Option Investor
Updates

THE ARTICLE IN QUESTION

HAVING TROUBLE PRINTING?
Printer friendly version

I've had a number of emails in the last few days in support of how I dealt with Option Trader magazine and their attempt to cannibalize the article I sent for publication. Also, many of these same emailers were eager to read this article. So, below is the column (as I originally submitted it). It discusses our Siamese Condor strategy. It will be new for some and a review for others. Enjoy!!

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

Everyone Loves A Quickie

There are many ways to skin a cat -- and none of them are a big thrill for the cat. Usually the quickest way is the least painful for the cat -- and it still leaves time for a snack afterwards. That's why quickie trades can often be the most rewarding.

Today, we're going to explore a quickie option trade in which the risk is small and the potential profits can be substantial -- and we don't even have to touch your cat.

The next concept we have to embrace is that directional traders are crazy. Why are they crazy? Because they have to be right about too many things. If you buy a call, you have to be right about 1) the direction; 2) how far the underlying will move; and 3) how long it will take to get there. I'm not that smart and, those that think they are that smart, are kidding themselves. They're gambling. They're the ones that finance those huge hotels in Las Vegas. They're also the ones who provide us option premium sellers with a very nice living.

Enter, the Siamese Condor. Paints quite an image, doesn't it? It's an ingenious creature that combines the attachment of twin sleek felines with the freedom generated from a pair of magnificent condor wings.

With the Siamese Condor, the objective is to take advantage of the fact that the market stays in a trading range about 80% of the time. For the best trading results, we need to limit the underlying securities to which we apply this strategy.

We're going to use indexes. Why? Because individual stocks are vulnerable to specific news events. Picture this. A biotech company believes they found the cure for cancer. What happens when the FDA results of a phase three test that says the placebos work better than the drug? The takes a 50% haircut overnight. That's not good. However, if that biotech stock is part of a 500 stock index, there are 499 other stocks there to cushion the blow. An index will hardly feel it. Diversification is a good thing.

With a week remaining before expiration, let's explore how we can take advantage of a seeming range-bound situation -- using indexes.

Option Therapy patients are having a love affair with Iron Condors - and justifiably so. The Iron Condors are trader friendly. They offer a conservative way of taking in premium and allowing a stock or index to move up, down or stay the same - all the while, generating a nice return on risk.

A brief review of the Iron Condor reminds us that it consists of placing a bull put spread beneath a support level and placing a bear call spread above a resistance level. We have, thereby, established a nice wide range between the short put and the short call. Since they are both credit spreads, between the two, we have taken in a nice chunk of change.

The object is for the underlying to not violate either the support or resistance level and finish anywhere in the established trading range. It's a beautiful thing - IF you know what you're doing.

Prepare Yourself
Before you read any further, I suggest you get a good night's sleep, have a hearty breakfast and prepare to focus - or at least turn off the TV. It'll be well worth the effort. Ready? Assume the position and let the therapy begin.

It's All Relative
The Iron Condor has a distant relative I've named the "Siamese Condor." Sounds exotic, doesn't it? The Siamese Condor consists of four options working together in the spirit of cooperation (like a minage-a-qua) with one common goal. A put and a call joined at a particular level being watched over and protected by another put and a call. The risk is small and the potential rewards are high.

Ahhh! The things we do for love - and money - and the love of money! Well, let's pull back the sheets, expose this strategy for what it is, and get started.

Setting The Stage
Recently, the OEX was trading at about 576 with one week left to expiration. In recent months, OEX had demonstrated some resistance above 580 and some support near 565. There's a reasonable expectation that OEX will stay within that 565 to 580 range -- at least for five days. Now, the question is: How do we take advantage of that prognosis? How can we corral some dead presidents, give ourselves some room for error, limit our risk and make a few bucks at the same time?

One Of Our Favorite Positions
Our objective is to take in as much premium as possible (without going in-the-money). We can take in the maximum time premium by selling the near term puts and calls as close to the money as possible. Option savvy readers of this column will recognize the first part of this trade as a sell straddle (another fun position). But, we know not to indulge in this activity without protection. So, we will buy out-of-the-money puts and calls to prepare for the unthinkable (but possible).

