I don’t know about you, but I am wondering when the next big market crash is going to happen. I’m always wondering about this. Why? Because there are ways to make huge profits from them. While most option traders are running for cover (literally, ha ha, option joke, get it?), there are ways to be on the winning side of the crash. There are many ways to do this, but I’ll discuss one of them now.

**Back Ratio Spreads**

The Back Ratio is a very interesting trade that can bring you huge profits over a market crash. While other option traders will be covering their naked positions, credit spreads, or buying puts to protect whatever positions they have on, the Back Spreader is counting how much money his/her account is going up. But the Back Spread is not so easy.

**Negative Theta**

The Back Spread has a negative Theta position, so one has to be a master of this trade to use it a lot. If you do not understand its Greeks deeply enough, you might find yourself losing trade after trade while waiting for that big crash to happen. There is also a big hole that can develop in the trade’s risk profile, so be very careful if you trade it.

**Know Your Vomma**

A good quality of the trade is the positive Vomma. This means that the Vega position will rise as IV rises and that is how this trade can make some handsome returns over a market debacle. Option trading is all about volatility and the more you understand it, the better trader you become.

So that is your first lesson about Vomma. Over 97% of option traders (as well as educators) do not understand how to implement this second order Greek, so you are now one of the smartest option traders on the block!

Even though we are just touching the surface of the Back Ratio Spread, we hope you’ve enjoyed this lesson. Next time we face a market catastrophy, be wise and make a small fortune! And if you want to learn it right, then give us a call. We’d be glad to teach it to you.

]]>In our last conversation we started to talk about the reality of option trading and the probability of various option spreads. Today, we’ll look further into this topic by comparing a high-prob Condor trade with a low-prob Butterfly.

**Theoretical Probability**

Traditional options platforms tend to display probability of an option spread based on standard deviations. When we look at the following trades, we’ll see that the Iron Condor has a probability at expiration of over 80% while the Butterfly is closer to 40%. One would think the 80% probability style of trade would produce more consistent returns over time. Let’s compare the realistic risk of each trade.

**High Probability Iron Condor**

Below you will find a typical set up of an Iron Condor constructed with about 30 days to expiry. The dark red area illustrates the profit zone at expiration date.

Next you will find a Butterfly Spread created at the same time. Notice that the probability at expiration is more narrow on this spread.

Here you see the “Realistic Probability” of the Condor is about 40% once you factor in a 10% loss. The red dashes indicate the loss area as the underlying asset moves around. The red zone gives the underlying wiggle room within a 10% loss to the upside or downside.

Here you see the “Realistic Probability” of the Butterfly is also about 40% once you factor in a 10% loss.

As you can see the **High Probability Condor **and the **Low Probability Butterfly** have a very similar short-term risk profile. The fact is we trade in “real time”, not in the future, which means the realistic probability (day to day risk) of these 2 trades is very similar. If you also take the time to look at Calendars, Diagonals and Credit Spreads, then you will see that they all fall into this type of realistic probability – somewhere around 40%.

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**Realistic and Theoretical Probability** – A New Approach To Option Trading

Hi, in our last conversation we talked about back-testing and how important that can be. Today, we are going to compare Realistic and Theoretical Probability.

**Theoretical Probability** **of Profit (POP)**

When we say Theoretical Probability, we are referring to the mathematical probability that is implemented into most options analytical software which is based on standard deviations and the bell curve. Many option traders use one, two and three standard devations to determine their probability to make money on a trade. Although this is a common approach, it has serious flaws that are very commonly overlooked.

The first problem is that this type of analysis doesn’t factor in risk. For example, a typical spread may have a theoretical probability of 85% at expiration, but this 85% contains a lot of real estate that requires the trader to take on tremendous risk during the life of the trade. In most instances, 50% of the theoretical probability is in a **High-Risk-Zone** by SJ Options’ standards. In other words the popular trades that have a POP (probability of profit) of 85% or higher only have a RPOP (realistic probability of profit) of about 42%.

The other problem with the common analytical tools is they assume the Bell Curve Center is right at the money. This is wrong. Our software shows where the actual center really is for each product, and it’s quite often not right at the money. So, this also throws off the probability analysis of each trade.

**Realistic Probability** **of Profit (RPOP)** = Probability of Safety

Each trade has a Theoretical Probability which contains a safety zone within that total probability that we at SJ Options have coined as the Realistic Probability of Profit or RPOP.

When we think in terms of the RPOP, we are referring to the probability of safety. This is the realistic probability of each trade since the area outside of this zone forces the user to take on great risk. **We believe it’s unrealistic to include an area within the probability that is not safely usable. **

When we trade options, it’s very important to understand the difference between these two probabilities. If you only look at your Theoretical Probability, you’ll run into problems over and over again. Many adjustments will be required once outside the safe zone, and in this business, we do not always get filled on our trades. This happens a lot to people who trade with limit orders while they are working full-time at another job. If you miss an adjustment, it can cost you thousands of dollars.

