From the May 01, 2009 issue of Futures Magazine • Subscribe!

Dan Keegan: Adding to a winner

Dan Keegan spent more than 20 years learning the nuances of trading options on the floor of the Chicago Board Options Exchange (CBOE) and now along with exercising those lessons in his personal trading, he is passing them on as a mentor.

Keegan started as a runner at CBOE in 1978, working his way up the ladder to become a floor broker for A.G. Becker. He got a big break when veteran options trader, adventurer and balloon enthusiast Steve Fossett took Keegan under his wing and sponsored his early trading efforts. Keegan says Fossett helped launch many careers by giving new traders opportunities and not micro managing. “If he thought you knew what you were doing he would leave you alone,” Keegan says of Fossett, who died in a plane accident in 2007.

Today, taking a page from Fossett, Keegan instructs prospective traders on basic and sophisticated professional strategies at “We try and get them up to the level of professional trader or market maker,” Keegan says, adding, “It is something every retail trader is capable of learning.”

Keegan developed his trading philosophy over many years of short-term trading on the floor. He doesn’t like to trade in and out of the same positions like a typical scalper, but puts on a position and then makes adjustments to it based on risk management and changing market conditions.

He likes to keep a delta neutral approach, trading volatility as opposed to direction. He will hold a directional bias at times but rarely does the success of a trade depend on directional movement. He puts on time spreads, butterflies, back spreads and front spreads. “You are looking to put the odds in your favor,” Keegan says. “You are trying to manage risk and [get an] edge on every new trade.”

Keegan tries to find anomalies between options and the underlying market and among option strikes. “If there is a mispricing somewhere, I will try and take advantage of it.”

An example of a back spread would be to sell the underlying and buy calls to offset the position based on delta. He describes this as more of an aggressive volatility play as opposed to a front spread, which would be used if you expected volatility to decrease. For example, in early May IBM was trading at $105.60. He would buy 20 of the 106 calls — with a delta of 55 — and sell 1,100 shares against it, creating a delta neutral position. If IBM tanked he would only lose the premium (about $9,500) and be able buy back the stock for a profit. If the stock rallied significantly he would be holding more long positions via the calls with a higher delta than his short position.

However, Keegan would not sit on the trade. If IBM rallied to $111 pushing the delta to 70, he would maintain his neutral stance by selling 300 more shares. If it then returns to $106, he buys back the additional shares at a profit more than offsetting any time decay on the options. He would continue to adjust the position as the market moves. The only way he loses on this trade is if the stock remains in a relatively tight trading range.

Keegan says it is hard to be profitable trading one position at a time in options. That requires that you must be right on that position.

“If you trade one option position at a time your chances of success are slim. You have to learn to spread the options against each other,” he says.

Every position Keegan puts on is a starting point. He knows what moves he will make to alter the position in certain market conditions before those conditions materialize. And finally, he is constantly adding to winning positions.

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