Ep 130: Understanding Profit (Risk Profile) Pictures for Stocks & Options

April 6th, 2017

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We're looking at the S&P.

Those of you that have been on the critical charts that have been with me for some time have been looking at the charts.

I've been positioning myself to be more bearish. That's because the market was stretched further.

There's a lot of news a lot of talk out there of:

  • why the markets are going up
  • why they're not going up
  • why they sell-off
  • why they're doing something else

All these news, the whole big picture behind them is they try to pinpoint an idea or a concept to one thing or another.

Example of The New Story For The Day

For example, pull up any news story for the day. You'll see something like this:

"Markets pull back as Fed fears."

They'll blame it on something. There might be the scenario when they are saying things like the Fed looked positive.

It's interesting how the news tries to push things one way or another. The thing is that we humans want to put the blame somewhere. We want to find a cause and effect. That's why we get attracted to TV shows on channels. It's because we're looking for a news catalyst.

We're looking for a reason. And the exciting thing is when you stop looking for a cause you tend to become a much better trader. That's when you start looking at more of the energy of what's going on behind the market.

You can see the futures are down about five points. I've been tweeting and chatting about this. The market since that election is a little bit overbought.

Look at the world markets:

This gives you an indication of what's to come probably the next day. Or how the rest of the world is trading. You start looking at these kinds of markets. The Hang Seng hasn't been opened yet. Neither has the DAX but Japan's markets already basically down. You could see that one is already open.

Looking at these markets and insights, it gives you some indication. Japan is selling off already at almost 1% the next day after our markets. This could be an indication that we could have some serious trouble over the next day or two. Again five points it's not major right now. And it doesn't mean we won't see a significant reversal just like we saw a reversal just now.

Triple Timeframe

Look at the triple timeframe right here. The one over on the left side is weekly. Then you have the daily, and then you have an hourly.

When you're looking at it, you have some resistance. We're stretched.

Think of it like a rubber band.

Then we have this little zoomed in the area right there. When you look at this again, there's our resistance. It keeps trying, and you notice that a few times it tried to get above that.

But it couldn't do it. And this time it tried to get above it. It wanted to go, but it couldn't do it. Look how it ended the day. That bar opened right under that little area, and then we closed right there at the lower level. It's fascinating how that reversal happens.

If you look at the day's action once we got too far stretched it couldn't do it. Just a couple hours take out of almost a full day's worth. Two hours can take away four hours worth of gains. It always works that way. It's exciting and fascinating.

Take a Look At The SPY Volume

You start looking at breaking apart what's going on here. Let's look at the ten minutes. You can see you got some volume coming in. But you can see that when you start comparing that significant volume coming in you knew this thing was tanking pretty good. And you nearly have double the amount compared to before.

How the day ends usually is what the next day follow-through. You're always watching the end of the day. That's not still the case. You're looking at the market, the bigger picture and price patterns.

Now we're getting into some exciting things. You got this 50-day again which could be the support. We can see that we had a massive reversal right here where we dip down and we tried to hold it. That's an exciting concept in the markets.

The other interesting one is this. It's working on this level. You have support. It's coming in, and there's resistance. It's trying to get into those levels, but it can't do it.

Because of that, it's staying under this. You see that we're starting to get some resistance and we're also creating a rounding area here. The bearish volume is picking up. This 50-day needs to hold. If it doesn't hold, and then we get under it, then you might see it drop under come in here and test this. And then roll back under there so that could happen as well.

I don't think this pullback will be significant when it comes. The main reason is that they're still hoping for the tax reform which as you know my take on that as well if they couldn't get the health care thing done that makes me think that they could get the tax thing done.

Even if they put a few amendments and there here and there that's not reform, that's just a little adjustment. For now, the market is going on hope. Maybe we'll get a 50 point pullback over the next week. It's possible we get to 2250 or even 2200. That would be an excellent buying opportunity.

