The M3 Options Trading System
 

Well, I haven't quite watched all of the video, but so far I've only understood about 20% of it.

To fully get it I'm going to have to take a refresher course on the "greeks" and the butterfly spread.

But right off the top I have two questions:

1. In the video example trade he did an awful lot of adjusting, which generates a lot of commisions? No?

2. Is your loss on this trade capped out at 5K, or with all of the "adjusting" can you blow past that number if bad things happen?

I understand it like this:

You should have $5000 for every "one" of these you want to trade. It generally costs me less than $2000 to get into the trade if you get in when he says to get in (about 50 days away from expiration). The closer you get to expiration, the more expensive these become.

The rest is in reserve in case you have to adjust.

No, one would never lose the entire $5000 (per butterfly), and I doubt very much if you'd even ever have $5,000 at risk (again, per butterfly...). Like I said, usually, I have less than $2,000 at risk at any time (per butterfly spread).

Plus, the rules state you are to look to exit the trade if you are down $500 or more, and you look to exit the trade if you are up $500 or more. You are also to exit the trade if there are only 20 days to expiration or less....if you were trading more than one butterfly spread (say you had $20,000 and you were trading 4 of these each time, then you would look to exit with either a $2,000 loss or $2,000 profit).

I have never had to make more than one adjustment thus far, and I've been trading these since around January....

This is a rather boring and slow way to trade...it's not something you have to monitor throughout the day...maybe take a look once at the start of the day and once at the end...they say you've made it as a trader once things get boring... :lol:

And yes, if you don't know much about options, or if it's been a very long time, it's all going to sound quite foreign in that video...I haven't been trading options all that long (a couple of years), and even I was a little confused watching the video...

This is why I think much of option trading will be replaced by specialized ETF trading.

Options are too damn confusing.

The guys @ SMB seem to know their stuff at least. Options can be very tricky with all of the things you can do with them.

Options trading volume has been going nowhere but UP...

http://www.businessinsider.com/goldm...me-went-2013-2

"Goldman Sachs options strategists Krag Gregory and Jose Gonzalo Rangel have the details:

The pace in 2013 has been even more remarkable for VIX options where the year-to-date average daily volume is running at a record high of 614,658 contracts – that is 1.4x the 2012 average and 22.4x the 2006 average.

VIX options had a record setting January: A breakdown of average daily volume by calendar month shows that VIX option average daily volume recorded an all-time high in January 2013 while S&P 500 options were in their 90th percentile relative to a 10-year history."

From a volume standpoint, I can't argue.

Do you think a significant % is retail, or is it primarily the banks and funds hedging?

I think retail investors have definitely become more comfortable with options in the last 5-10 years...the emergence of tastytrade and the acquisition of thinkorswim by TDAmeritrade hasn't hurt...that's how I become fully exposed initially, to the world of options...I've always been curious but was also always too intimidated to give it a go..

The SPY weekly options have drained most of the volume from the big S&P. The volume is enormous. The spread between bid and ask is pennies, and the premium is relatively small. Yes, the retail guy is in there trading.

Often you can get 10-1 on a Friday if you are correct.

IMO, no need to get into the sophisticated strategies. I just bet on the put or call.

A couple more questions:

1. It sounds like he's saying, "The T + zero line." Am I hearing him right. What is that.

2. What trading platform is he using to generate his charts. TradeStation? OptionVue?

3. Am I correct in assuming the trade starts out as a straightforward Put (or call) Butterfly spread? (He seemed to prefer doing these trades with puts for various reasons.) [Sell two at the money puts and buy two puts one in the money and one out of the money equal distances from the at the money strike.]

10-1 on what? Volume? ??

Let’s watch and see. On Friday, we will watch if the high and low on options expiring on that day have a high and low that is equivalent to 10-1.

Volume? One can easily buy hundreds of out of the money options, with hours/minutes to expiration. This is betting, not investing.

Well, I see now after further viewing he starts out with a bearishly positoned Iron Butterfly.

I googled Iron Butterfly and came up with

In-A-Gadda-Da-Vida

:D:D:D

1) I think you are hearing him right. I'm not sure what he means by that either...I thought T+ refers to settlement date of options. I thought he was just referring to the current P&L line which to me is the curved line in those graphs...I'm sure I'm interpreting this all wrong, but that line does represent the current P&L of the trade along various price points.

