Disclaimer:
The features and tools demonstrated in this video reflect the TradeSmith platform as of the recording date. Please note that our software is continuously updated to enhance your experience. The current site may appear differently.
Slide 1: Introduction
Hi everyone! I’m Marina Stroud, and on behalf of our Education Team—myself and Kristin Magenst—I’m thrilled to welcome you. Together, we’ll be your guides as we explore the world of data-driven investing and help you make the most of the tools available through TradeSmith.
Today, we’re shining the spotlight on one of our most powerful resources: TradeSmith’s T-Line tool, also known as the Fair Value tool. This innovative feature is designed to help you identify opportunities to boost potential profits while managing risk—especially in your options trades.
And for today’s special segment, you’ll hear directly from Michael Carr, our Chief Quantitative Strategist. For years, individual investors lacked access to tools that could pinpoint when an options contract was mispriced—but now, the T-Line makes that possible.
So, let’s dive in and see how this tool can transform the way you trade.
Hello, Mike!
[Mike says his hellos]
Slide 2: Disclaimer
This information is for educational purposes only. We are not financial advisers and cannot provide individual investment advice. Any performance results shown in this presentation are backtested and do not represent the performance of any actual investment.
Slide 3: Finding True Value with the T-Line
Slide 4: The Problem We Want to Address
Slide 5: Our Answer
Slide 6: Decision Support Tool
Slide 7: The T-Line Tool
Slide 8: The T-Line Tool
Slide 9: Instead of Arb, Use to Find the Best Strategy
Slide 10: T-Line Shows Fair Value
Slide 11: Using Fair Value
Slide 12: Example of Overvalued Options
Slide 13: Example of Undervalued Options
Slide 14: Example of Arb Opportunity
Slide 15: Start with an Opinion: Bullish XLE
Note: The Seasonality graph displayed in the slide is available with a Trade Cycles subscription.
Slide 16: Calls are Generally Overvalued
Slide 17: ITM Puts: Overvalued; OTM Puts: Undervalued
Slide 18: Based on What Fair Value Shows
Slide 19: Short-Term Bearish on TSLA
Note: The Seasonality graph displayed in the slide is available with a Trade Cycles subscription.
Slide 20: Pattern Statistics
Note: The Seasonality features displayed in the slide is available with a Trade Cycles subscription.
Slide 21: TSLA Calls are Overvalued
Slide 22: Puts are also Overvalued
Slide 23: I'm Bearish
Slide 24: Trade Builder Agrees
Slide 25: T-Line led to the Trade Builder
Slide 26: Additional Information Needs to be Reviewed
Slide 27: Trade Builder
Slide 28: Applying Fair Value: Bullish
Slide 29: Applying Fair Value: Bearish
Slide 30: Applying Fair Value: Short-Term
Slide 31: Applying Fair Value: Long-Term
Slide 32: What to Expect
Slide 33: Fair Value and Trade Builder
Live Q&A:
Disclaimer:
This Q&A transcript has been generated from a live webinar recording. It may contain minor grammatical errors or variations in punctuation due to the real-time nature of the audio transcription. The content has not been edited for grammatical accuracy.
Cesar: How do you decide which one to pick?
Mike: So this is a chart to QQQ. These are options expiring today, and I'm looking at this and I'm not going to pick any of them.
There's no clear trend on the overpricing or underpricing, which means market makers don't have a firm opinion on pricing.
So this is Calls. I'm going to click over to Puts here.
I see that they are consistently overpriced, but it's in the money that is grossly overpriced. I can make money on these, but generally, it's not a good idea to sell puts that are in the money because even though you can make money, it's hard.
You're going to have to either close the trade of the profit before the open or pay a lot of attention. If you go too far in the money, you may get exercised a lot and doing that has a lot of risks.
So I'm looking here out of the money. I'm seeing that $.30, $0.57. The strikes aren't far enough apart. I'm looking here at QQQ. There's no trade right now, but it's 11:15 a.m. Eastern now.
If you think about volatility, there's a volatility smile throughout the day. So at the end and the beginning of the day, volatility is high, and in the middle of the day, volatility is low. That's the volatility smile.
