The index trading course

430 Pages·2006·5.24 MB·English

by  George Fontanills, Tom Gentile

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The Index
Trading
Course
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Copyright © 2006 by George A. Fontanills, Tom Gentile, and Richard Cawood. All rights
reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
Fontanills, George A.
The index trading course / by George A. Fontanills and Tom Gentile ; with a
foreword by Frederic Ruffy.
p. cm.— (Wiley trading series)
Includes index.
ISBN-13 978-0-471-74597-6 (cloth)
ISBN-10 0-471-74597-9 (cloth)
1. Stock price indexes. 2. Stock options. 3. Stock price forecasting.
4. Stocks—Prices. I. Gentile, Tom, 1965- II. Title. III. Series.
HG4636.F65 2006
332.64'5—dc22
2006005660
Printed in the United States of America.
10 9 8 7 6 5 4 3 2 1
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Contents
Foreword ix
Acknowledgments xv
About the Authors xvii
CHAPTER 1 A Look Back 1
CHAPTER 2 The Index Market Today 11
CHAPTER 3 Trading the Market 29
CHAPTER 4 Understanding Options 47
CHAPTER 5 Basic Strategies Using Call Options 73
CHAPTER 6 Basic Strategies Using Put Options 93
CHAPTER 7 Complex and Advanced Strategies 111
CHAPTER 8 Catalysts 133
CHAPTER 9 System Trading 157
CHAPTER 10 Getting an Edge with Indicators 181
CHAPTER 11 Sector Trading 221
CHAPTER 12 Tracking and Trading Volatility 257
CHAPTER 13 Making Adjustments 287
CHAPTER 14 Risk Management 309
vii
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viii CONTENTS
CHAPTER 15 Important Index Facts and Strategies 327
CHAPTER 16 Getting Started 343
APPENDIX A Important Tables and Lists 357
APPENDIX B Focus on Technical Analysis 373
APPENDIX C Option Strategy Reviews 389
Index 403
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Foreword
Shortly after I heard George Fontanills and Tom Gentile speak at an
options trading course in the year 2000, I quickly realized that they
shared my passion for trading. At the time, the Internet boom was
going full throttle and this particular hotel conference room in Silicon Val-
ley was packed full of enthusiastic listeners. There being no empty seats, I
stood in the back, listening as well.
George Fontanills took the stage. After an introduction, he listed off
and explained various strategies that were working well in the volatile
markets of the time. Among the trades, he outlined a scenario for the NAS-
DAQ 100 Index Trust (QQQQ), or “Qs,” that had profit potential regardless
of directional bias. It made money whether the NASDAQ went higher or
lower. Since it happened just before the great tech wreck, a time when
even Aunt Mildred had her portfolio tilted towards high-technology stocks,
the trade suggestion proved extremely insightful at the time.
Prior to that, I had worked on an options trading desk of an institu-
tional firm in New York, so options were not new to me. However, some of
the strategies were. In a nutshell, Tom and George were taking advanced
concepts used by market makers on the options exchange trading floor
and presenting them in a format that individual investors could easily use
and understand. Many of these strategies involved stock options, but oth-
ers were applied to the index market. As an index trader, I found it fasci-
nating. I began working with their system, Optionetics, shortly thereafter.
Six years later, I was excited to hear about The Index Trading Course.
Although the bookstore shelves are lined with investment books, a quality
book about index options trading has clearly been missing. After reading
the first draft, I am convinced that Tom Gentile and George Fontanills have
put together another winner. I think the reader will come away with sev-
eral things from this book, and these are the same things I have been fortu-
nate enough to learn through my association with the authors.
ix
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x FOREWORD
First, options are one of the most versatile and exciting investment
vehicles today. I have traded funds, foreign exchange, stocks, futures, and
options on futures. Strategies using options on stocks and indexes have
become my favorite and most lucrative trading endeavors. In addition,
given the liquidity and the opportunities in the options market, I have little
doubt that options trading will remain one of the fastest growing areas of
the financial markets. In short, one of the first lessons is that the options
trading world is the place to be.
The second thing readers should come away understanding is that,
when trading options, there are strategies and rules. It pays to follow what
the gurus have already learned! We’ve all speculated at times, experi-
mented, placed bad bets, and eventually lost money. Why do we do this
when there are proven strategies that work? I guess it’s just human nature
to figure things out the hard way. In the financial markets, that can be an
expensive proposition. So, lesson two: I’ve learned that it pays to learn
from those who have been around the block a few more times than I have.