2) Not sure of the platform, but it's not tradestation. It might be OptionVue...it's one of the more expensive ones I believe

3) It's not a bearish trade. In fact, it starts out as a delta neutral trade, because after you purchase the put butterfly spread, you're supposed to purchase stock or calls to bring the delta to zero. Thus, you are protected a bit to the long side (due to the stock/calls purchased) in case of a big run up shortly after you put the trade on, plus you have a lot of downside to work with because the butterfly itself is a bearish-type trade...so even though the butterfly spread alone is a bearish trade, when combined with stock or calls, it brings it to a neutral trade in terms of delta.

Again, I'm sure I'm butchering the terminology here...I'm still no expert when it comes to trading options...I just know enough to do a little damage... :lol:

OK, having been out of the game for a while, I'm having to go back to school. I wrote a simple spreadsheet to analyze the possible positions you might take according to his entry rules. With the RUT closing at 1120 today these are the numbers.

Strike Put/Call Lots Debit/Credit
1050 $14.70 1 -$1470
1100 $28.10 -1 $2810
1100 $41.70 -1 $4170
1150 $23.50 1 -$2350

Bottom line is that it generates a $3160 credit with a maximum loss of $1840.

1. Does the iron butterfly always generate a credit to begin with?
2. If I've done things right, the next step is to buy some IWM stock. What is IWM stock, is that a Russel Index fund? How much do you buy?
3. Then he says instead of using IWM stock he (buys?) deep in the money calls. Are these RUT calls? How deep in the money? How many?

I guess the numbers I'm showing are not delta neutral. You have to make that first hedge with the stock or the calls to get to that delta neutral point.

Am I on base with all of this?

I guess I should have read more closely what you said. Perhaps that's why you have to pay him the money...so you can see exactly how he hedges.

From the video it appears to be a combination of rolling up (or down) the butterfly, vertical spreads, or purchasing calls.

After playing around with it for a while, I can't figure out exactly how he's doing it.

Like him, I buy calls (IWM calls, not RUT), not outright shares of the ETF (IWM is the ETF for the Russell). It achieves the same purpose of getting me to delta neutral and keeps everything in options. If you are trading multiple lots of these butterfly spreads, then you'd probably want to look at buying the RUT calls instead of the IWM calls....a RUT call would be too much though if you're only trading a "one lot" of these spreads...the IWM is smaller in size and works much better when you're only trading one or two lots of these things.

The long put butterfly is a net debit trade. You're buying the trade, not selling it (thus you don't get the credit deposited to your account when you open the trade like you do when you sell a credit spread). However, it is a theta positive trade (or at least your goal is to keep it a theta positive trade), so it acts much in the same way as if you were selling a credit spread. I don't know enough to explain why...I just know it is...

That spread you posted looks about right in terms of max profit/max loss. If your trading platform does not support you putting in butterfly orders (ie. you have to buy each individual leg of the spread and cobble it together yourself), then I would not be trading this system, or spreads in general. Find a broker/platform that lets you enter a single order for the entire spread at once, and executes the whole thing at once. I currently use thinkorswim...but I am still in the early stages of this. If I choose to get serious, I will find another broker with more favorable commissions.

With that said, the thinkorswim options platform at TDAmeritrade is an excellent piece of software for the options newbie...

I would also check out tastytrade.com. Their videos and streaming live shows can teach you a lot.

And again, I haven't paid Mr. Locke one cent...I got everything I basically needed off the video to get rolling with this...and I have rarely had to adjust...what he's doing in the video is NOT the original M3 trading plan. I am trying to duplicate the original M3 plan...I think he outlines the rules of the original M3 plan in the video early on (I believe there is a single slide in the presentation that has all of the rules...there aren't many rules), but what you see him trading through the rest of the video is NOT the original M3. He adjusts a LOT in the video...not sure if it's because of the trading environment he was in at the time (probably), or if his modifications over the years have led to more adjustments...but keep in mind what you see him doing in the video is NOT the original M3.

The original M3 is a simpler plan...and one that seems to agree with me thus far...

Thanks. This is what I originally thought. Early on in the video (at the 5:43 mark) there is a slide of his original 2007 M3 Trading Plan. Rule #5:

"Enter 1 put or Iron Butterfly 50 point wings 15-25 points below RUT price." That's where I got it.

The Iron Butterfly is a credit spread, and the long put butterfly is a net debit trade as you say.

I've looked at both. The Max profit/loss for the long put butterfly (entered 20 points below the close) at yesterday's closing prices is +$3960, -$1060.

Somehow, by adding stock, this brings the profit/loss to +$500, -$500.

I don't know why he called it an Iron Butterfly...or maybe my interpretation of the M3 trade isn't exactly what he meant...lol...an Iron Butterfly doesn't use all puts...but I'm pretty sure his M3 uses all puts...and I'm pretty sure the M3 is a net debit trade.