You're not going to find a lot of opportunities around lunchtime in New York, so this is not unexpected. I can look out to find a better example. I go out to Friday, I'm bullish.
These are Friday Puts in QQQ. Still, I see that the out-of-the-money puts look pretty enticing. The calls are also overvalued.
I'm bullish. I don't want to have anything to do with overvalued calls. So I want to sell a put, and I'm going to come here, and I have today, which is Tuesday.
I have a lot of time to expiration. I want to go a little bit out of the money.
We're at about $600, it looks like those options are trading at a significant premium, and that would be my trade here. I sell a $600 or below put on QQQ based on what I'm seeing.
Innocent: When there is a RED put option signaling a sell opportunity. Is there an expectation that the market will correct?
Mike: The options pricing isn't generally showing you the expectation like that. That's why you need the other indicators. So, just because the option is overvalued does not mean the market makers are expecting a correction, or undervalued does not mean they're expecting a correction. Remember, they're generally going to be overvalued because the option maker is treating it like an insurance product and they're selling insurance.
So that's why it's a decision support tool, not an indicator. We have not been able to find a relationship between fair value, actual value, and future market performance. So, we're still testing that but we don't have anything yet.
Robert: You're showing a particular expiry date, does the software scan multiple option expiries to find the particular option expiry that is overvalued or undervalued?
Mike: In Trade Builder, it does. Here on the screen, you just have to go through and look strike by strike, or I'm sorry, expiration date by expiration date to find what you want to see in the chart. But when you use Trade Builder, you select short term, medium term, long term. I forget what we called it. I think intermediate term. And it scans multiple contracts and multiple expiration dates to give you the best trade given those inputs.
Derrick: So what I’m understanding is this t-line works most accurately with short term options on week expiration same day expiration?
Mike: Those are the examples that I showed. But you can certainly use it longer term, and it's exactly the same. So here's QQQ. I want to go up to January 2028. Here are the puts:
Here are the calls:
Generally overpriced. This is telling me if I want to buy a long-term call or put on QQQ, I'm going to need a very large move in order to overcome the valuation. Now, I may find better-situated options.
If I don't go out so far, let's go out maybe six months to March, and it's closer. Calls, puts, the extreme overvaluation is going to be common because, remember, there's insurance.
So, I know that a lot of times, someone would like to buy long-term options as a proxy for the stock. These charts show the hurdle that you're facing when you do that. You're going to need a big move in the stock, and you're going to have to overcome the gap between fair value and the actual value of the option.
So, you're going to find more trading opportunity is in the short term. In the long term, you'll find opportunities from time to time, but you're consistently going to see this overvaluation.
Cesar: Does the system tell you at point which one is the best trade, including which stock? Or do you have to search ticker hy ticker?
Mike: You can use the screener to find the best stocks, and under the options screener, you can screen for overvalued or undervalued opportunities, so you'll be able to go in there and pick the different criteria that you want right there in the options screener and Marina that's probably a good walkthrough for you to schedule using the options screener with the line.
Walter: Where do I find the chart?
To access the T-Line or Fair Value graph, go to your Dashboard and scroll down to the Fair Value widget:
You can also search for a ticker on the upper right of your program site. The site will route you to the Asset Details page. To review the T-Line or Fair Value graph, go to the Options tab and select the Fair Value button.
Bala: What role does time play in this? Is this chart good to trade if it is 3 hours before close?
Mike: So the question was the factor of time that's going to be your preference. So I have found this to be that last hour. Volatility is high. I have a directional bias going into that last hour. There are different things that I use. I found that to be my personal sweet spot.
If you're looking out a couple of weeks again, you're going to have the charts to help you there too, because you can go and change the dates here. So the charts work on any time frame. They show you what's happening. So if you want to go out a couple of weeks at the end of October, the chart comes up for you. These charts are going to be especially helpful when we have a big market move. I'm not saying the markets are going to crash, but someday they will. I don't know when that day's going to be, and I'm going to be on these charts all day as the market is crashing, and the next day and the day after, as prices revert towards normal, that's when you're going to find these opportunities.
Orlando: Does the T-Line work for day trading or can it be use in different timeframes?