For our example we'll use a 10-contract position.
Sell 10 contracts of the OEX 575 calls @ $6.00 (x 1000 = $6,000)
Sell 10 contracts of the OEX 575 puts @ $3.80 (x 1000 = $3,800)

Our total credit is $9.80 ($980 per contract) x 10 = $9,800
Thus far, we have taken in $9.80, but we're naked. We need to go to the option drugstore and buy some protection - or at least a raincoat. They're having a sale on the extra-strength OEX 590 calls and 560 puts. Now we will:

Buy 10 contracts of the OEX 590 calls @ $.50
Buy 10 contracts of the OEX 560 puts @ $.45

The cost of giving birth to any unwanted financial dependents is $.95 x 10 contracts = $950. Pretty cheap for the amount of fun we may have.

Our net credit is $8.85 or $8,850 ($9,800 less $950).

Basically, what we have is a bull put spread and a bear call spread with the short puts and calls at the same strike (575). It's like an Iron Condor with the two spreads up close and personal. They are joined at the short strike - hence, the name "Siamese."

How We Make Money
We've taken in $9.80 and our protection cost us $.95. Therefore, we have $8.85 in our pocket. The closer OEX finishes to 575, the more of the $8.85 we'll be able to keep. If OEX finishes exactly at 575, all the time value will have eroded away in the five trading days prior to expiration and we would keep the entire premium. As in any credit spread, time is working for us. The more time goes by, the more premium stays in our pocket.

Our bailout point in this strategy on the topside is 583.85 - calculated by adding the $8.85 net credit to the strike price (575). On the bottom side, our bailout point is 566.15 - calculated by subtracting the $8.85 net credit from the short put strike price (575). These bailout points are ABSOLUTE and I'm not talking about the Vodka. I mean, when it reaches these bailout points, it's time to EXIT THE TRADE!

The Beauty Of Closure

In reality, though, if the OEX is trading right near 575, we would want to buy back a short put or call just prior to expiration - even if it's only $.10 on each side. Why? To completely eliminate the chance of exercise or assignment. In the markets, strange things happen. Although rare, stocks and/or certain indexes can get exercised and/or assigned though they are slightly out of the money. It's better to spend the $.20 -- just for peace of mind. Closure is a beautiful thing - especially if it's a profitable closure. An ounce of precaution is worth a pound of pastrami on your celebration deli platter.

The Siamese Condor is a strategy that requires you to pay attention. You will need to monitor the position -- not minute by minute, but you have to be aware. If the OEX moves towards the exit parameters, you need to be prepared to act. It's possible to use contingent buy orders to close your positions, but it is more cost efficient if you close the positions yourself.

What If Scenarios

What if . . . OEX finishes at $573? The short $575 call will expire worthless along with the 590 call and the 560 put. The 575 put will have an intrinsic value of $2.00 that we will give back. We took in a net credit of $8.85. The cost of the 575 put is $2.00. Profit is $6.85 (x 10 contracts = $6,850).

What if . . . OEX finishes at 581.25? The short 575 put, the 560 put and the 590 call will all expire worthless. The short 575 call will have a value of $6.25 that we have to give back. We took in $8.85. Profit is $2.60 (x 10 contracts = $2,600).

The OEX is a "cash settled" index. That means that, if you choose, you do not have to close out the positions. Upon expiration, the options will be settled in cash based upon Friday's closing prices. The gains (or losses) will show up in your brokerage account on Monday morning. It might save you a few commissions, but, if you have the right broker, those should be insignificant anyway.

Bailout Points

What if . . . OEX moves up to 583.85 with time still left until expiration? Be prepared to act! It's time to get the hell out of Dodge! The same holds true if OEX trades below 569.15. Remember, 583.85 and 569.15 are the bailout points.