As to your last line in your last reply...the only purpose of adding stock (or calls), is to bring the trade to delta neutral at the beginning. It does not bring the max/profit loss down to $500/-$500.

The $500/-$500 is your exit point in terms of profit/loss. You aren't going for max profit with this trade, and you're certainly not holding on until max loss. You're exiting the trade as soon as it hits either +500 or -500 or until you hit 20 days before expiration, whichever comes first. Of course, as you gain experience, you can bend the rules a bit. For instance, my September expiration trade, I hit the 20 days to expiration point, and I was at break even with the trade. I looked at the charts and thought there was little risk in holding on a bit longer, as I thought the market was probably going to head down some...I ended up exiting about 10 days later with about half my profit goal, which was better than just break even...

If you're trading multiple lots, then of course, the +500/-500 goal becomes +1000/-1000, +1500/-1500, +2000/-2000...etc...etc...

OK, I think I've got it, just a couple of things. How much stock do you add, or how many calls do you buy and how deep in the money?

Also, is the Thinkorswim software telling you when your delta comes into line? Are you aiming for the +/- 50 for delta neutrality?

[I'm using IB, and I'm sure it has that capability, I just haven't figured out how to do it yet. IB is much, much more feature rich than when I was using it ten years ago.]

You add as much as it takes to get the delta as close to 0 as you can, within reason (and this only occurs when you open the trade). Since I've only been trading this system since January, I'm still only trading one lot. So I've only ever had to add one IWM call. Of course, the deeper in-the-money the call is, this will also have an effect on how much it moves your delta towards 0. But of course, deeper in the money calls cost more. It's all a balancing act. I could buy more of a lesser in-the-money IWM call, which is cheaper in price, but then you're paying more in commission.

I would imagine, as you increase your lot size of these butterflies, you can switch to straight out RUT calls...

Just as a hypothetical example (I'm not sure if the ratio of number of calls to number of butterflies is accurate because I'm not in front of my trading platform now to verify), if you were trading 5 lot butterflies, instead of buying 5 IWM calls, you might only have to buy 1 RUT call, saving you on commissions. Or maybe you only have to buy 3 IWM calls if you buy deeper in-the-money calls. Like I said, it's a balancing act where you can go in a couple of different directions.

And if buying stock is cheaper, you could go that route too, and buy shares of IWM to get to delta neutral. I like to keep things simple, so I've only looked to trade all options when doing the M3.

If you don't mind just to clarify:

1. After establishing the initial butterfly spread, are you purchasing 1 IWM call (40,50,60) points out of the money or whatever as a proxy for the stock?

2. let's say the initial spread looks something like this:

1050 (buy 1)
1100 (sell 2)
1150 (buy 1)

And now the Russel takes a 30 (or 40, or 50) point drop to 1070~.

Do you wait until it drops below 1050 to roll down, or are you rolling down now because it dropped more than 20 points below your middle strike?

And, if and when you do roll down do you also purchase another IWM call at the same time? Roll down your first IWM call? Or let it stand?

Thanks

I'm purchasing 1 IWM call that is DEEP in the money.

This is the most recent trade I made, which I closed out yesterday for full profit (a little over $500 including commissions).

Opening day = September 15, 2014 (I broke the M3 rule about buying around 50 days out...I believe there were about 30 days to expiration when I got into this trade, but that's because I held my September trade much longer than I should, and I didn't even think about opening the October trade, which I probably should have done...but I've gotten away with breaking this rule in the past...when you break this rule, you're basically giving up all chance to adjust if something goes very wrong to the downside especially).

Bought 1 RUT Oct 18 2014 1170.0 Put @ 37.63
Sold 2 RUT Oct 18 2014 1120.0 Put @ 15.99
Bought 1 RUT Oct 18 2014 1070.0 Put @ 6.35

Bought 1 IWM Oct 18 2014 107.0 Call @ 7.42

As you can see, the 1 IWM call I bought was well in-the-money, as it was trading around 114 on September 15, when I bought the 107 call.

I exited on September 26:

Sold 1 RUT Oct 18 2014 1170.0 Put @ 56.54
Bought 2 RUT Oct 18 2014 1120.0 Put @ 21.3
Sold 1 RUT Oct 18 2014 1070.0 Put @ 6.56

Sold 1 IWM Oct 18 2014 107.0 Call @ 4.58

Profit was about $518 including commissions (commissions were a little under $50 roundtrip...like I said, commissions aren't very good on TDAmeritrade...$9.99 per trade plus $.75 per option. So in the above trade, each side costs $23.73...$9.99+$3 for the butterfly, and $9.99+$.75 for the IWM call).

