How Does It Work?
The system that we use is actually quite simple. After each expiration we apply a mathematical model to an index expiration to get our program trade numbers. We usually use the S&P 100 because of its close correlation to the Dow and because it is more volatile than the S&P 500. This gives us a number for the probable outside boundaries of an index. . We concentrate our trades on the cash S&P 100, 500 and the futures S&P 500 options index. We then suggest to subscribers, from our experience, which trades we would make for both an upside trade and a downside trade unless we think it is best to start with one side and then wait for the market to move before placing the other set of trades. Its great to do an upside (call) trade and a downside (put) trade at the same time. Since an index (for example the S&P 500) cannot expire in 2 places, youre guaranteed to win on at least one side of the trades even if by the slim 8% probability there is a loss in the other trade.
The program numbers we supply are currently 92% reliable on giving us the outside boundaries of a particular index. Even though this number is high, we strongly suggest that traders use only 1/3rd of their trading capital on a given trade in case there is a loss (2/3rds if they are trading both calls and puts.). If a person is trading all of our sectors, Regular or Conservative or Outright Sell trades we suggest they divide their capital in quarters.
On average, index options last 3 months before they expire. Mr. Davidson found from his studies that it is hard to predict mathematically what the market will do in 3 months. Because of this we only trade month to month, normally 20-25 days before expiration.
The basic method of the trading program is to sell an index option and to buy an index option creating a credit spread. The example below demonstrates the idea of how one of our Regular credit spreads would work graphically. Both of the graphs below were actual trades. An investor could apply this method to any cash or futures index if they knew Mr. Davidsons calculation for that index.
As mentioned above, we use the calculation to come up with the probable outside boundaries of an index. In this example were using the S&P 500 cash index. It calculated how far the index could go from expiration to expiration, being 830 for the upside and 770 for the downside. The short trade that is shown is used more for technical analysis and peak momentum movements. An example of a possible short trade is also shown below.
Using the above example we would get a $1.50 credit, or $150.00 per contract on the cash S&P 500 index and $375.00 for one futures S&P 500 options. About, 30% profit for one trade, or if both call and puts were done it would be a $3.00 credit, 60% profit. If the S&P 500 went above the 830 level or below the 770 level we would still be protected by owning the 835 and 765 calls and puts. The biggest benefit of spread trading is that even if the market rallied upward all month, or downward, our trade would remain about the same because of the declining premium, shown by the sloping graph. You can see by the graph that the index was on an upswing the whole time but it didnt make it above the 830 level before expiration. As we also do Outright Sells a person could have just sold the 830 call and 770 put and some subscribers do that but we ask them to let us know so we can provide stop numbers.
Heres another analogy to help explain the whole process. Lets say you buy a brand new motorhome and your friend Bob (sorry to any Bobs out there) asks if he could borrow it for a few months to live in. When he gets back to his camping spot another person asks if he could rent it for 3 months. Bob takes a $5000.00 deposit which he puts into the bank in order to gain interest on. The guy that borrowed it from him drives around the country like a crazy man. When he comes back the motorhome is trashed. Of course, Bob keeps the deposit but instead of getting it fixed, he just gives it back to you with an apology! Bob pockets the $5000.00 plus interest and goes off to borrow another motorhome from someone else!
This example is exactly how our trades work. You borrow an option from somebody and then sell it to someone else. When the option expires worthless you give it back to the owner. You dont actually borrow directly from a particular person. The options you sell come from a huge float of existing options. The main point is that you get time working for you instead of against you! This program helps to figure out the time=index movement quotient giving you, the trader, a 92% advantage of making an average 134% profit per year!
Copyright c 1996, 1997, 1998, 1999, 2000, 2001,2002,2003,2004,2005. All rights reserved. The information contained in theAGORA OUTLOOK NEWSLETTER is based upon data that is believed to be accurate, but is not guaranteed, and subject to change without notice. All projections, forecasts, opinions, and track records cannot be guaranteed to equal our past performance. Persons reading this newsletter are responsible for their actions. Officers and employees of this publication may at times have a position in the securities mentioned, or related services