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The ROCK Trading SystemPart 2 Adjustment Guidelines and a Simple Example Brought to you bySMB Training A World Leader in Options Education Created and taught by John Locke Locke in Your Success, LLC. “Know what you want, make it happen!”

John Locke President of Locke In Your Success, LLC Options Trader Success Coach Options Trading Mentor

ROCK Configuration Most of the time, the trade will be in “ROCK” configuration. The most common reasons for changing out of ROCK configuration would be: High IV entry Excessively large price movement

ROCK Configuration Guidelines Normal Delta Range: +100 to -250 Delta Range may be loosened up to +250 to -250 when fully scaled in particularly, when the trade is near expiration and you find the trade is getting chopped back and forth with price movement There are no Delta Theta ratios or Vega concerns in this configuration

ROCK Configuration Upside Guidelines The trade size is increased or scaled into as the market rises. With a typical entry we will be approximately ½ scaled in with the position consisting of 1/3 of a position at the bottom butterflies and ½ of 1/3 of a position at 40 points over the lower butterflies. If negative Delta increases to greater than -250, then we will gradually increase the number of butterflies at our upper strikes until the trade reaches a total of 20 butterflies (10 at each strike) This is considered 2/3 entered.

Typical Entry – ROCK ConfigurationLooks like the “Prudential Rock™” This is approximately ½ entered

ROCK Configuration2/3 Entered

ROCK Configuration Upside Guidelines As negative Delta continues to increase and exceeds -250, we begin gradually scaling into butterflies 20 points higher than our highest strike butterflies until we are fully scaled in with 10 butterflies at our highest strike.

ROCK Configuration Fully Entered

ROCK Configuration Upside Guidelines If negative Delta continues to climb to greater than -250, we will gradually begin selling off the lowest strike butterflies until they are gone and we are back to 2/3 position

Lower butterflies are sold off until we are back to ROCK configuration 2/3 Entered

ROCK to Bearish ButterflyConfiguration Upside Guidelines If negative Delta continues to climb to greater than -250, we gradually scale into a Bearish Butterfly position by buying butterflies 20 points over our upper short strikes. From this point, we will gradually transition over to Bearish Butterfly “into expiration” guidelines with Delta limits for a $50,000 position. Intraday Delta limit of +/- 500 and an end of day limit of +/- 250 as outlined in the Bearish Butterfly training series. If price drops or runs sideways, we will manage as a Bearish Butterfly position If price continues to rise through the Bearish Butterfly position, we will use modified upside guidelines

Bearish Butterfly

Bearish Butterfly Upside Modification If price continues to rise through the Bearish Butterfly position, we will transition back into a Rock Position by rolling out the upper butterflies 20 points. We will go back to ROCK guidelines

Back to ROCKOr more specifically reverse rock which in managed in the same manner as normal ROCK fully entered

ROCK ConfigurationDownside Guidelines What you do on the downside will depend somewhat on what your position is when the price drops. Downside guidelines will be given with the position “between” 1/3 entered and 2/3 entered, 2/3 entered or fully entered. If you find yourself between those numbers, then adjust Delta by scaling down to the nearest 1/3. Note: If between ½ and 2/3 entered, you may roll back into CAT position and increase the trade size to 2/3 (there is an example of this in the series).

ROCK Configuration Downside Guidelines(when less than 2/3 entered) Excessive down movements will trigger 2 adjustments. The second adjustment will put us into M3R configuration and the guidelines will change to a slightly modified version of M3 guidelines From there if a substantial upside whipsaw occurs, M3R guidelines will put you back into ROCK configuration

Downside Adjustments in Rock Configuration (when less than 2/3 entered) Adjustment 1: If Delta becomes greater than +100, roll the put butterflies back 20 points Correction: If a whipsaw occurs see upside rules for ROCK with 1 roll back. Adjustment 2: If Delta becomes greater than +100, roll back put butterflies 20 points. Then add an ITM call to cut Delta to less than -100. You are now in M3R Position and will manage the trade by M3R guidelines.

