Last week's article addressed a question subscribers frequently ask writers on the site: Which charts do we use? When deciding on a price chart and the indicators or oscillators you'll use, the combinations are nearly as flexible--or complex--as the strategies you can compose with options.
As is always a theme with decisions about options trading, no single best or worst choice exists. Last week's article discussed the needs of traders who employ directional strategies in options, particularly those who trade short time frames. However, if you trade delta-neutral complex options trades and don't know a thing about technical analysis, you probably care as much about the ability to chart implied probabilities as you do the price of the underlying. You may want only the most basic of price charting capabilities. You may want the ability to draw a trendline or look at one or two key moving averages. You may want to determine whether implied volatilities are in the high or low end of the range for last few months or year. Above that, you may not ask much of a price chart.
You may be much more interested in another type of chart, however, a risk-analysis or profit-loss chart. In my own trading, I chart all my positions on a risk-analysis or profit-loss chart. I watch those charts as much or more often than I do a price chart.
What are such charts and where can the trader obtain them? Imagine that on September 9, with GIS at $36.25, I decided to enter a 1-contract OCT10/JAN11 put calendar for $1.05. This is not a trade I entered, nor is it a trade recommendation. I just picked something at random to throw on the charts. I was envisioning a long-term calendar trade, in which the sold put would be rolled out each month when the time value shrank.
Your brokerage may provide these types of charts, with some sources more flexible and easier to use than others.
Trade Calculator from OptionsXpress or BrokersXpress:
Unfortunately, I could not shrink this chart down enough to include the entire thing without making the information on the vertical and horizontal axes illegible. On the brokerage site, the profit-loss chart of course does extend fully on both sides. The blue line indicates potential profit and loss, if volatility remains stable, at the expiration of the sold October option. The green line indicates the theoretical profit-loss values as of September 23, two weeks after the chart was snapped. The zero line that marks the difference between profit and loss is difficult to see in this snapshot, but much clearer on the page. This chart offers a theoretical maximum profit of about $6.00 on September 23.
One caution arises. OX and BX offer two ways to change the date to view the green line, one via a slider on the page and one under "Chart Options." If one enters the date on the slider or the calendar just above it, the position shows all losses on September 23. So which is right, the chart produced above or the one via the slider?
I apologize in advance for the dark colors on the following TOS chart. I know some of you who like to print articles, but I could not manage to change the background color.
Risk Analysis Chart from Think-or-Swim for the same position, as of September 23:
The red line is the potential profit or loss at expiration, with the white line showing the theoretical profit or loss on September 23. TOS shows a maximum potential profit of about $10.00 on September 23. That's really not a big difference from the OX/BX chart shown previously, considering these are theoretical calculations, and OX and BX charge a minimum ticket charge, which is calculated into the profit-loss chart. So, it seems that the pictured OX/BX chart is the correct one, not the all-losses version I obtained via the slider.
Although I can't show the subscription-based charting system I use for my trades, it shows a potential profit line on September 23 that's similar to the two shown here, just a couple of dollars higher than TOS's. It is set up to include commissions based on TOS's commission structure.
Let's try another such charting system, from the freeware OptionsOracle. In this software, you can see the expiration chart or the theoretical "today" chart on a specific date, but you can't see both. I'll show the chart with theoretical profit and loss on September 23, the "today" line on the previous charts.
Risk Analysis Chart from OptionsOracle:
This software's theoretical calculations closely matches the theoretical ones shown on TOS and the other sources, although none are identical. This chart shows a potential theoretical maximum profit on September 23 of a little over $12.00, but no commissions are currently included. Obviously, some minor differences exist in the theoretical calculations made by the various charting systems, probably due to the option pricing models or assumptions the system may be using. The differences are not large, and may be mostly due to differences in the size of commissions and whether they were included or excluded. In each case traders can learn much from following trades from inception to completion on these types of charts, investigating the effects of various adjustments.
All of these charting systems allow for at least one additional input: a change in volatility. Some allow more inputs. For example, TOS allows traders to change the volatility estimate on each individual option, especially useful with options of two different expiration cycles. I don't believe either of the others allows IV adjustments for individual options.
Other profit-loss or risk-analysis charting choices exist, and I suspect others will come on the market soon. As you can see from my own examples, some are free and some require fees and subscriptions. I believe that anyone who is trading complex options strategies should be setting their trades up on some form of profit-loss chart and then inputting several variables to see how the trade performs. Much can be learned about when an adjustment might be needed, when the trade can be expected to be profitable, when the losses are going to start accumulating sharply, and other such important matters.
But do you need to pay huge subscription fees? Those who are TOS clients certainly may not need to do so although subscription software sources may provide more backtesting abilities.
These last two articles have discussed what I've termed both price charts and risk-analysis charts. If you have limited monies to pay for charts or charts, should those monies be allocated to one or the other type of charting system or split between the two? I'm sorting through these decisions myself. Because of the type of trading I do, I've been scaling down what I pay for regular price charts and scaling up what I pay for profit-loss charts such as these. Such decisions are best made by each trader with that trader's specific needs in mind. If you don't want to pay for such charts, I would first experiment with whatever version your brokerage might have available, if it has such perks. If not, search for a freeware or inexpensive source, and see if that meets your needs. You may eventually elect to pay for the latest and greatest, whatever that happens to be at the time, or you may elect to split your monies between the two types of charts.