I say that because now we're going to take out all these Ggines. That is roughly about four or five months worth of gain. It's pretty good. I like these kinds of things because it creates new chart patterns. It sets up new opportunities, and it creates more volatility. That gives you a chance for better setups. When the market is at these highs, you have to be very cautious as a trader. It's crucial especially once you start putting more and more money on the line.

Be very cautious about putting all of your eggs in that basket. It's crucial you're trading cautiously, you're always hedging so you're not making as much. But once the pullback calms at least, then it's something to where you're okay.

Well, we had a little bit of something. We had a little bit of consolidation and digestion. We have some digestion that way.

It's Time For Big Stocks

I've talked about this when I tweeted about this the day it broke out here. If you didn't catch this one check out my critical charts on twitter. That's my main stock chart account.

It's been doing well. Volume picking up and I would take profits in the strengths. I mean you can't be greedy when you had a run of about 50 points in just a few days.

That one also looks pretty good. That's the overall big picture market. As far as your trading plan which you want to do - be prepared.

We are extended over here. If you're looking at this, this was also your support level. Now we're breaking under there as well. That was your resistance level. I've talked about that.

Then you have long word upward level as well which is now pressing against it - the 50-day. It's all coming in there.

The question is:

  • Which way it's going to snap?

Look at the Bollinger Bands on the daily we're okay. As you look to the weekly, we're still a little bit stretched. If you look at the lower end on the Bollinger Band, we're right at 2200.

But with volatility, if that picks up, it might open up to about 2100. We'll see but similar to Brexit that stuff got bought out. Anyways time will tell.

You need to make a plan:

  • what are you going to do if the market keeps selling?
  • what are you going to do if the market starts heading upward?

That's the key - create a plan.

Getting Started With Options and Stock Profit Pictures

Today we're going to talk about how to read and understand options and stock profit pictures.

Disclaimer:

Anything that we discuss here is of course for educational purposes. It's not any recommendations to buy or sell any stock or options. It's for educational purposes. But we're going to take a look at understanding the options chain for the profit pictures. Then we'll take a look at the stock profit pictures as well.

I think it's essential to understand things visually. It's like you look at a dollar bill. You see that dollar sign. You know it real quick the value of it. If it's $10, $50, $100 you understand it quickly.

It's the same when it comes to drawings. If I did a smiley face you know, that's a smiley face. And it's easy to relate to a picture or a drawing. Some emotions go along with it. Some evaluations go along with it.

You don't have to read a sentence of emotions, and you don't have to evaluate it. You know precisely what it is. And that's what happens with profit pictures.

The thing is that you're merely looking at something and understand precisely what that means for your:

  • risk
  • reward
  • positions

That's the fantastic part behind profit pictures. That's what we're going to talk about today. I'm using the thinkorswim platform in this demonstration.

I'm going to put on some positions and explain to you these profit pictures. Also, I'll tell why they're so powerful. You can understand your position and your risk.

Look at a position (Apple) and analyze 500 shares. The way that I did this is by getting in my trade panel.

I'll right-click, and I'll buy the shares on the last price. This will pop out an order entry, and from here I can analyze the trade (the right click).

As I analyze the trade, it takes me to this risk profile area under the analyze tab. First, if you're in the trade area, you can go to the analyze tab and then risk profile.

If you're somewhere else (in the trade tab or the monitor tab) go to the analyze tab and go to the risk profile tab. You should see it right there.

Now when you look at this profit picture, it tells you a lot about this position. Of course, If you understand the graph.

It's just like in grade school. It's all about just learning how to read a graph. If you didn't pay attention to math class pay attention real quick right here. Here at the bottom, this is our x-axis.

And this is our strike price of the stock. If the stock price gets to 110, that's the price that you would be would. Maybe you're at 130, 140, 150, 160.

Pay attention: Stock price is on the bottom.

On the left side, this is our profit or loss. The zero-line is the axis right in the middle. Anything above that line is a positive profit that you make. And anything below that is a negative amount that you lose.

Take your pick. If I bought this stock at 143, 55 and then I run up to exactly where it is I'm at the zero-line. It's effortless.