Our Exposure and Maintenance

As in an Iron Condor, technically we're exposed for the $15 difference between the strike prices. In this case, we're short the OEX 575 calls and long the 590 calls. That's 15 points or $1,500 per contract. Our exposure is the difference between the strike prices (575-590 or 575-560). Our maintenance is the same for the put side as it is for the call side -- $1,500 per contract.

We already have taken in $8.85 ($885 per contract). So, our actual out-of-pocket exposure is only $6.15 ($615). That's not a bad risk/reward. The beauty of the position is that, if we were to allow our Siamese Condor to go to expiration, we can only be wrong in one direction. Our profit (safety) range is 583.85 to 566.15. That's a $17.70 range.

The Risk

As described above, if you follow the plan, the risk should be minimal -- about a buck. However, if you don't have the self-discipline to bail out when you're supposed to, you can take a significant loss. If you don't have self-discipline, you should forget trading and open a fruit stand -- because you will lose your money.

Why A Siamese Condor Instead Of An Iron Condor?
One of the benefits of the Siamese Condor strategy is that we give ourselves the opportunity to make a lot more money. We could possibly have created an Iron Condor on the OEX with a 580/590 bear calls spread and a 570/560 bull put spread. With only a week left to expiration, we could have perhaps taken in a total of $1.20 and had a maximum profit range of 570 to 580. In this scenario, $1.20 is the maximum profit possible.

The benefit of the Siamese Condor provides us with the opportunity to make up to $8.85 if the OEX finishes near 575. That's substantially more than the maximum of the estimated $1.20 we could potentially make with a normal Iron Condor with a 570 to 580 range.

Lower Risk
Pay attention -- this will take some extra focus. With a typical Iron Condor, it's difficult to calculate the optimal time to bail out of the trade. Do we bail when the short strike is violated? When a support or resistance line is broken? Do we just wait and hope?

Note that, as the stock approaches the short strike (Iron Condor), the amount of time value in the short option is increasing. When it reaches the short strike, it will be at-the-money. Since the most time value exists when a stock/index is ATM, we would have to pay more to close out the position.

On the contrary, with a Siamese Condor, for every dollar OEX moves away from the short strike (575), the further in-the-money OEX becomes. The more intrinsic (ITM) value there is in the option's price, the less time value there is. Since we took in $8.85, once the OEX reaches the 583.85 bailout point, there won't be much time value left in the 575 call - maybe $1.00 or less (depending on when the move occurs). So, you might have to pay $9.85 to close the short 575 call.

Then, if the OEX continues to move up before expiration, you may even recoup $.25-$.40 (or more) when you sell the long $590 call. Thus, to close the bear call portion of the Siamese might cost only about $.70. That's not bad for a position that has gone wrong.

Wait! We're Not Done Yet
As the Big Bad Wolf said to Little Red Riding Hood, "who's your daddy?" and "you're not out of the woods yet, baby." Don't forget that, in the above example, we're still holding the 575/560 bull-put spread. With only days remaining until expiration, the value of the 575 put should be very small. To be on the safe side, you may opt to close it out when you close the bear call spread to eliminate any additional exposure. Though it's not likely, the OEX could suddenly reverse and moves back below 575. Then, you could be faced with possible additional losses.

Getting' By With A Little Help From Our Friends

Also helping our cause are our friends(?) the market makers. Check the option chains. You'll likely see that the 575 puts and calls likely have a very high (if not the highest) open interest. As option expiration approaches, the market makers have a tendency to try to manipulate a stock/index toward the strike price with the highest open interest. Why? Because the closer the stock trades to a strike price with high open interest, the more option transactions it will generate as people cautiously close out positions and roll out to future months. In this scenario, market makers would actually be working toward increasing our profits.

For Those "Aggressive" Types

There is a way to increase your profit range, but it comes at a price (doesn't everything?). Instead of buying the OEX 590 calls and 560 puts for your protection, you can go out further and purchase the OEX 595 calls and 555 puts. The cost might be only $.40 compared to the $.95 we paid for the 590s and 560s. Our final credit would become $9.35.