While options strategies and the associated rules can be learned
through study, investors today also have a lot of tools and information
that simply weren’t available when I first started trading. Unlike today, fi-
nancial television was not very helpful. Nobody used the Internet. At that
time, the only real source of information was the newspaper. I don’t know
what Tom and George used when they first started trading (smoke signals
and ticker machines maybe?). It was someplace far away from the here
and now that Internet access provides. Today, we are inundated with in-
formation from print, web sites, e-mails, and television. It can easily lead
to information overload (or “analysis paralysis,” as George likes to call it).
Victims of this malady spend too much time digesting information and not
enough time understanding the basic tools that help successful traders
make money over the long term—strategies, rules, and risk management.
Fortunately, another thing I learned is that you don’t have to know
and understand it all to make money. In fact, sometimes less is more. A
simple trading system with easy entry and exit rules can generate a lot
more money than spending hours each day watching TV and reading web
reports to figure out what is moving the market and why.
The key to a successful trading system, however, is in its develop-
ment—back-testing and evaluating what works and what doesn’t. Systems
have become the tools of choice for many traders because they are objec-
tive. A system follower adheres to a specific set of guidelines that leaves
no room for guesswork. Don’t get me wrong—we are not all system
traders. But understanding how systems are developed and why systems
work can help traders at any level. Tom Gentile has done a lot of work
with systems and he reveals some interesting trade secrets in this power-
ful book.
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Foreword xi
In that respect, traders today have another important advantage over
traders of the past: They have access to sophisticated software that allows
for system backtesting and development. Until recently, these programs
were available only to the big players—the large financial institutions and
funds. That is no longer the case. Software developers are creating great
trading programs that are within affordable price ranges. So another thing
I learned was to use the tools that are out there. It is certainly possible to
trade without the latest technology, but having it saves a lot of time and
exponentially increases the odds of success.
Good traders are also good risk managers. This is extremely impor-
tant, especially for new traders. You don’t have to be right all of the time
to make money. That’s something that I struggled with earlier in my trad-
ing career. I felt that being wrong about the direction of the market or on a
strategy meant that I was a bad trader. Today, I believe that good traders
are wrong just as much as bad traders. The difference is that they know
what to do when they’re wrong. If you plan on trading, understand that
you will be wrong at times, and know what to do when it happens. George
Fontanills once told me, “Before I take a trade, I always ask myself, ‘what
if I’m wrong?’ ”
This book takes George and Tom’s Optionetics philosophy and ap-
plies it to the index market. Index trading is quite different from trading
stocks. Obviously, the trading instrument is different. An index repre-
sents a basket of securities. It is more diversified and will behave differ-
ently, often with less volatility. In order to trade profitably over time, it
makes sense to understand the product you are trading. The Index
Trading Course provides the most comprehensive discussion of the in-
dex market to date.
Moreover, this book goes beyond simple explanations and provides
specific trades and money-making strategies for the index market. Many
trading books use an inordinate amount of space explaining strategies,
trading tools, and investment vehicles. This book goes to the next step
and shows readers how to trade successfully. It takes readers beyond the
theoretical aspects of index trading and into the real world where the seri-
ous index trader lives, breathes, and makes money.
Anyone who has watched the market for more than a few days
has probably used an index. For instance, a news reporter might
say, “The Dow is up 96 points and the NASDAQ is 21 points higher
on Wednesday.” The Dow and NASDAQ are market averages or indexes.
These powerful tools help make sense of what is happening in the stock
market and offer insight into whether more stocks are moving higher
or lower.
Traders can also use indexes to make money. Options on the S&P 500
Index ($SPX), the NASDAQ 100 Index Trust (QQQQ), and the Dow Jones
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xii FOREWORD
DIAMONDS (DIA) are some of the most popular instruments for trading
the market. They are exciting, fast-growing markets that can help in-
vestors build and protect wealth.
In order to successfully trade the market averages, however, traders
must develop a plan that often involves determining how the stock market
will perform and where the market averages will be in the future. In addi-
tion, index traders must ask questions like, will the market trade quietly or
will volatility spike higher? Is this a bull market or a bear market? Is the
current trend going to last or is there a chance of a reversal? Ultimately,
successful index trading requires a certain amount of skill and knowledge
that is not shared by many. It is a different set of skills when compared to
trading futures, stocks, or stock options.