Correction – added slideRock with 1 roll back upside guidelines When less than 2/3 entered When rolled back into “ROCK with 1 roll back”, we typically will use the same guidelines to scale back into a full ROCK position as the normal ROCK guidelines, however, due to the complication of those way OTM butterflies keeping your Delta down, it often makes sense to scale into the butterflies 40 points higher than your lowest butterflies before Delta hits -250. Therefore, we need another guideline to cover this situation. If the price exceeds 30 points past the lower short strikes, then begin adding in the 2nd third of the position as needed to bring Delta down to under -150 and continue adding in the second 1/3 when Delta exceeds -150. Once the 2/3 third is fully entered, return to Normal ROCK guidelines.

Downside Adjustments in Rock Configuration (when 2/3 entered with butterflies 40 points apart) If Delta becomes greater than +100, roll the put butterflies back 20 points, this puts you in CAT position. Use CAT guidelines. Remember if you are more than 2/3 entered you will scale out of your upper butterflies until you are 2/3 entered

Downside Adjustments in Rock Configuration (when 2/3 entered with butterflies 20 points apart) If Delta becomes greater than +100, roll the put butterflies back 20 points, this puts you in ROCK configuration with butterflies 40 points apart, see those guidelines for further adjustments

Downside Adjustments in Rock Configuration (when greater than 2/3 entered) When the position is fully entered and maximum positive Delta will be increased to + 250 intraday and +150 end of day When maximum Delta has been exceeded Remove upper butterflies until positive Delta is about 100 Once all upper butterflies are removed, follow downside rules for when the position is 2/3 entered

CAT Guidelines CAT position is considered to be a “holding position” that can be used when the market is volatile and we do not have a sense of where it is likely to go. We will typically hold this position until either the market chooses a direction or we encounter a negative Theta problem. If the market pushes to either side of the position, we will flip back into ROCK position. We would end up in CAT configuration for 1 of 2 reasons If ROCK position was 2/3 entered with 40 points between the butterflies and we were forced to roll back. If ROCK position was fully entered and we purposely removed the center butterflies to reduce price movement risk because we were getting chopped back and forth in the position.

CAT Guidelines Suggested Delta limits in this position are +/- 150 There are 2 scenarios of how we can have a Delta problem We are at the outer edges of the position and continued movement in the same direction will cause losses We are toward the center of the position and a reversal will cause losses

Adjustments when we are at outer edges at the position

Adjustments when we are at outer edges CAT position Downside: Roll lower butterflies back 20 points and go into M3R position. If you can not buy at least 1 ITM call and correct Vega for M3R positioning, then cut down upper butterfly size until you can. Continue trade using M3R Guidelines

Adjustments when we are at outer edges CAT position Upside: Roll lower butterflies up 20 points This puts us back in 2/3 ROCK position. If we need further Delta adjustments, use ROCK guidelines

Adjustments when we are toward the middle of CAT position

Adjustments when we are toward the middle of CAT position Downside: Roll upper butterflies down down 20 points This puts us back in 2/3 ROCK position. If we need further Delta adjustments, use ROCK guidelines

Adjustments when we are toward the middle of CAT position Upside: Roll lower butterflies up 20 points Theta: Roll the butterfly furthest from price in 20 points This puts us back in 2/3 ROCK position. If we need further Delta adjustments, use ROCK guidelines

M3R Configuration Guidelines The M3R can be looked at as an M3 with extra OTM calls. The trade will be managed using M3 guidelines with a few exceptions which are listed on the following pages. **M3 guidelines are not fully covered in this program. Please refer to the M3 video series for a full set of guidelines. To the down side, for the most part, we will be rolling the position back 20 points when Delta gets to +100. To the upside for, for the part, we will be adjusting the position using ITM calls and verticals when Delta exceeds -100 or Vega becomes positive. Keeping in mind we are a little “loose” with the -100 Delta number with favorable Vega and Gamma trend.

M3R Guideline Modifications From M3 The trade size will be considered to be the same as the original ROCK trade at entry, in this case $50,000 PC. Profit target and max loss will remain 20% PC unless this does not seem reasonable. The only modification to the down side is that we will allow +100 Delta as apposed to +50 on a normal M3. The M3R upside guideline modifications are designed to address… Complications arising from OTM calls The desire to get back into ROCK positioning with an excessive up move

M3R Upside Guidelines OTM Call Interference Use the normal M3 upside guidelines as far as Delta, Theta and Vega numbers As price of the underlying rises, the OTM calls will create excessive positive Vega. We typically add vertical spreads to correct Vega. At some point the verticals will interfere with the existing OTM calls. If this occurs, we will reconfigure the trade to ROCK position by selling the M3 position and all hedges. We will then reposition into the ROCK trade “Normal Entry” position.

M3R excessive up side movement If price moves up to the point where it is approximately 60 points over the short strikes OR to where you can not control Vega in your current butterfly position, then… We will reconfigure the trade to ROCK position by selling the M3 position and all hedges. We will then reposition into the ROCK trade “Normal Entry” position. Unless…It is determined that the market is too volatile for a normal entry via ROCK Guidelines. If this is the case, we will maintain M3 configuration and roll up the butterflies as in the regular M3 guidelines.

M3 Configuration Guidelines If you end up in a straight M3 position, simply use the M3 guidelines that are in the M3 program with the following exceptions. (M3R excessive up side movement guidelines) If price moves up to the point where it is approximately 60 points over the short strikes OR to where you can not control Vega in your current butterfly position, then… We will reconfigure the trade to ROCK position by selling the M3 position and all hedges. We will then reposition into the ROCK trade “Normal Entry” position. Unless…It is determined that the market is too volatile for a normal entry via ROCK Guidelines. If this is the case, we will maintain M3 configuration and roll up the butterflies as in the regular M3 guidelines.

Modified ROCK Configuration Upside Guidelines In this configuration you should regularly be checking both your un-hedged Delta and your hedged Delta. We want to reconfigure to normal ROCK or M3 ASAP. If un-hedged Delta climbs to over -200 and underlying is LESS than 20 over short strikes, sell the hedges and reposition to normal ROCK configuration. If hedged Delta climbs to over -200 and underlying is MORE than 20 points over short strikes, roll up the put butterflies to between 10 and 20 points under price and then test to see if numbers work for a normal ROCK entry. If so, reconfigure to normal ROCK, IF not, we will either reposition our modified ROCK or reconfigure to M3

Modified ROCK Configuration Upside Guidelines If underlying exceeds 40 points past short strikes OR trade goes negative Theta, roll up the put butterflies to between 10 and 20 points under price and then test to see if numbers work for a normal ROCK entry. If so reconfigure to normal ROCK, IF not either hold modified entry or reconfigure to M3

Modified ROCK Configuration Downside Guidelines When Delta exceeds +100, sell position Test to see if Normal ROCK, M3 or Modified ROCK entry is appropriate for re-entry Re-enter position as appropriate

Notes: If you find yourself in a position that you are uncomfortable with, you do not understand how to manage or you are unaware of your risk, ALWAYS: Reposition to a configuration you do understand OR EXIT THE TRADE

Notes: In the examples presented, there are multiple times where we have large amounts of margin and/or are taking on unneeded risk. In most cases we could easily mitigate that risk or reduce margin, however, I have chosen not do so in order to avoid confusion. If you would like techniques on reducing risk, we can go over them in coaching if you choose to do so. Let’s do an easy example!!!

November 2012 ExpirationRisk Management and Profit Targets Planned Capital - $50,000 Profit Target - $10,000 Max Loss - $10,000 Profit Target may be adjusted up or down as trade progresses Max Loss may be adjusted down but will not be increased

Model 10 put butterflies 10 -20 points below the money and check DeltaWe want to know what our Delta is at 20 points over our 830 short strikes (at 850). Currently, we are showing -206 at RUT 841. Therefore we know our Delta will be greater than -200 at RUT 850 and we can proceed with a normal entry

If we are less than -200 at RUT841, then we would want to check to see what our Delta would be “IF” the price was at RUT 850, 20 points over our short strikes(-281)

Guidelines for Normal Entry Once we have determined that we will do a normal entry…. Add call butterflies with 50 point wings, with the short strikes 40 points over the short strikes of the existing put butterflies until our Delta at 20 points over the short strikes of the put butterflies is less than -200

In this case, we find that adding 5 870 call butterflies will bring the existing Delta to -59. Let’s check the Delta at RUT 850

If RUT was at 850, our Delta would be -180.6 which is acceptable

Trade Entry - October 17 November 2012 Expiration

Entry Graph

October 19 (2 days)- 28 DTE RUT is down 11 points and maximum Delta has been exceeded

Analyze graph before adjustment

Downside Adjustments in Rock Configuration (when less than 2/3 entered) Adjustment 1: If Delta becomes greater than +100, roll the put butterflies back 20 points If a whipsaw occurs and Delta becomes greater than -250 see upside rules for ROCK with 1 roll back. Adjustment 2: If Delta becomes greater than +100, roll back put butterflies 20 points. Then add an ITM call to cut Delta to less than -100. You are now in M3R Position and will manage the trade by M3R guidelines.

Roll put butterflies back 20 points

Rock ½ entered with 1 roll backFrom here, we will roll back again if Delta exceeds +100 OR.. We will adjust using upside rules if Delta exceeds -200

November 7 (19 days) - 9 DTE Maximum Delta has been exceeded

Analyze graph before adjustment

Downside Adjustments in Rock Configuration (when less than 2/3 entered) Adjustment 1: If Delta becomes greater than +100, roll the put butterflies back 20 points If a whipsaw occurs and Delta becomes greater than -250 see upside rules for ROCK with 1 roll back. Adjustment 2: If Delta becomes greater than +100, roll back put butterflies 20 points. Then add an ITM call to cut Delta to less than -100. You are now in M3R Position and will manage the trade by M3R guidelines.

For second down side adjustment, roll put butterflies back 20 points

We now hedge the put butterflies with deep ITM calls and vertical spreads (if needed)This puts us in M3R configuration

From here, position will be managed with M3R guidelines

M3R configuration Guidelines The M3R can be looked at as an M3 with extra OTM calls. The trade will be managed using M3 guidelines with a few exceptions which are listed on the following pages. **M3 guidelines are not fully covered in this program. Please refer to the M3 video series for a full set of guidelines. To the down side, for most conditions, this means rolling the position back 20 points when Delta exceeds +100. To the upside for, most conditions, this means adjusting the position using ITM calls and verticals when Delta exceeds -100 or Vega becomes positive. Keeping in mind we are a little “loose” with the -100 Delta number with favorable Vega and Gamma trend.

November 13 (6days) – 3 DTE Price has continued down and we have exceeded maximum acceptable positive Delta

Existing Position

For third down side adjustment, we would normally roll put butterflies back 20 points but in this case we are so close to expiration it does not make sense

Saves the cost of executing and leaves a lottery ticket

Summary In this section we covered: The adjustment guidelines for 6 configurations of the trade Normal Rock Modified Rock M3 M3R CAT Bearish Butterfly The November 2012 Expiration Trade Normal Entry Adjustment into ½ ROCK with 1 roll back Adjustment into M3R position Removing risk for expiration

In Part 3…… High IV Set Up September 2011 Expiration Sample Trade

Locke In Your Success, LLC John Locke www.lockeinyoursuccess.com john@lockeinyoursuccess.com Facebook: Locke in Your Success Twitter: locke4success 603-738-1795

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