Options on Elliott

Ryan Sanden 06/16/2009

Part I: Options? Why?

Tools
Options trading Elliott Waves primarily involves three options trades: long calls/puts, vertical
spreads, and horizontal calendars.

Vertical Spreads:
Vertical spreads will be used most of the time. They are suitable for basic corrections as
well as most directional movement. They can also be used at any time the market appears to have
made an important turn but has not yet confidently confirmed this fact. They are also suitable
whenever you have cause for concern about the timing of a move since they contain a short
option that can help to eliminate time-decay risk.
Debit spreads (Bull calls / Bear puts) will be used in motive waves. They will be used
when we can identify price and time targets around which to structure a spread. For debit spreads,
we must achieve movement to make money. At the time these positions are entered, implied
volatility should be somewhat low just when it should be high and an increase in IV will help the
position.
Credit spreads (Bear calls / Bull Puts) will be used during corrections immediately after
impulsive waves are believed to be complete. At these times, implied volatility will be very high
just when it should be low and a decrease in IV will help the position.

Long Calls/Puts:
There will be times, when structuring a vertical debit spread, that the short option should
be placed extremely far away, such that it doesnt make sense to place it at all. A vertical spread
missing its short option is just a long call or put, and there are times when they are the right trade.
Long calls and puts are for motive impulsive waves. In these waves, movement is fast
and furious, generally outweighing any time decay experienced from buying a long option.
Furthermore, if the option is purchased near the beginning of an impulsive trend, implied
volatility will increase as well, helping the option further.

Horizontal Calendars:
Calendar spreads will be used for complex corrections (which are actually quite common).
Wave 4s, for this reason, are often a beast to trade. If youre in a corrective pattern waiting for
a termination likely to be weeks away, calendars are your tool. After all, with 13 types of
corrections, the ultimate type of corrective pattern that will unfold is likely only to be clear when
the correction has finally ended. In the meantime, money can be made with calendars as the
market bounces around in a corrective manner and without necessarily even having clearly-
defined range-bound support and resistance. So, when youre obviously in an unclear corrective
pattern, calendars become a very logical choice.
Stop Losses and Trade Adjustments
First, I want to apologize for a lengthy introduction to this section. It will sound like Im beating
about the bush. But Im about to explain a fundamental difference between trading futures (or
stocks) and trading options on them. Another trader whom I respect feels that trading options and
trading futures are equivalent, except that options involve time decay and are more complicated.
His trading method is very futures-based, and every trade has a close and defined stop loss. He
looks at options as nothing more than a way to acquire leverage, and argues that futures do the
same thing except a bit more efficiently. He says that if you position size accordingly, you
should have very little difference between trading futures and trading options.

I respect him and understand his position, but I cannot agree with his point of view. When I first
began STS education, I was interested by the idea of no stop losses, but then looked at trade
adjustments as just being an underhanded way to incorporate stop losses without really
admitting it. After all, if I enter a spread trade and then adjust it 5 times at a loss before making a
larger profit, how is that different than just entering 6 separate trades and adding the results to
show the same profit? I know several others feel the same way that I felt. I am going to answer
this question once and for all, definitively. Then, Im going to use that concept to explain why
the STS options-adjusting methodology is fundamentally sound. I will then incorporate it into a
fully developed trading system based on Elliott waves, and then conclude by writing up a
complete Trading Plan for use with this system.

Stop losses are a very controversial topic. As traders, we are incredibly dependent on effective
risk management for long-term profits. If you risk too much, you will go broke; end of story.

In life, we only have two forms of risk management: one is to use stop losses. The other is to use
options. They can even be used together, but I dont recommend it. Allow me to explain.

Please examine the following theoretical example.

Case 1:

Case 2:

In the first case, we sell (short) a top perfectly according to a reversal-confirmation bar signal
and cover it perfectly at a major bottom. We Sell Short on Jan 7, 2009 at 8770. We cover on Mar
6, 2009 at 6500 for a profit of $2,270 per contract.

