premium
Earnings Breakout:
CAN’T BE SHORT PREMIUM
ANYMORE
Using the Market Makers Targets to Potentially
Make 600% Profits:
Us Smarter Targets to Set Up Low Risk High Reward
Strategies
Using the Market Makers Targets to Potentially Make 600%
Profits
We talked about how we can use the market makers targets to find levels for Iron Butterflies and
Iron Condors.
We can also use these targets for more speculative trades. We will look at how to use them to set
up low risk high reward strategies called Call and Put Butterflies.
We trade these strategies ahead of earnings announcements or other catalyst events.
Using the Market Makers Targets to Potentially Make 600%
Profits
Earnings Trade in SWKS:
SWKS is reporting earnings on 4/22/2014 After the bell:
-
Stock was trading around $37.00
-
The Apr 25th 37 Straddle was trading around $4.00
-
The chart was looking very bullish
-
We calculate an upside target of $41.00
Using the Market Makers Targets to Potentially Make 600%
Profits
My Trade: I bought 15 SWKS Apr 25th Weekly 39-41-43 Call Butterflies for $0.38
Risk: $38 per 1 lot
Reward: $162 per 1 lot
Breakeven: $39.38 and $42.62
This trade has a better than 5-1 reward to risk set up but it is typical to see setups with a 6-1 or
better setup.
Shares of SWKS gap higher right to the
measured move target
Using the Market Makers Targets to Potentially Make 600%
Profits
On Friday I was able to sell my SWKS Call Flys for $1.60 or 500% Profits.
•
These are huge profits and the reason this trade worked out so well is because I had great
targets calculated using the straddle.
•
This is how market makers develop targets and it works better than anything else out there.
Summary
•
Institutional traders are the ones who control the market. These institutions are hedge funds,
mutual funds, pension funds and big banks.
•
Traders can spot trends in the put/call ratio to determine what the overall sentiment of the
options market is on a given stock
•
Market makers targets are far more accurate than price targets developed using fib levels or
other technical analysis methods.
•
Traders can use these targets to trade Iron Condors and Iron Butterflies around catalyst events
or for income strategies.
•
Thursday morning is the best time to sell premium before market makers “roll their date
forward”
•
We only want to trade credit spreads in trading range stocks, if they breakout we become debit
spread traders.
•
We want to trade debit spreads in trending stocks
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