The Index Trading Courseoffers specific tools for predicting market
moves, not just in the major averages like the Dow Jones Industrial Aver-
age and the NASDAQ, but also in specific sectors, industry groups, as well
as in individual stocks. The reader is also introduced to specific options
strategies that yield profits from these anticipated moves. So the book is
designed to help investors understand what indexes are, how they are
used, and, most importantly, how to make money with them.
In addition, since it is the fourth book in a series (following The Op-
tions Course, The Stock Market Course, and The Volatility Course), not
much space is given to the basics of the options market, the difference be-
tween puts and calls, or how options prices are calculated. There is some
mention of delta neutral strategies, the option Greeks, and complex
strategies like butterflies and backspreads. But the book primarily as-
sumes the reader has a rudimentary knowledge of options trading. In-
stead, it is more focused on trading the markets and how to make profits
with indexes.
However, while options are not covered in as much detail as their ear-
lier books, indexes and exchange-traded funds are discussed in depth.
During the past few years, a large number of new index products have
started trading. There are so many, in fact, that it’s impossible to track
them all. Consequently, several chapters in this book are dedicated to ex-
plaining the various index tools, as well as listing the ones that are worth-
while trading vehicles (not all of them are).
Various trading strategies are presented in Chapters 5 through 7. The
strategies include examples from the index market and include rules for
entry and exit. These “rules” have been developed from decades of experi-
ence in the options market and are well worth reading and adhering to.
Volatility is an especially important aspect of successfully trading the in-
dex markets because it has an important effect on option prices. In fact,
an entire chapter (Chapter 12) is dedicated to dissecting volatility in the
index market.
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Foreword xiii
Trading systems are becoming more possible as technology makes
system-building more readily available to smaller traders. A trading sys-
tem provides specific buy and sell signals that leave nothing to the imagi-
nation. We discuss system building, including examples of trading systems
and how to build them in Chapter 9. Risk management and trading rules
are key elements to any kind of trading system. Both topics are discussed
extensively throughout the text.
The myriad of ideas, indicators, and trading systems are included here
to give readers the tools to better trade the markets. A lot of it can be used
as reference material and to look at what has happened in the past, in or-
der to gauge what might happen in the future. There is no need to use all
of the indicators, strategies, and ideas. In fact, plenty of money can be
made using just one or two. Pick the ones that are right for you—the ones
that make sense.
Some approaches to the index market look at fundamentals, and
decisions are based on macroeconomic factors such as changes in in-
terest rates, overall levels of corporate profits, retail sales activity, and
energy prices. Geopolitical events such as elections, terrorism, and nat-
ural disasters can also affect the market. Other traders rely heavily on
charts and technical indicators. Still others use trading systems that are
based on very specific rules, and often leave the trading decisions to
computers. There is no right or wrong way to trade as long as the
method yields profits.
The final chapter is designed to empower the reader to actually
start trading. More experienced traders probably understand this infor-
mation already. However, new traders are encouraged to pay special at-
tention to this chapter. Trading in the index market is exciting, but it is
not without risk. For that reason, we encourage new traders to start
slowly and to move at their own pace. There is no reason to rush into
the market. Instead, spend time learning and test strategies that seem to
fit your trading style. Then practice them on paper before putting hard-
earned money on the line.
While George and Tom are confident that their students and readers
can achieve success over the long run, they are also aware of the pitfalls
that many new, inexperienced traders sometimes face. In that respect, in
addition to providing a detailed discussion about index trading, this book
is intended to be a shortcut along the options trading learning curve. It is
designed to teach winning strategies while avoiding the pitfalls and mis-
takes new traders often encounter.
I believe that it is never too early or too late to learn something. In
that respect, the cost of this book is a small price to pay for the number
of years of experience and research that have been put into writing its
pages. Without a doubt, I have learned a great deal from Tom Gentile,
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xiv FOREWORD
George Fontanills, and the other Optionetics instructors, as well as the
students. We all share the same goals of becoming even better traders
and developing solid financial security for our families. In these
respects, The Index Trading Course is certainly going to empower
those traders who wish to improve their skills and successfully trade in
the index market.
FREDERIC RUFFY
Senior Writer and Trading Strategist,
Optionetics