This is why it’s very important to increase your **Realistic Probability** as much as possible when you trade options. By having a larger safety zone, you can trade safer, and you won’t be making as many adjustments. Your overall risk will be greatly reduced, and your true probability of each trade will be greatly increased which means more money in your pocket at the end of the day.

See the image to illustrate the Theoretical and Realistic Probabilities of a traditional Iron Condor.

]]>First, let’s talk about the positive attributes of the credit spread. The reason most credit spread traders fall in love with this option strategy is because the trade can be designed to have a high probability of profit. By selling a credit spread really far out of the money, the option trader can create a probability of over 80%. Another attribute of the credit spread that traders typically fancy is that it’s relatively low maintenance when things go as planned. Often times a credit spread trader can put on a credit spread and basically set it and forget it. The credit spread can also yield 5 to 10% in a month when it’s placed out of the money. Those are some of the positive attributes of the credit spread that most option traders value.

Next, we will discuss some of the negative attributes of the credit spread. Although the out of the money credit spread has a high probability of profit, it also has a horrible risk to reward ratio. The trade can make 5 to 10% in one month, but when things go wrong, they go wrong in a very bad way. The credit spread can lose 100% of its investment, which is normally 10 times the amount that it can make if the trader sells a far out of the money spread. Therefore, one mismanaged trade that results in its maximum loss can wipe out an entire portfolio, or at least it will wipe out 10 winning trades.

Decay Rate Ratio

Another obstacle with the credit spread is that it has a very poor Decay Rate Ratio between the short and long contracts. The Decay Rate Ratio formula is a trademark of the San Jose Options teaching methods. In the credit spread the long contracts decay faster than the short contracts, and this causes a Decay Rate Ratio of less than one. Although this trade has a positive Theta, it still possesses is a poor Decay Rate Ratio.

If a credit spread trader chooses to use a really wide credit spread, then he/she runs the risk of entering into a trade that will perform like a naked position. Because of the poor Decay Rate Ratio, the long contracts decay first and falls off the “totem pole”. Then, the trader is left with a position that behaves just like a naked position although on paper it looks as if the position is covered.

Another negative attribute of the credit spread is that the trade is very directional. If the underlying asset immediately moves in the wrong direction, then this trade can experience a draw down of much more than it will ever make. This puts the option trader in a very difficult situation. Many option traders, panic and close out the trade at a tremendous loss while others take on a tremendous amount of risk and sometimes lose the maximum investment of the trade.

Those are some of the highlights of trading the credit spread. If you choose to utilize this option strategy, then make sure you paper trade many of years before you ever go live with your trading account. As always, we wish you the best of luck with your trading and have a great day.

]]>In my humble opinion the reason why most option traders never find long-term success is because they don’t spend time or have the tools to back test their strategies to create specific rules based on their back tested results.

Option trading and software is still really in its infancy, and the back testing tools on the market are very limited. The current tools on the market are obsolete and they require the user to expand great energy in order to back test and to create reports that they need in order to design trades that work over and over again.

Since back testing is so tedious, most option traders do not do any at all, while others do just enough to preview the results of their trading system. The lack of back testing and gathering this necessary information is one of the grandest reasons why option traders never succeed.

The other reason is simply discipline. Once the trader has a system that theoretically works, it’s also just as important to stick to the rules that have created such a favorable trading strategy. However, human emotion and greed often take over and most option traders bend the rules until they break. When this happens, the designed strategy will fail.

Another reason why the option trader might not succeed is because of trade execution. Often times the trader will know the adjustment that needs to be made, but then if the broker does not fill them at the price they want, they pass up the trade. This is very common and once again it will lead to problems. In fact, a good rule to add your trading system is to make sure you get filled even if you have to cave-in on the price a little bit in order to do so.

Another reason why the option trader may not find success could be due to the lack of understanding of options and their Greeks. Although it might not be necessary to have the deep understanding of options in order to design a successful formula, it certainly does help. When you do not have this education, then most likely you will find that your trading system has exposure to risk that you were not aware of because of your lack of education on the topic.

I hope you’ve enjoyed today’s lesson on why most option traders fail, and I wish you the best of luck with your own trading and creating your own successful option trading strategies.