Mike: Absolutely, yeah.
Bala: If the T-line indicates that an option is underpriced, how much time does it take for it to move to the fair value?
Mike: It will move to fair value by expiration. That is the only rule we have in the options world. Mispriced things can't persist up until expiration.
Greg: If I want to buy Calls, how far out from the expiration date do I buy, and how do I know when to sell?
Mike: I think we have the Options master class available for those kinds of questions, don't we?
To access your Options Master Class, go to your Publications widget on your Dashboard:
Chris: Apologies if I missed an answer on this: Are these over/under- values typically represented within a bid-ask spread or outside of it? i.e., is a wide bid-ask one possible signal or limit of over/under-value?
Mike: No, so a wide bid spread is simply an indication of liquidity. It doesn't really have anything to do with the fair value. Market makers are setting that wide because there's not really a lot of demand for that particular option. They set that wide, and I know we want to read a lot into them, but it's actually just a market maker message that their inventory is not where they wanted to be for that particular trade. So they set the spread wide. If you want to go in at the midpoint, you know, usually it will be executed because they can make a profit trading to the midpoint of almost any spread. I know a lot of people look at the wide bid and say, "I don't want to trade that if you got the midpoint, and it's a liquid stock." A liquid stock being a member of the S&P 500, for example, you're going to be fine. It doesn't really matter what the spread is, just trade what you want to trade.
Anonymous: When you sell calls, do you typically buy to close when there's enough profit, or do you let them expire? Also, if there's no POP percentage, is it best to avoid that trade?
Mike: Yeah, so that's a great question, and that's a personal risk question. Should you take the profit when it's available, or do you let it go and squeeze out that last five cents? I mean, that's up to the person. Personally, I think just take the gain and move on to the next trade. But a lot of people don't want to do that. I think almost all brokers now let you close a position that's less than five cents for free.
So there's no reason to let it expire because the one in a million always hits once in a lifetime. It costs you a lot of money, so that's that part of it.
If there's no POP percentage, is it best to avoid that trade?
No, it doesn't really mean anything if you don't see a POP. Brokers calculate POP differently. There are various formulas for it.
If the trade is recommended using just a standard Black-Scholes type model, the POP, the probability of profit on the Trade Builder recommended trades, is generally going to be 70% and higher, and that'll be just with the Black-Scholes model. Our website uses a slightly different version of that. It uses a different options pricing theory to find the POP.
So, if you look at your broker's offer of POP, you're generally going to see 70 and above on most trades from Trade Builder. most trades from Trade Builder.
Joe: I reference the ROI statistics when looking at the Options calendar/trade summary page. What is the relationship between T-line and ROI… if anything that is meaningful.
Mike: So ROI is going to be slightly higher for an undervalued option compared to an overvalued option. It is factored in.
Satya: Can I use covered call on my stocks to know a good option?
Mike: Yeah, absolutely. This can help you find covered calls. Let's say you were holding SPY and you wanted to sell a covered call. That's a great opportunity right now.
This is where it really can help you in the long run. These are calls expiring October 31. My definition of long-term may differ from yours, but I can look out here and see the $678, $6.00 fair value $3.50.
That's a great idea if you're looking at covered calls to use this and you know it's just decision support. Are you looking at selling a covered call? This is December where the gap is closed quite a bit.
So this can help you narrow in on your time frame.
Allan: What does POP tell of significance here?
Mike: POP is basically the probability that the option will expire worthless. So if you're selling an option, you would want a higher probability that it's going to expire worthless.
Drusilla: Previously Mike said left of the dash was in the money, right of the dash was out of money. Does that apply to calls only, and does it change for Puts?
Mike: So here's calls, and a call is going to be here.
It's in the money, meaning that the strike price is below the market price, and then you're out of the money to the opposite side, and then on Puts, it's reversed.
So a high-priced put here you were at $670ish on S&P. So the $715 put is in the money. Meaning if you were to buy that, you are right away in the money. That option would be worth about $45.