In the second case, we are a bit early, although the actual selling price is quite good! In fact, it is
better than the selling price at #1. We Sell Short on Nov 28, 2008 at 8829. We cover on Mar 6,
2009 at 6500 for a profit of $2,329 per contract.
Case 1 looks really beautiful, but to futures traders it has a special gleam. Theres something
golden about selling short and the price never looking back. It means we didnt get stopped out.
We are generally willing to take a little less profit, any day, if it means we can avoid being
stopped out. Wonderful; print this trade in full color and hang it on your wall!

Case 2 has a significant problem, however. Lets again pretend we are trading futures. It is
highly likely that our stop will be somewhere near our entry price (or lower) by two or three days
after entry. The ensuing price action then stops us out near a high and we either make a little or
lose a little. We then look for another entry to sell short again. Such is the life of a futures trader.

Now, switch gears and pretend that we instead have a really stubborn futures trader. He sells
short as in Case 2 and decides not to place a stop loss. Why? Because he is sure that this market
is going DOWN. The day after entry, the market falls hard. 95% of stocks on all exchanges had
losses on the day. His position is three thousand dollars to the good, but theres a lot more to be
had. The bears are back! Then, the market rallies. Persistent rallies over the next three days push
his position into a loss. But thats OK, he thinks to himself, because this market is going
DOWN. Sure enough, hes back into a profit. Another rally, and again at a loss. Another decline,
and still profitable again. Ok, he thinks, this cant go on forever. What if Im wrong? If this
goes up, I could lose thousands per day. I have been in this trade for a full month now, and its
not making any money. Whats wrong? Our trader friend is beginning to feel reality, because
his risk is unlimited. How far does the market need to go up before he cant accept the loss any
more? He feels a little trapped, and quite nervous, even though hes showing a small profit. He
decides to take the wait and see approach. Almost immediately, the market begins to rally- and
rally persistently: a full week of solid gains, day after day! His position is showing a loss of just
under $1000 now. What if we really have put in a bottom? What if this is going up a lot more
before it goes down? People are buying this now; they believe in it!. Finally, on the morning
of Jan 6, 2009 at a price of 9165.00 he covers his two short contracts at a loss of $1478. The
market continues to rally for the next half an hour, and then proceeds to decline in wave 5. Our
trader doesnt even realize the big decline is finally here until after it takes out two support levels
and is far too late to re-enter.

Now, given this situation, I have to ask you: Did the futures trader make a mistake by covering
his position? Not really. He made a mistake by not planning his stop loss and risk management
from the get-go. But the risks described here are very realistic. After all, without a stop loss, he is
in very real risk of losing more than he can afford to lose.

But his analysis was correct! He essentially was saying I think, with a very high degree of
certainty, that this market is going to fall hard over the next couple of months. He didnt know
exactly how high the market would go before it fell, but the higher it went, the harder it would
fall. He didnt want to be bothered about being stopped out repeatedly at the high and having to
find opportunities to re-enter. He just wanted to be either Right or Wrong: either the market was
going to fall hard, or it wasnt going to. So, he shorted some contracts and decided to wait. But
life just doesnt work that way in futures. Unlimited risk is bad, but stop losses can take you out
of the game before you even have a chance to see if you were right or wrong!
Options are the answer.

Now, granted, if you trade options like futures- buying long calls or puts with stop losses at
reversal bars and then position sizing based on the distance to your stop loss- then youre not
gaining anything from your option over using a futures contract directly.

But if you use the options contract as a one-way-bet, that by the time your contract expires you
will either be Right or Wrong, then you have gained something valuable.

Consider a bad day in the market:

You sold
here

Bad Day

You went short a 10-lot on the day indicated. You were then stopped out on the gap open (red
bar) at a $2000 loss. It was a bad day. We cannot assume that you were in front of your computer
for re-entry or that conditions were favorable for re-entry at any time the following day.