Zero profit and loss - 143,55. That's that dotted line right there.

If that stock price drops to 130, I draw this line to the upside see where it connects to that white line. That white line is my position and goes all the way over to this left side. That's how much profit or loss I would make.

You could see right here it's negative $6,800.

If the stock price dropped to 120, I'd be losing about $11,700.

And the same thing is right to the upside. If the stock price goes to 150, I'm making $3288. There is another scenario if I go to 160. Then I make $8329 and so on. As I roll my mouse, you can see that profit and loss changes.

Quick Question:

  • Why does it change as I move my mouse?

Well, that's because of our Delta. And if you don't understand Delta, this is all where you get into the Greeks. For many people, Greek is very confusing.

To simplify this real quick: The Delta is all you're going to have in stock, In options, you'll have Gamma, Theta, Vega and the Delta. You'll have those additional factors.

But in stock, you have a delta. Right now we have 500 Delta because we have 500 shares. That means for every $1 move the stock makes to the upside I make 500. For every $1 move it makes to the downside, I lose 500. That's because I'm a positive 500 Delta. If I were a negative 500 Delta, I'd be making money as it goes down.

You'll see here in a second how this works. If I offset this and let's say we add $1 to our position you can see this dotted line.

The axes and the numbers haven't changed. I'm zooming right into it. Now I went up one dollar, so the red tick is the current price. That's the price right there that I'm paying. But because I offset it by one dollar, I make $500.

Why is that?

Well, that's because it's up to $1.00 and I have 500 shares because my Delta is 500. I hope that makes sense.

In this scenario, I had 250 shares. Well, you can see that the graph dropped. And if I went up to $1, I would have made $250 only because I only had 250 shares.

The more shares that you buy you can make more money. That's what most people want to do.

The steepness of this curve changes. If I had only 122 shares, you could see the steepness of that curve. The angle of elevation changes. It's not an angle like this big - like a 45-degree angle or a 60-degree angle.

The angle now becomes smaller. I have 122 shares, and I only make for every $1 that stock goes up I make $122.

If it only goes up a little bit, I make $74. It's a bit tough to calculate but basically if it's not a full dollar you can make $74,42. That's because my Delta is 122. So I need it for every one whole dollar I make a $122. But if it didn't go up a full dollar, I made whatever that amount is.

We can go back, and we do one full dollar, and I go in and do 1,000 shares. You can see I make $1000 because the angle of elevation is higher. If I do $2 this graph shifts and I make $2,000. That's because the price moved up.

Now, what happens if it goes down?

Well, let's go back to zero first. If it's zero and it didn't move, you're at zero.

Maybe it's a negative one. Then you lose $1,000. If it's at negative two, you lose $2,000 and so forth.

Anyways it's the baseline behind looking at a general profit picture and overlaying your position. When you see this, it allows you to evaluate what your position is.

Let's say you're short. Here I'm negative 300 shares short of Apple. Right now I'm adding negative 300 Delta because I'm negative 300 shares.

  • What does that mean?

That means I want the price to go down. The reason is that I'm a negative Delta price. Delta refers to price. This right here if it goes down one dollar I make $300.

Quick Note:

In this case $288 due to commission's and borrowing the shares and so on but it's $300. That's because of the Delta.

If it went up a dollar, I lose that $300. Here it's $312 again due to the bid-ask spread and so on.

That's because if it's back at zero you down $12. If I do positive $2 meaning if you're short 300 shares and the stock goes up to $2 you're down 612$. You're short 300 shares. If you were short 400 shares, you'd be down $800.

People are looking to make more from this because of buying more and more shares. That's how they hope to leverage up.

When you're short, and the stock goes down in this case that's where you make money. Look at a profit picture. If we go down $1 with a negative $500 Delta, you'll be up or in positive territory of about $500. If the stock goes down $2 and I'm short 500 shares you're almost profitable about $1,000.

Pro tip: It's powerful to look at a profit picture and understand your position.

Maybe you're positive 500 shares. Reloop this back to zero - let's negate all this. You could see how nice this is. Right now as I'm looking at it, it's easy to see my position.