We want to be out of the money when we're selling puts. Unless you're a more advanced trader willing to do what needs to be done to capture those gains. I mean, there's a lot of mispricings in those in-the-money.It is worth paper trading that idea to get comfortable with it, but to learn how to close the trade, take that gain quickly and move on to the next one. next one.
David: Will T-Line recommendation trades be issued by Tradesmith?
Mike: We are working on something related to that question. We are working on a lot of that short term stuff.
David: I have a question about how you back tested the approach. Obviously, it is good to know how the model would have performed, but there is always a danger that the closer you tune formulas to fit past data, it's predictive value is diminished because future conditions will be different than past ones.
Mike: So when we do back testing. We use what I call "good enough statistics," and that's not a technical term. But what we're looking for is to avoid that overfitting problem that is so common.
So we do not overfit. We limit the number of variables very strictly. When we look at different parameters, we don't pick the spike parameter that performs the best. We look at where the average is of the different parameters, and we pick a value for our parameters that is near average.
Then we have, let's say, that we're testing a moving average. We test every value from 2 to 200. And let's say the 100-day has an average annual return of 130%. The 99-day has a loss. The 101-day has a loss.
Well, clearly, the 100-day is an anomaly. We don't want to use that. We calculate the average and we use the one that gives us the number of trades. We have a goal of a certain number of trades that we generally want to see for an indicator.
We don't want too many, we don't want too little, and we want the nearby values to be consistent with the parameter we're selecting.
So we have a lot of checks built into our backtesting to ensure we don't optimize, let alone overoptimize. Because I've been trading a long time now. I know that no matter what I test and build, the biggest drawdown's going to occur in the future, and I want to do all I can to minimize that risk.
And you know, to be honest, we use these tools. So we build them for what we want now. And hopefully, it's what you want. We know it's useful, but they're built, like I said, by traders for traders now.
Raza: What are guidelines for stop-loss on options? How much time should one give the trade before deciding the stop-loss (the idea is that time-premium is working in favor of the sellers of PUT option and longer one waits the more time premium is on the seller of the PUT option).
Mike: Yeah. So that's going to depend on what you're trading and your time frame. But generally, our research has shown once you get a 50% loss or so, your odds of recovery dropped dramatically.That's not a blanket 50% and you're out, and you can't place that stop loss in the market. If you place a stop loss order for an option in the market, the market makers' job is to fill orders. They may know it's a stop loss, but it's their job to fill it.
Pardon my language. Market makers exist to screw you. So if you put that order in, they will take the first chance they get to execute it and leave you with that loss. Then it's going to turn right around.
So don't put it in the market, but set up an alert, and then you can go in and manually work the trade going between the bid and the ask to get it filled. So I hope that helps.
Joe: Mike, what is your favorite Tradesmith screener or most frequently used feature?
Mike: So for me, it's Predictive Alpha. I know the accuracy of Predictive Alpha, and I just love that tool. We are constantly monitoring that tool.
We're trying to find ways to improve it. Right now, my theory is that if we can incorporate sentiment into Predictive Alpha, it'll do even better. So what we need to do is build something that analyzes the tone of text.
That's what we are working on today. Well, not solely what we're working on, we got a lot more things in the pipeline.
Lily: Does the T-Line work on leaps?
Mike: It does. It shows you the hurdle you're facing with leaps in most cases. So, be patient, look for the trades and understand that they're more generally going to be overvalued the further out in time you go.
So you want to find ways you can minimize that overvaluation. Don't just blindly buy a LEAP saying, "I love this stock.” I'm sure it's going to go up 20%. The premium might be 20%, and you're not going to make any money. This is a great visual to help you see the risk of leaps.
So be patient and use the tools to find the right one.
Cesar: Going very basic here - how do you start your day screening and looking for those options trades?
Mike: So I'm looking the last hour, generally, unless it's a Fed day, and then I'm looking thirty minutes before the Fed announcement and then again thirty minutes before the Powell conference. I use SPY and QQQ. I don't need to venture beyond SPY and QQQ, because we have so many services, and I don't necessarily know what they're going to recommend. But I'm not allowed to trade it if they recommend it, so SPY and QQQ are the safest for me. I know that doesn't help you, Caesar, but that's where my focus lies.
Slide 34: Contact Us