That would make our OEX profit (safety) range from 584.85 to 565.65. The price we're paying for the additional premium is the extra five dollars of exposure. Instead of being exposed for only 10 points, we are now exposed for 15 points. We would need a larger account size to accommodate the extra maintenance than would be required for the 15-point spreads.

Brokers, Don't You Just Love' Em?

If you're going to trade the Siamese Condor (or the Iron Condor), you should seriously consider having your account with a progressive brokerage firm that requires maintenance on only one side of the trade. Why would you want to tie up $15,000 for the bull put spread and another $15,000 for the bear call spread? A broker that holds only $15,000 for one side frees up the other $15,000 to use elsewhere - productively. It's a more efficient use of your trading dollars and simply makes good sense. If your broker requires maintenance on both sides, contact me. I'll send you a list of progressive brokers. Unfortunately, it's a short list.

Our Time Is Up

Well, our time is up for today. Hopefully, today's session has been enlightening and thought provoking (and kept you awake). This has been a lot of information to digest in one session - with a lot of advanced concepts. Don't hesitate to send me questions. It's important to understand the concepts of how options work together before you can comprehend the more complicated strategies.

_____________________________________________________________

Mike Parnos
Mike Parnos, the "Options Therapist" and the HCP (Head Couch Potato) of the Couch Potato Trading Institute. He's been trading, consulting, teaching option strategies and presenting seminars for over 12 years. He specializes in conservative and non-directional strategies while providing therapeutic guidance to individuals, brokers and institutional traders individually and at his seminars. He welcomes new patients and Couch Potato Trading wannabees. Five couches, no waiting. Send questions or comments to Contact Support.

(End of Article)
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

TRIPPIN' TO THE PHILIPPINES
Just a word to CPTI students. I will be leaving on Wednesday, August 10th for a two-week adventure to the Philippines. I will be moving around from city to city and I will be taking my trusty laptop. I tell you this because I don't know what the Internet capabilities will be like there. I will do my best to post regular articles, etc. But, the days may be different. Plus, I won't be able to answer questions as quickly as usual.

Have your exit points in mind in case the market or a trade gets away from us. I won't necessarily be able to see the daily action or to send out timely alerts. You will, to a large degree, be on your own when it comes to exiting trades. If you're not up to that, don't put on any new trades that you won't be able to handle.

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

AUGUST POSITIONS
CPTI AUGUST Position #1 - SPX Iron Condor - 1226.42
On Thursday, June 23 with the SPX trading near 1200, we sold 12 Sell 12 SPX August 1140 puts and then bought 12 SPX August 1125 puts for a credit of $1.30 ($1,320). The market moved down in the morning and we were able to get filled at $1.30. Some CPTI traders who were late to the dance got even more.

Then, on June 28th, we sold 12 SPX August 1265 calls and bought 12 SPX August 1280 calls and actually got filled at $.70 ($840), although we placed the order for $.65. That is not an unusual occurrence when you have the right broker.

Our total net credit for the Iron Condor is $2,160. Our maximum profit range is 1140 to 1265. That's pretty comfortable, but we have to wait for another seven-plus weeks. Maintenance is $18,000.

CPTI AUGUST Position #2 - SOX Iron Condor - 471.19
On Friday, July 01, with the SOX trading near 420, we put on an Iron Condor.
We sold 12 SOX August 380 puts and bought 12 SOX August 370 puts for a credit of $.60 ($720). Then we sold 12 SOX August 465 calls and bought 12 SOX August 475 calls for a credit of about $.60 ($720). Our total net credit and profit potential of about $1.20 ($1,440). Our maximum profit range is 380 to 465. Our maintenance is $12,000.

On 7/19 we closed the SOX Iron Condor for $500/contract = $6,000. Our loss is $6,000 - $1,440 (premium received) = $4,860.

CPTI AUGUST Position #3 - SPX Bull Put Spread - 1226.42
On July 8th, we sold 12 SPX August 1145 puts and bought 12 SPX August 1130 puts for a credit of $.90 ($1,080). We will watch for an opportunity to put on a bear call spread. But we won't compromise safety for premium. Maintenance is $12,000.