Here's where the advance strategy starts to come in. Once you get into options, you can do plenty of strategies within options. I'm not going to go in detail with all of this. But I'll give you a quick little rundown.

Let's say I'm going to position myself — this position I have to the upside. I want to sell some basic calls from Apple.

I'll sell:

  • a single
  • about five contracts

Then we analyze the trade. Here this becomes a little more complicated. The reason it becomes a bit more complicated is that you have time value and time decay. With that, you get this Gamma, Theta, and Vega.

Let me simplify this: Delta and Gamma are price risks. Theta is time risk, and Vega is volatility risk.

When it comes to a stock:

  1. you don't have Gamma
  2. you don't have time decay
  3. you don't have volatility problems

Technically you don't have volatility problems because it doesn't affect the stock on the options side. However, you still do have volatility if it starts selling off. But in general, you don't.

When it comes to an option, you do have the Gamma, Theta and the Vega. There's also row which is interest rates, but that one's not necessary to watch.

Theta is the amount of time value that you make. Let's get rid of the stock. Here I'm selling the calls. If I sold the calls alone, they would be considered naked. But since I do have the stock, it's okay.

General Discussion - Volatility, Delta, Profits

Let's use this example as a general discussion. Here if that stock doesn't reach 155 by the end of that term (May 2017), I make $12 every single day. And as time moves forward that white line which is the current line gets closer to the green line.

I still have my Delta here, and I also make negative. I make $42 when that stock goes down. That's the case because I'm selling the calls. And I also make money from the volatility. If the volatility also drops because I'm negative volatility.

This can be confusing. Bear with me here for a second. We're going to put it together, and you can see how learning about profit pictures you don't need to understand all of the positions on hand. But you'll be able to see your significant portfolio easily.

The profit picture tells you that you want the stock ultimately to go down. You make money when this stock goes down or stays below this 156 price level. The zero-line is there. That's what you want.

You want that stock to either go down or stay in that range. When I put the stock together in a stock position, you want it to go up. I am combining these two from a stock position I want this to go up. However, from the option position, I don't want it to go up too much because I also collect option premium. In this case $345 at the end of the expiration that you can see at the lower left.

Putting them together this is why at this price point when you put the stock and the option together you max out. You max out your profits at $6070, and that is because you're selling some option contracts.

If you had only the stock and the stock continued to go, you could make $18,000 or $27,000.

In our case, we're selling some options right here are five contracts because we can only sell five. Because one contract is 100 shares of control. And since we're selling or buying 500 shares of stock, we can only sell five contracts. So putting them together I'm capped out and maxed out right there at the 155. And even if it goes to 190, I don't make anymore.

Now you could technically do three or two. Sell just two option contracts, and you could do that. What that does is you can see the curve how it changes. It changes and reduces your curve. Look when I start going from five I flatten myself out at the 155 level and max out my profit at $6070.

But if I go to four, that curve can still keep going.

However, it's slower. Look at the angle of elevation right here. The angle is much greater than the angle right there.

The steepness is a lot smaller because of the change of that angle. We were only doing one additional hundred shares. By then 400 of my shares would be gone at the 155.

The reason is that I'm selling the calls. If I did a three, I could increase my angle of elevation. Then I'm getting more and more stock position to the upside. But on the flip side if I want a little more downside room and protection I could stack more contracts.

I could even do it to the point where I'm stacking a lot more contracts. Let's say I stack 30 contracts on the call side to hedge my position. Now if this stock pulls back even to the 140, I'm okay. The main reason is that I'm compensating enough option contracts for a potential downside move. You could see what happens here.

Whereas in this situation if I only had the stock. And I had the stock just sitting there you make $0.

This is what's all about:

  • The stock didn't move - you make $0
  • The stock goes up - you're making money
  • The stock goes down - you're losing money

And you continue to lose 500 Delta. The stock goes down about a point you lose about $500.