]]>**The Weaknesses**

Both of these trades are tough to manage because they are exposed to risk on the downside as well as the upside. The other weakness in the structure of these trades is that they possess a negative Decay Rate Ratio. Although they are both positive Theta trades, they are structured such that the long contracts decay faster than the short contracts. Therefore, the structure of both of these trades is rather poor. The Butterfly has and even worse Decay Rate Ratio than the Iron Condor. The reason the Decay Rate Ratio is worse on the Butterfly is because typically the short strikes on the Butter are usually placed near the money and the shorts of the IC are placed OTM. This is the primary difference in the structure of the two spreads.

One thing to understand about Theta is that it’s slower at the money, then it is out of the money. Even though it has a higher numerical Theta ATM, the option contract is decaying at a slower rate compared to the OTM contracts. This is one very important point to understand about Theta that is very commonly misunderstood throughout the entire industry.

Although the Decay Rate Ratio is worse on the Butterfly spread, it offers slightly more safety if the underlying asset drops rather quickly. The reason for this is because again, the long contracts are farther away from the short contracts in the Butterfly compared to the Iron Condor, and therefore, the Butterfly technically could have more positive Vomma than the Iron Condor does.

**Summary**

So to summarize the information presented today, the Butterfly will typically have a worse Decay Rate Ratio than the Iron Condor, but it will have more positive Vomma which makes it slightly safer if there is a market crash of your underlying asset. Finally, this assumes that there is an inverse correlation between price action and volatility of your underlying.

I hope you’ve learned something new about options today, and if you would like more information about our mentoring program, please don’t hesitate to contact us. Thank you very much in good luck with your trading.

]]>R-POP stands for realistic probability of profit. We arrive at this calculation by removing the necessary amount of risk from a trade’s risk profile and then calculate the probability of profit after. So the R-POP is a probability measurement of an option spread which only includes acceptable risk for that trade.

In the options trading industry option traders traditionally calculate probability by looking ahead to expiration date. This method is known as the POP (probability of profit). The POP includes all risk associated with the trade inside the profitable zone before the trades reaches expiration. Therefore, using the traditional POP as a way to calculate probability, is not realistic for option spreads that have high short-term risk. For most option spreads, you cannot possibly utilize the POP or you would wipe out your trading account. Therefore, the POP is an obsolete method to calculate probability for option traders.

San Jose Options developed the R-POP in order to calculate a realistic probability of profit which addresses the shortfalls of the traditional methods known as the POP. The R-POP can be found in our software only, and it gives you a far more accurate picture of the probability of your option spread. More accurate trade analysis leads to better performance and eventually higher consistent returns over time.

We hope you’ve learned some new things about calculating probability, and if you have any questions about our mentoring program, please feel free to schedule a live demo. You’d be glad that you did.

R-POP is a registered trademark of San Jose Options. Use of our trademarks falls under San Jose Options – .

]]>One of the most common questions that we consistently are asked is, “What’s the difference between your course and other courses on the market?”

Well, there are numerous differences between San Jose Options and the rest.

1. San Jose Options does not teach any traditional option strategies. These include short-term iron condors, credit spreads, naked puts, naked calls, naked strangles, covered calls, double diagonals, calendar spreads, or butterfly spreads. You get the picture.

2. Our strategies are designed with volatile markets in mind. We construct our trades in such a way that they can withstand sudden moves in the market much better than the said traditional option strategies.

3. We design our trades around R-POP instead of the POP. R-POP is a trademark of San Jose Options Trading and it stands for the realistic probability of profit. In short, we design our trades with probability that only includes safety while traditionally option traders calculate probability that includes an enormous amount of risk. Therefore, the San Jose Options methods of calculating probability are far more realistic than the rest of the industry.

4. We teach by example. Since 2008 we have demonstrated to our students the effectiveness of our strategies by implementing them, applying our adjustment system, and following the trades from beginning to end.

5. San Jose Options holds several pending patents. As pioneers of the options trading industry, we’ve invented faster methods of back testing and more effective and comprehensive ways to analyze option spreads and game changing probability tools.

6. San Jose Options is the most advanced options training program on the planet. We are Masters of first and second order Greeks. We’ve integrated our extensive knowledge of second order Greeks into our options trading platform for the benefit of all of our clients, and we take it even further than that.

7. Our founder has also formulated calculations between the first and second order Greeks to make managing an options portfolio simpler than ever before. The DV Ratio and the Diggit’s, both trademarks of San Jose Options, are proprietary formulas that include multiple Greeks all into one number making trade analysis much faster, much more accurate and more streamlined than ever before.

As you can see San Jose Options is nothing like the rest. Over the years there have been many imitators, but they will never be able to keep up with us because we always keep on moving forward at a very quick pace.

We provide our clients with the very best options education available anywhere, as well as the most scientific tools on the planet. San Jose Options is your best choice to get an options education and to put realistic probability on your side.

Thank you very much for your interest in our company, and as always, we wish you the best of luck with your trades.