Of course, if you were holding 10 previously-out-of-the-money puts with no stop, it was a rather
good day, not least because the Fed filed for bankruptcy protection citing TARP losses and you.
The reason I have presented these examples is to emphasize the following point: the breach of a
stop loss does not necessarily mean that your expectation has changed!

We have learned that we adjust trades when our expectations have changed. Sometimes, that is
immediately as soon as particular critical support or resistance is penetrated. More often,
expectations are a process. They depend on an ever-developing wave count. Most of the time,
breaching a previous boundary doesnt turn a trader from bearish to bullish, but just from
immediately bearish to just bearish as soon as the market is ready. An example is in order:
In the first example, it appears that we have had an ABC wave (4) and should be heading down
immediately for wave (5). The second example adds another month of data. The last swing high
on the chart took out what appeared in the first chart to be an incredibly important pivot.
However, we can see from the wave count that were still looking at a corrective wave (4) that
should head down for a wave (5). Therefore, although we expect the market to fall immediately
when we buy a put spread in the first picture, we dont necessarily need to close the trade or
adjust to a bullish trade just because our initial high was exceeded. We can always do a what-if
in our head to see just what the implications of a high being exceeded would be. More often than
not, it means very little. We only adjust when our expectations have changed.

Again, someone will say that you can trade futures this way. Dont try it. When I buy a put
spread, I know exactly how much money I can lose even though I have no stop loss. When I sell
a futures contract with no stop, I have no option, and no plan, when the market pushes against
me in a way I dont expect. My only escape is to trash the contract when it hurts too much, and
that will leave a painful scar that the spread could never have caused.

In short, futures contracts require you to be right before you are wrong. Options only require than
you be right at least once. Of course, theres no free lunch; options involve expirations and time
decay. But it is important to define the differences in an objective manner so we can create a
system that uses them appropriately. This is the real intent behind STS no stop losses idea.

Position Sizing
Option position sizing is very easy. You just assume you will lose 100% of your investment.
That is the basic position-sizing assumption whenever you dont have a stop loss, and as such it
applies perfectly well here.

First, you choose a percent of your account size that you can afford to lose and that you would
reasonably be able to get back if you lost it. A 20% loss requires a 25% gain to recover, but a
75% loss requires a 300% gain to recover. Therefore it is more than three times as difficult to
eventually recover from a 75% loss as it is from a 20% loss, and that recovery process is likely to
take years at the least, not to mention being psychologically damaging.

So, lets for example choose 20% as a maximum loss on the account. Now, lets assume that we
want to be able to be wrong 15 times in a row before actually achieving this 20% loss. This
results in risking about 1.5% on each trade. (1 - 0.8 ^ (1/15) = 1.48%).

In these examples we will assume a $100,000 starting portfolio size. 1.5% is $1500. As the
account grows or shrinks 1.5% will represent more or less cash, but it will (by definition) be
1.5%.

At-the-money calls are more expensive than out-of-the-money bull call spreads or calendars, so
by our 1.5% rule we cant buy as many of them, while we can absolutely load up on out-of-the-
money calls without violating our risk management criteria. Of course, we cant do this
arbitrarily: if youre going to buy a lot of out-of-the-money calls, then the analysis had better
support it, otherwise it has a disproportionately high chance of becoming a complete loss. But
its when these types of trades are correct that the big money is made, so theres no shame in
putting them on when the time is right. After all, in a Wave 3 collapse, it is a lot more risky to be
holding a conservative bullish collar trade than it is to be holding a bunch of out-of-the-money
puts.

Part II: Riding the Waves

The Halfway Rule

If you are expecting a particular move to happen by a particular date, it is most often best to buy
a call or put with strike halfway between the current stock price and the expected destination.

I offer the following data, calculated via a Black-Scholes with the following criteria:

Call options
Stock currently at $50
Expected move to $60 within 3 months
90 days of time value in options at time of purchase
Implied Volatility of 33%
Interest rate of 0.25%

If the $60 is hit at expiration, the call percent profit looks like this:

Profit @ Expiration

300
250
200
150
Percent Profit

100
50
0
-50 25 35 45 55 65 75

-100
-150
Strike Price

If, instead of happening at expiration, the move happens with 10 days left to expiration, the profit
curve looks like this:
 Profit @ 10 Days to Expiration

300

250

200

150
Percent Profit

100

50

0
25 30 35 40 45 50 55 60 65 70 75
-50

-100

-150
Strike Price

And lastly, if it happens with a full 30 days to expiration, it looks like this:

Profit @ 30 Days to Expiration

300

250
Percent Profit

200

150

100

50

0
25 30 35 40 45 50 55 60 65 70 75
Strike Price

You will notice that the $55 strike price is highlighted. $55 is halfway between the initial stock
price of $50 and the expected/resultant move of $60. The halfway rule is quite effective over a
wide range of implied volatilities, time periods, remaining time value, and interest rates. It is
worth remembering.
The One-And-A-Half Rule
If, instead of wanting an option to increase in value due to a move in the underlying, you instead
want it to decrease in value due to the underlying declining yet staying above a particular value,
then you should short the option that is one-and-a-half away. For example, if a stock is at $50
and you expect it to fall but not penetrate $44, you should short the $41 put. $41 is one-and-a-
half away; the original price was $50 and you expect it to fall to $44, a difference of $6. Add
another half ($3) to this difference to get $9. Short the put $9 away ($41).

Again, if we have a $100 stock that we expect to fall but not penetrate $92, then we should short
the $88 put. $88 is $12 away from $100. $12 is one-and-a-half the initial difference ($8).

If you think I am crazy for talking about shorting a put when we expect the underlying to fall,
its because this short put will be used as the short put of a bear put spread and as a hedge in case
were wrong. Bear with me.

Again, under the following criteria,

Put options
Stock currently at $50
Expected move to $44 within 3 months, but not penetrating $44 (options priced at stock = $44)
90 days of time value in options at time of purchase
Implied Volatility of 33%
Interest rate of 0.25%

Here are the graphs for the same three situations. Our chosen $41 strike is highlighted:

Captured Premium @ Expiration

1.5
1
0.5
0
Premium

-0.5 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50

-1
-1.5
-2
-2.5
-3
Strike Price
 Captured Premium @ 10 Days to Expiration

0.5

0
35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50
-0.5
Premium

-1

-1.5

-2

-2.5

-3
Strike Price

Captured Premium @ 30 Days to Expiration

0.5

0
35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50
-0.5
Premium

-1

-1.5

-2

-2.5

-3
Strike Price

It is true that this short put in a declining market is not a great way to make money. But the
goal is to capture a little premium if we can and also to help cover some of the time decay in the
long option of a spread. Youll notice that, if we can nail the expiration perfectly, it is always
best to short an option with a strike exactly equal to our expected support (or resistance) level.
However, if we must close the trade even 10 days early, that option hasnt made any money!
(That would be shorting the $44 strike in the above example.) This isnt good because it forces
us to wait until expiration instead of taking a more logical market-based exit. We want to avoid
conflicts between our technical analysis and the desire to just hold out for a few more days.
Therefore, we want to choose an option with a farther away strike price. But if we choose a strike
too far away, we cant get any premium for it. The one-and-a-half rule is the best compromise
over a number of different implied volatilities, time periods, remaining time value, and interest
rates. It is also worth remembering.

Strategy
In the previous couple of sections, we introduced a few interesting ideas about placing strike
prices. Strike prices are important. Now we want to move forward and begin to place these ideas
into an Elliott Wave framework.

Im not going to divide my strategy into Waves 1,2,3,4,5,A,B,C, and then talk about which
spreads to use for each wave. Thats redundant. Instead, lets use the waves to generate support
and resistance, price and time targets. Then, use these levels to structure a spread. This simple
methodology can be applied to all waves in all time frames, is simpler, just as effective, and far
easier to remember.

Corrective Waves I: Simple Corrections

Lets use an example of a correction after a 5-wave decline. Without any further information, we
simply assume that this will be a simple correction. Simple corrections have an A-B-C form and
generally complete somewhere between the 50% and 78.6% retracement level of the previous 5-
wave advance or decline. I have also marked options expirations as vertical lines on the chart.
(Marking expirations is something you may wish to do in your options trading as well.)
We can easily see that we will choose the December expiration for this trade. If its not an
obvious choice, then its best to err on the side of buying too much time than buying too little.
However, in this case the expiration runs right through the target zone and makes a fine choice.

Its also worth noting that indexes also generally offer weekly options as well. That is, you can
buy or sell front-week calls and puts for very near-term moves. ETFs unfortunately dont.

We are expecting a price increase into this area, and we will structure a vertical spread for this
move. The standard target for corrections is the 61.8% retracement level at 13686. The current
price of the Dow as of the reversal day shown in is 12981. We are therefore expecting a Dow
rise of about 700 points. By the Halfway Rule, we look for a long call at a strike around 13,334.
The closest were going to get is the 13300 call. (Practical note: most people would trade the
dow ETF DIA which is 1/100 of the Dow. This is equivalent to the DIA 133 call).

Ok, now for the short call: corrections should remain below the 78.6% retracement level at
13947, so we should short the Dow 14000 call (or the DIA 140 call).

For the sake of simplicity, lets use the DIA. I dont have historical data for this, but at that time
the VIX was probably no more than 25 and these options would have cost, according to Black-
Scholes, $1.87 and $0.44. The spread, therefore, cost $1.43 per share or $143 per contract.

Now, assuming that we have an investment account of $100,000, we want to risk a constant
1.5% on each trade, which is $1500. At $143 per contract, we need 10 contracts to meet but not
exceed our desired risk. Therefore, we buy a 10-lot of DIA 133-140 bull call spreads for a total
of $1430.

If we were trading futures (or the ETF) instead of options, we would go long now and place a
stop below yesterdays low at 127.25.
The following day, the Dow continues to decline and takes out our low. If we were long futures
we have been stopped out. Has our expectation changed? Not really, because we are still in the
right price (and time) region for this wave 5 to end.

Wide-range
reversal bar

The next day, we get a wide-range reversal bar providing another go-long signal for futures
traders. We just hold our position.

However, something has changed. The previous low has been replaced by a new low. That
means that our Fibonacci retracement levels have also changed, and that could potentially mean
that our chosen spreads strike prices are no longer suitable. Furthermore, this new low is 2 days
later than the original previous low, so its also possible that our chosen expiration is no longer
valid.
Well, this time (as well as most times) nothing material needs to be done. We dont need to make
an adjustment. The Fibonacci levels have moved, but not much. The time projection region has
moved, but not much. This is normal. But it is important to consider at each market juncture.

Three days later, the market has rallied significantly to reach our 50% price target and then
pulled back intraday to create an inverted hammer candlestick:

Is the correction likely over? Well, no, probably not. Most corrections have at least 3 sections (a-
b-c) and are not complete before the 31.8% time retracement. However, our spread is now
showing a decent profit and the correction has met the minimum requirements for a correction.
Lets consider our situation. We purchased 10 spreads at $1.43. They are now worth $2.39. If
this is indeed the end of the correction, then the market will fall and our spreads will become
near worthless. Therefore, our downside risk is still 1.4% to the account ($1430). This is
probably a good place to sell half of our spreads to help reduce our downside risk.

(Note: My research has shown that it is beneficial to exit the short-term-half of positions as soon
as they hit predetermined exits, but try to exit long-term positions on 1-day trailing stops or
signal bars into resistance areas and such rather than just arbitrarily exiting them. Markets
sometimes runaway and you can pick up a lot of points from the 1-day trailing stop method).

If we had automatically exited our 5 spreads at the 50% ret., they would have been worth $2.86.

Selling half of the spreads at $2.39 locks in a profit of $0.96 per share on 5 contracts ($96*5 =
$480). We now have 5 contracts exposed for a possible loss of $143 * 5 = $715, less the $480
netted in the trade so far, for a total risk of $235. Our risk has been reduced from the initial
$1430 to $235. This is significant.

Now, if we were trading futures, we would be using trailing stops already to ensure we locked in
a profit, but we dont do this with options. Often our options positions will show a gain, then a
loss, before finally showing a more substantial gain. Trailing stops can have adverse effects on
this process. That said, it is often prudent to close half of a position at a short-term target on a 1-
day trailing stop as a way to reduce risk when its possible that a correction or trend has
completed before initial expectations.

And on we continue:

Our simple ABC continues on as anticipated. The Wave C from Wave A alternate price
projections create two possible endpoints: one at the 61.8% retracement that we hit today as well
as one just above the 78.6% retracement. That means today is in a perfect position to complete
our correction. We prepare to exit the other 5 spreads at a 1-day trailing stop.
We are then stopped out two days later on a 1-bar trailing stop at a price of $3.02. Profits on the
second lot are $1.59. Total profits on both parts of the position are $480 + $795 = $1275.

Impulsive Waves
We may now continue on and consider impulsive waves. We dont know if a wave 3 or a wave C
is unfolding (although a look at the higher-time-frame wave count suggests it is a wave 3).
Furthermore, were not really certain that were getting a new downtrend, either. After all, what
if the 5-wave decline pictured in the previous section was really the Wave C end of a complex
correction? In that case, we should really be heading up, not down. Well, what can we do?

Just as discussed in Dynamic Trading, we make two targets: a short-term and long-term target
and trade them together. This is a good practice and always recommended. It helps to get risk out
of a trade in a logical place.

Another couple of charts are in order.

Trend Picture

Countertrend Picture

Well, this looks complicated. Its relatively simple for the futures trader; he covers half on a one
day trailing stop once reaching the short-term target and then the other half on a trailing stop
after reaching the long-term target. For the options trader it presents a problem because the trades
that optimize these two possibilities are different.
Lets first look at the trend picture:

The trade that optimizes the trend picture is a 129/102 bear put spread (using the 1.00 APP at
12278 as the target and the 1.618 APP at 11306 as the support that should not be penetrated.
The halfway point is 12856 and the one-and-a-half is 10243). Well clearly be using the
February expiration.

The spread components look like this:

Long 129 put: $3.29

Short 102 put: $0.02

Well, that put doesnt really look to be worth selling. What we dont do is now look for a better
place to sell the put and look for reasons to put it elsewhere, or choose a new support level or
such. We just dont sell the put. We just have a long put instead of a spread. No problem. The
last thing we want to do is cap our profits in the case of a genuine collapse, and certainly not for
2 cents!

Trend position: Long Feb129 put @ $3.29

Ok, now lets look at the countertrend position:

The first thing that jumps out at us is just how far away expiration is from the reversal zone. Its
not anywhere close: December expiration is three days away (not enough time) and January
expiration is very far away. That means were not selling a put; theres no way we could get any
premium out of it if the market fell down quickly over the next few days. On the bright side, our
long put wont suffer much time decay during such a short time.

Very well, it seems this will be a long put as well. The target is 13144 and the halfway point is
13288 or $133 for the DIA. ( (13432+13144)/2 = 13288 )

Countertrend Position: Long Jan 133 put @ $3.65

That wasnt so hard. Now, we split our position risk into two equal pieces and position size
accordingly. The account size is now $101,275. 1.5% is $1519. This creates two equal risk sizes
of $760.

Trend position: $760 / $329 = 2.3 contracts. 2 contracts Long Feb129 put @ $3.29
Countertrend pos.: $760 / $365 = 2.1 contracts. 2 contracts Long Jan 133 put @ $3.65

(If one of these came out to 1.8 or 1.9 or 1.99 contracts, I would still trade 2 contracts of course).

Ok, so we are going long 4 long put contracts on the Dow. Our risk is $1,388 (1.37%). Two of
those contracts (Jan 133s) are for a short-term target and two (Feb 129s) are for a long-term
target. Both were originally planned to be vertical spreads but analysis showed that they are best
opened as simple puts instead.
The short-term target at the 61.8% retracement is hit one week later at 13144. The short-term Feb.
133 calls are worth $6.09. The short-term position was closed out at a $2.44 profit on 2 contracts
($488). The position risk is now just the two Feb 129 puts opened at $329 less the $488 profit
just made, for a total risk of $170. Position risk has been reduced from $1,388 to $170. Again,
this is significant.

The long-term position hits the target (1.00 APP) at 12278 on Jan 17 and a 1-day-high-stop is
engaged. It isnt stopped out until Jan 23, however, at a better price of 12167.
The calls are worth $8.06, netting a profit of $4.77 per contract on two contracts ($954). The
short-term unit earned a total of $488, so the combined position earned $1442. The account is
now $102,717.

Reflections
At this point it is becoming clear that futures do offer some advantages: a futures trader making
the same entries and exits as these is probably making significantly more money in his trading.
But he does need to manage his stops very well and potentially make several entries or re-entries
at various times. The analysis shown here is extremely easy to employ. We are waiting until an
objective is hit, with no stop loss. When it is hit we either sell immediately (if it is a short-term
half of the position) or employ a 1-day trailing stop (if it is the long-term half of the position).

STS initial education suggests in the RFF workbook that all trades are to have a 5% risk, then
ambiguously states that no trade should lose more than 50%, although it also should not have a
stop loss. Lets take this to mean that all trades are to have a real risk of 2.5%. Well, I have been
using 1.5% here, so it is probably safe to increase this to 2.5% and this should boost returns
proportionately. Depending on your aggressiveness, you can choose anything from 0.25% to 5%.
I generally use 0.5% myself.

Another reflection is that options trading requires a LOT of capital. We traded 4 call contracts on
a $100,000 account. People dont realize this, which is probably why so many people go broke
trading options. The misconception is that options can be traded with a smaller account than a
stock account due to the fact that options are cheaper. Everything in markets is related by its
volatility and stock options are among the most volatile of all assets. Therefore, effective
position sizing requires either a very solid amount of capital, or a strong stomach, or both.

One possible solution is to trade $10 stocks instead of $100 stocks. The options are likely to be a
lot cheaper per contract and you can do better position sizing that way.
Part III: Adjustments
[This section is coming soon. I want to do a good job on it.]

We adjust when our wave count changes. Its that simple. Then again, thats not very simple. We
always have alternate counts and were never really certain where we are in the waves.

I want to give a very thorough idea of adjustments. Sometimes were pretty sure were in wave 2
of a big downtrend, and then that wave 2 keeps going up, until its clear that the big trend is up.
Well, make some new wave counts, some new projections, and some adjustments.

Sometimes, there are key signal levels that warn that we have some new wave count to
consider. For example, if we are in a wave 2, that wave 2 should not exceed the wave 1 extreme.
From the big downtrend example just given, we could assume that if the recent top from which
wave 1 began is exceeded, then were probably in some other structure. We can then put a stop-
buy on a call at this level, so that we automatically buy a protective call into our spread when this
level breaks. This way, we can (literally) buy some time to evaluate the situation.

Wave counts change often, and at all times there are usually some key levels to be aware of.
By focusing on Fibonacci supports and resistances, we can always assess what should end up
being the most optimal spread position, and then adjust to that when the time is right.

So, thats the basic idea. After some examples, it should be pretty clear.