With our negative 30 contracts that are only 255 Delta. With negative 255 Delta the difference between 500 negative 255 - well if you combine them you can see I'm still positive 244.

It allows me to create this cushion of additional space to hedge. The thing is it creates a hedging position. It also gives you that extra wiggle room. I'm not saying you need to be trading 30 contracts.

If you're brand, new 30 contracts might sound like a lot. Five hundred shares might seem like a lot. But as you continue to get bigger, you need to learn to protect your position.

Here's the cool part about this: Remember when you hold stock, you're not making any money if that stock stand still. Once you have 30 contracts in 30 positions on this and you have 500 shares - then you're trading a pretty good-sized account.

When you have a little more capital, you're making $70 a day when that's just standing still. We can expand and zoom into this curve. You can see how day-by-day as this stock doesn't move that white line (which is today's line) and I'm shifting the date (a few days later) you're up already $600.

What if Apple goes up a buck and comes back a little bit. Goes up another dollar and comes back a little bit.

Then maybe does a significant drop to 145 again and then goes back. And then at least by then, you're 148. You're still up $500-$600 roughly.

I mean, of course, volatility and the time plays a role. But as that white line continues to get closer at the end of the day even if the stock barely moves you're making $3850. That's at the end of the month. And if it doesn't move.

If you had a stock position, you're only making when you compare it. At this price point (147) you're making $3,800. Or in a few days, you're making $1145. But in a stock position at 147, you're only making $1,700. Now granted you can make a lot more if the stock goes up. However, we know stocks don't go up all the time.

That's why when you create these positions you're looking at what's the profit picture telling me. Stocks don't go straight up. They don't go straight down. They don't go straight up.

Things You Can See on Profit Pictures

It gives you an opportunity of looking at pictures to see things quickly.

You'll see:

  • What does that picture tell you?
  • Where are you profitable?
  • Where are you losing?

In this picture, I'm losing areas in red.

Where're my winners?

Well, I'm winning anytime I'm between here and this range (green area). My price point is 140 to 158. That's pretty good.

I mean when you look at probabilities of the price movement you can see this picture right away.

Focus on this:

  1. Where're your profits?
  2. Where're your losses?

If I look at it just the stock you need to see where are you profitable and where are you losing.

You can go and start to create some additional trades.

Do some Amazon and put on a calendar. This one works a little bit differently. Looking at the picture you don't even have to understand what exactly it does. You only need to know where are you profitable and where are you losing.

I'm losing between with a calendar of 9:10 my range is 862 to 970. So I'm profitable from that 862 to 970. My loss is anything outside of that range. Anything below about 855 or anything above 970. That's a nice setup or profit picture.

Let's do another one - a vertical. If we bought a vertical, this is the scenario. Let's spread this out - choose 910. You can see where you are winning and losing.

A vertical on the 910 to a 930 on Amazon. Anything below about 920 I'm at a loss. Anything above 920 I'm profitable - it's pretty easy to see that profit picture. Once you look at the pictures, you get good at it. And you get to see your position. You can tell how much Delta you have.

You see the Delta, the price, the theta, the Vega. If you got a position and let's say you're stacking 30 contracts.

Here or it could also be with stock. It doesn't matter what it is. But you got a pretty good size Delta. Even if it's let's say 300 doesn't matter what the number is. If you have an ideal position on there to the upside down days like the last couple of days could wipe you out.

That's the case especially if you're new to trading. Because you're stacking 3000 on that. If you go down a point or two right so looking at it, you're down about 24-25 grand.

Plus your Theta that you're also going to lose on a day-to-day basis. If you were trading stock the same thing, you're down a good amount.

Here're some questions you need to ask yourself:

  1. What do you need to do?
  2. What do you need to learn?

Well, you need to learn how you can hedge. Looking at these profit pictures what can you do to reduce that Delta. Well, let's say you short some shares.

I sell some Amazon shares, analyzed and here my Delta is 2860. If you're shorting a thousand shares, it reduces your Delta by a thousand.

As you continue to increase that it goes by a hundred. Because you're shorting the stock, it's very easy to do that. You can now see how that position and the curve is changing.