]]>Trader uses 20 credit spreads simultaneously, does not make any adjustments, and then simply relies on probability to make money.

This system has a few requirements.

1. The underlying assets are not correlated with each other.

2. Each credit spread has a probability of 90% or higher.

3. User trades 20 credit spreads each month on different assets.

4. User never makes any adjustments and leaves all trades on until they expire in order to take advantage of the POP (Probability of Profit).

This trading system is purely about probability, and at first glance, it appears that it may work very well. In my opinion, there are a few inefficiencies with this trading system that I’ll explain.

First of all, for this credit spread system to be effective, the trader must find numerous underlying assets that are not correlated. But there is a problem here. Under normal market conditions, we may not see a strong correlation between the selected numerous underlying assets. However, once the market become directionally biased (extremely bearish or extremely bullish), then your NON-correlated can quickly become VERY-correlated. In other words, the correlation theory behind this trading system is really a set up for disaster. In fact, I’ve heard numerous stories of traders blowing up their accounts for this exact reason.

Let’s consider various scenarios to illustrate the problem with this correlation theory. Let’s say the trader initiates 10 Bull Put spreads and 10 Bear Call spreads while each vertical is placed with a different underlying asset. Again, this trader believes they have a high probability of success, and there is no need to manage any of the trades. The goal is to make money because of the high probability, and we assume that mathematically the winners’ profits will outweigh the losers’ losses. Consider what would happen over a serious market decline. Although each asset is theoretically not correlated, when we have a serious market decline, the correlation between all assets sharply increases. Therefore, it is highly probable that 10 out of 10 will realize there maximum loss. At the same time, the 10 Bear Call spreads will realize there maximum gain. This scenario is very similar to what would happen to one Iron Condor. So although the trader begins with a maximum credit of 10%, in this scenario the overall trade would assume a 100% loss since the trader loses the full amount invested into the trade.

A similar scenario occurs in a very bullish market. Most likely 10 out of 10 Bear Call Spreads will result in their maximum loss while all Bull Put Spreads realize a small gain. In other words, the trade once again results in maximum draw-down very similar to one large Iron Condor trade. So although this trading system seems like a good idea at first glance, it may perform similar to an Iron Condor, but it will be much more difficult to manage since there are so many trades to supervise.

Another scenario is that the trader only does one side of the trade. For example, let’s say the trader only does the put side. Again, in an extremely bearish market, it’s very likely that every single Bull Put Spread will realize the maximum loss. This is my point of view.

This is only my opinion, and I am speaking from experience of what I have seen happen in the markets over the last 20 years of trading it. You certainly don’t have to believe me, but what I would recommend is to back test this concept over those extremely directional markets such as 2008, 2011, and even the bullish moves of 2012 and 2013. It will be interesting work to be done, and as you back test this, you will discover one more problem with this trading system. It’s a ton of work and way too hard to manage! Even if you do not make adjustments, it’s still going to take up all of your time to research and fill your trades. Try backtesting it and you’ll get a good taste of just how much work this really is.

The last problem with this trading system is the obvious as I just started to discuss. Managing 20 trades at one time will be too much work for one trader. If you like to sit in front of your computer screen all day long trying to manage a portfolio of 40 strikes and 20 different underlying assets, be my guest.

Other risks include dividend risk as well as assignment risk. You’ll also pay higher taxes for trading options on stocks.

Finally, in order for this type of system to work, the mathematics have to produce a profit. Mathematically, the credit spread can yield about 10%, based on the required investment; however, the said trade can lose 100% of its investment. Therefore, one loser can wipe out 10 winners more or less. So remember this fact in your calculations before you attempt to profit from such a trading system for long periods of time.

Finally, Tsunami gives us further insight into this study. Tsunami can show us the statistical probabilities of each trade instead of theoretical probability that is produced in traditional software. In order to see if this technique has actually worked overtime, we could use Tsunami to better classify this trading system with statistcs. Perhaps in another study, we will continue this investigation. Thank you very much and as always… good luck with your trading!

]]>To All My Fellow Option Traders,

Thank you for expressing interest in the San Jose Options mentoring program. We are excited to have you step aboard. Through our newsletter service you’ll find that we are not your ordinary options course, but rather a pioneer in the industry. We design innovative spreads with options that keep it simple – simplicity is key.

We are also developing our own software, SJ Troo, which is based on our very own perspective of trading options. We believe it takes the fog off the lenses, and will help everyone become the best traders they can possibly be.

We are even creating our own Option Pricing Model! The innovation never stops here at San Jose Options! Well, that’s it for now…

**Welcome aboard and we hope to see you in our classroom soon!**

The San Jose Options Founder,

Morris Puma

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