As for your downside adjustment example, I would wait until it gets to 1030 before I roll down 20 points...of course, if this happens late in the game, you're likely just going to exit the trade at a $500 loss instead of rolling down. That's the reason for getting in 50 days prior to expiration...you have time to adjust in case things go south early on...

As for what to do with the call when you roll down, it all depends on what the trade looks like after you roll down the butterfly...will the existing call be enough to have a comfortable delta with the new butterfly? Or will you need to add another call? Or will you sell the existing call and purchase a new one?

I've never had to do this yet to the downside...the last time I remember having to roll to the upside, I was able to keep the IWM call as is...despite rolling up 40 points instead of the recommended 20 points, and that's because I must have held on a bit longer than I should have...I use the rules as a general guideline, but I also pay attention to the overall market and the daily charts to determine how risky it might be to break certain rules...

I misspoke. Deep in the money is what I meant.

At IB (unless I'm reading things wrong) this trade would have cost around $7 to $10 round trip. But there is also this:

$10,000 minimum to open most accounts
$30 per month minimum commission requirement to avoid $10 monthly fee (rises to $20 monthly if account balance is less than $2,000)
$10 monthly for market data feed (waived if trade commissions are more than $30 per month)

If you only did the one trade per month, the total cost (including inactivity fees) would be around $30, which is still less than the $47 at Ameritrade.

However, something else to consider is that you have the Thinkorswim software, which I believe is free with TD Ameritrade. This might be worth quite a bit, seeing as how OptionVue in conjunction with IB (they are cross compatible) is $125 a month.

Yes, commissions are a large chunk of profit when only trading 1 lot. Almost 10 percent...but once you move to a 2 lot, it becomes much less (5%)...and so on...

I've used IB in the past (not for a number of years), as well as TradeStation...probably time to take a look at their options platform and see if I can use it in place of Thinkorswim...I really like TOS for options though, which is why I haven't been motivated to look back to the other two brokers I've used in the past.

I edited the end of my previous post to address this. I've looked around, but I couldn't find Thinkorswim as a stand alone product. Apparently it only comes with TDAmeritrade now.

Friday call went from a low of 0.13 to a high of 1.39. Others had even bigger moves.

(If I knew how to post the chart I would.)

This is the chart for SPY on Friday.

You had a 1% move during the middle of the day. What strike price are you talking about?

http://i95.photobucket.com/albums/l1...pss5j0ixo9.png

[QUOTE=badcompany]This is the chart for SPY on Friday.

You had a 1% move during the middle of the day. What strike price are you talking about?

It was the 197 call.

It got up to about 198.40, thus, the 1.39.

Had you caught a nice chunk of the big up move, it was a good day. Of course, it's always easier after the race, as it assumes that you didn't bite on the two previous false breakouts earlier in the day, and that you didn't jump to the short side when the market started heading down.

My post had nothing to do with any of your assumptions. It was merely to confirm that 10-1 is possible on the last day of expiration, as I stated in a post last week. It was about leverage and that was my only intent if you read my previous posts.

Sorry for the confusion. I didn’t have it.

Three tough decision hurdles to jump, and you have to be right on all 3 to get the biggest pay-off. I doubt that even the most seasoned of investors could do it. The temptation to take down the smaller sure-wins would be too great.......

Just got into my October trade (Nov expiration):

Buy to Open 1 RUT NOV 22 2014 1140.0 Put Net Debit 49.34 -- -- 09:59:16 09/29/14

Sell to Open 2 RUT NOV 22 2014 1090.0 Put Net Debit 26.40 -- -- 09:59:16 09/29/14

Buy to Open 1 RUT NOV 22 2014 1040.0 Put Net Debit 13.36 -- -- 09:59:16 09/29/14

Buy to Open 1 IWM NOV 22 2014 108.0 Call Limit 4.73 -- -- 10:00:06 09/29/14

I'll update this thread with any adjustments and let everyone know how it goes...

What would happen (other than having to outlay a lot more money) if you bought, say a 55 strike IWM call for around $55.55. The extrinsic value being only .55¢ vis-a-vis the over $2 premium with the 108s?

If something cataclysmic happened and the Russell opened up 200 points down one morning, I'd be out a helluva lot more money if I decided to bail. That's for starters...

What would be the benefit of spending so much more for essentially similar protection to the upside?

Not sure really, but good point.

It was mentioned in this video, and that's where I got the idea.

http://optionstribe.com/2012/01/reco...rest-anderson/

Inactivity fees are waived for the first three months.

Snapshot of trade with vital statistics:

Probably wondering how the position fared on such a dismal day: