There are a number of new subscribers to the Couth Potato Trader. Where did they come from? Believe it or not, our reputation of success is spreading faster than mozzarella in a deep dish pizza. Many new subscribers are directional traders who are tired of donating their money to the Church of the Almighty Coin Flip. Then, there are escapees from other subscription services who recognize the value of our approach and want to learn more about option selling.
As option sellers, we're experiencing a premium draught. With the low volatility envirnoment we've had for quite some time, finding option premium in today's market is like trying to find a curve on Lara Flynn Boyle. There's a little there, but is it worth the effort?
Our favorite strategy is the Iron Condor. It's a neutral or non-directional strategy that creates a scenario allowing the underlying asset (index or stock) to move up, down or stay the same and still pocket a very nice profit.
The Iron Condor is a combination of two credit spreads -- a bull put spread and a bear call spread. Since both the bull put spread and bear call spreads are credit spreads, we will be "collecting" premium from the market -- not spending it. The challenge comes in determining the spread sizes, the placement, and the amount of premium to be taken in -- all the while remembering the importance of safety. Over the next few columns, we'll be taking a closer look at the Iron Condor -- it's components and how they work. We're going to start with the bull put spread.
The Bull Put Spread
a) sell a RUT March 590 put for $2.10 ($210 per contract)
If we only sold the 590 put, we would have unlimited exposure all the way down to zero. That's dangerous. Plus, most option traders will not have the trading approval level from their brokerage that will allow them to sell "uncovered" or "naked" options. So, to protect us from the market, and from ourselves, we will have to buy some protection -- in the form of a long put. Think of it as a financial condom that helps prevent traders from prematurely giving birth to empty brokerage accounts.
You'll notice that we have taken in $.80 more than we spent. That's ours to keep. If RUT closes, at expiration, above 590, both the short 590 put and the long 580 put will expire worthless. In most segments of society, the concept of "worthless" has a negative connotation (as in my ex-brother-in-law). However, if you're an option seller, you're benefiting from the passage of time. Why? With the passage of time, the value of the option you sold is eroding away -- hopefully to zero. And -- your obligation to perform is eroding away along with the premium. That's a good thing.
Your exposure in a bull put spread is the difference between the strike prices. In the above example, you're exposed for 10 points (590 - 580) or $1,000 per contract. Your real risk is a little less. Remember, you took in $.80 ($80) of premium that you didn't have before. So, your out-of-pocket risk is only $920 ($1,000 - $80). That is the worst case scenario.
In the above example, you will make money if RUT goes up, remains the same, or even goes down 47 points. You have a much better chance of success. Why try to guess a direction if you don't have to?
What If . . .
b) . . . RUT finishes at 550? This is the worst-case scenario. The RUT tanked all the way through the short 590 put and continued on down through the long 580 put. If this happens, without you making an adjustment, you will lose the difference between the strike prices ($10 or $1,000 per contract -- less the $80 premium received).
c) . . RUT finishes at 586.50? The 580 long put will expire worthless, but the short 590 put will have intrinsic value of $3.50. This $3.50 ($350 per contract) will be deducted from your brokerage account on Monday after expiration. Don't forget, though, you took in $80 per contract. Therefore, your out-of-pocket loss is only $2.70 ($270 per contract).
Always calculate your breakeven point. With a bull put spread, it's the short strike price (590) less the premium received ($.80) -- 589.20. Above the BE point, you make money. Below the BE point, you don't.
Next: The Bear Call Spread
Going With The Flow . . .
Notice that there aren't any strike prices available (at this writing) from 1130 to 1150. That will probably change in a few days, but remember that, even though you may want to put on a position now, you should never compromise safety for convenience or higher premium.
February Position #1 - SPX Iron Condor - 1203.03
February Position #2 - OEX Bull Put Spread - 575.09
February Position #3 - MSH Iron Condor - 475.78
February Position #4 - SPX Iron Condor - 1102.03
MARCH CPTI POSITIONS
We sold 10 March MSH 430 puts and bought 10 March MSH 420 puts for a credit of about: $.90 ($900). Then we sold 10 March MSH 510 calls and bought 10 March MSH 520 calls for a credit of about $.35 ($350). Our total approximate credit and potential gain of $1.25 ($1,250). We've established a maximum profit range of 430 to 510. The maintenance is $10,000. The actual exposure is $8,750 ($10,000 less the $1,250 premium received).
March CPTI Position #2 -- SPX Iron Condor - 1203.03
This year, we're using the entire $26,000 of extra cash as maintenance for Iron Condors. That should enable us to generate substantially more profit on this "no risk" strategy.
February Zero Plus Iron Condor Position - SPX - 1203.03
QQQ ITM Strangle - $37.75
Jacksonville -- Just The First Stop
Since I announced the three seminar dates last week, I've been inundated with over 50 responses by folks who want to reserve spots. I'm going to take a leap of faith and assume you are serious options traders or you wouldn't be reading my CPTI newsletter. You want to learn how to position yourself to take advantage of all those directional traders who lose their money betting on whims or the recommendations of others.
Options are marvelous tools -- but you have to know how to use them. There's more to consistently making money than a coin flip and a mouse click. For less than the profit on one Iron Condor trade, you can learn how to put the percentages in your favor. It's knowledge that will last you a lifetime. Join me at one of my CPTI seminars. The dates and locations are:
March 19/20 - Jacksonville, FL
Send me an email at firstname.lastname@example.org and I'll forward you all the details. The spots are filling up fast. Don't be left out! It'll be a weekend you'll never forget!
Mike Parnos, Your Options Therapist and CPTI Master Strategist _____________________________________________________________________________
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