Now, you get to see the way that your position is set up. You can see the profit picture. There is no need for you to short to a full zero Delta. All you need to do is take a look at the profit picture.

See where your profit picture is on a positive side and the negative side. Where are you making money? Well, this one's a little more tricky.

My real insight is between 920 and about 1010. And then I also have anything below the 810 range.

Then my downside or negative is anything between 810 and 920. Now, I need the stock to move. Doesn't matter which way it moves. I need it to move in a big way. That's another way to look at this these profit pictures.

Things You Can Do To Improve Your Strategies

You can be very creative with strategies. That's true especially as you put on options and many other things. And as you start digging deeper into searching for option profit pictures. It's easy to see what they do.

When you start looking at some of these, you can see this one.

This is a profitable upside right here. And your risk is to the downside below this 93 level.

If you look at this one on the right, you're making money when the stock goes down. You're not making money when the stock stands still or goes to the upside.

There are all kinds of profit pictures. You can see there are all kinds of options spread. In some scenarios you want the stock to go down and not to go up.

Sometimes you want the stock to go to the upside because there's your zero-line. There are all kinds of pictures. You can come across a straddle as well.

If that is the case, you want the stock to move either up or down. It works in both directions. The problem is you have significant time decay.

There's a short straddle as well. Here you want it to stand still. You don't want it to move.

As you can see, they're all kinds of different profit pictures.

Next, there are three leg options spreads. You can see a back ratio or ratio spread. In that case, you want the stock to go down or even pull back just slightly. That way you could get in the peak, but you don't want it to go up too much.

Anyways, you can be very creative with these strategies. The more you do these and start looking at profit pictures it allows you to see what's possible out there. That's what you're trying to do.

You'll be able to be more flexible if you are good at this:

  1. understanding the profit pictures
  2. understanding how to manipulate your positions

The downside is you need capital. And more capital to be able to hedge and make adjustments. If you're trading with less than one $100,000 account, it becomes difficult to build creative strategies and modifications and play with your positions.

Once you start getting into larger accounts, it's a lot easier to manipulate these things and play with them.

Maybe you're trading a smaller account - less than $5,000-$20,000. And you're trying to fix things. Frequently I find the better approach. It's a whole different ballgame. The better approach is to take a third of your shares off.

If you're trading 50 shares, you take 20 shares off. In the strength or reduce it to your risk. It's the way that you can hedge and modify your positions and looking at the profit pictures is entirely different.

That's some quick insight as far as money management goes. It's tougher to manage smaller account than a more extensive account. The main reason is that you have less flexibility. You don't have the capability of doing more things.

Quick Example: 

When it comes to account size, this is how things work. It's like walking into a bank with $50. They're not going to give you free checking in, and a free credit card. But if you walk in with $50,000,000, they'll give you a free safety deposit box, free checking, a backrub and everything else that you want.

Our capitalist industry itself is set up to focus and benefit the rich. If you're poor, you get some subsidies here and there. But in general, if you walk into a bank and you don't have the money you're going to pay a lot of fees.

If you have a credit card and you don't pay your debt, you're going to have a lot of fees. We're talking about 18% to 25%. If you have a lot of money, you'll be able to pay off your credit card. Or you're paying things on your debit card. You're not worried about those things. You have collateral.

Final Word

That's a fundamental insight to profit pictures. You've learned how to read and understand options and stock profit pictures.

Also, you've seen how profit pictures work for stocks and options. Besides that, you've learned how to evaluate and analyze them as well.

Author: Sasha Evdakov

Sasha is the creator of the Tradersfly and Rise2Learn. He focuses on high-level education speaking at events, writing books, and publishing video courses on business development, internet marketing, finance, and personal growth.

I'm Sasha, an educational entrepreneur and a stock trader. In addition to running my own online businesses, I also enjoy trading stocks and helping the individual investor understand the stock market. Let me share with you some techniques & concepts that I used over the last 10+ years to give you that edge in the market. Learn More

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