CPTI AUGUST Position #4 - RUT Bull Put Spread - 662.79
On July 14th, with the RUT trading near 667, we sold 12 RUT August 620 puts and bought 12 RUT August 610 puts for a credit of $.55 ($660). Again, we will watch for an opportunity to put on a bear call spread to complete an Iron Condor, but we won't compromise safety for premium. Maintenance is $12,000

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

SEPTEMBER POSITIONS
CPTI SEPTEMBER Position #1 -- SPX Bull Put Spread - 1226.42

On July 29 with the SPX trading at about 1240, we sold 12 SPX September 1175 puts and bought 12 SPX September 1160 puts for a credit of about $.80 ($960). We had about a 65 point cushion -- and various support levels above. Maintenance is $18,000.

CPTI SEPTEMBER Position #2 - RUT Bull Put Spread - 662.79
On August 3 with the RUT trading at about 685 we sold 12 RUT September 630 puts and bought 12 SPX September 620 puts for a credit of $.85 ($1,020). The cushion is about 55 points with support levels above the short strike price.

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

ONGOING STRATEGIES
ZERO-PLUS Strategy - September SPX Bull Put Spread - 1226.42
In my Feb. 8, 2004 column, I outlined a strategy based on an initial investment of $100,000. $74,000 was spent on zero coupon bonds maturing in about seven years at a value of $100,000. The principal $100,000 investment is guaranteed. We're trading the remaining $26,000 to generate a "risk free" return on the original investment.

In July, we placed an SPX Iron Condor with a total net credit was 1,500. It expired worthless. Our new cash position is: $31,500 + $1,500 (July Profit) = $33,000

This week we sold 20 SPX 1165 puts and bought 20 1150 puts for a credit of $.65 ($1,300). If the market levels off, we'll try to put on the bear call spread to complete our Iron Condor.

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

QQQ ITM Strangle - $39.48
We own 10 January 2007 $42 puts and 10 January 2007 $32 calls at a total cost of $14,600. Only $4,600 is at risk as the other $10,000 of intrinsic value will always be there. We then sold the March $36 puts and $38 calls, taking in a total of $1.10 ($1,100). If all goes well, the QQQQs will close somewhere between $36 and $38. We will then sell the April near term options, etc. etc. The objective is to sell premium every month for the next 22 months. When all is said and done, we should be able to show a very nice profit.

We rolled out of the July $37 calls and July $37 puts to the August $37 calls and August 37 puts. We took in a total of $.50 ($500). Our current short positions are the August $37 puts and August $37 calls. Our new total of generated premium is $4,900 ($4,400 + $500).

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

TWO NEW CPTI SEMINAR DATES!!

NEW CPTI SEMINAR DATE #1 -- DENVER, CO - OCT. 15/16
NEW CPTI SEMINAR DATE #2 -- DETROIT, MI - NOV. 5/6

We have liftoff, folks. I received an enthusiastic response from the good people in the Denver area. I'm pleased to announce the next CPTI seminar will take place on Saturday & Sunday, October 15th & 16th in Denver. Then, the next will be in Detroit on November 5th & 6th.

Our CPTI seminars are limited to ONLY 25 ATTENDEES. If you're a serious options trader and you want to learn the nuances of our advanced non-directional trading strategies and hone your trading skills, contact me ASAP at mparnos@optioninvestor.com. I'll send you all the pertinent information. The price is right -- $995.00 -- less than one profitable Iron Condor trade -- and you'll have a two-day experience that you'll remember, and profit from, for a lifetime.

Our recent Philadelphia CPTI Seminar was a great success (they all are). There are now 25 newly enlightened minds, with smiles attached, ready to generate a healthy annual return using our CPTI strategies. Remember, if you attend one of my CPTI seminars, you are entitled to retake the seminar a second time at NO CHARGE!

30 OUT OF 32 PROFITABLE MONTHS!

WANT TO ACHIEVE SUCCESS WITHOUT STRESS? OF COURSE YOU DO!! USE OUR CPTI WEALTH-BUILDING TECHNIQUES!

You should really try and make one of these seminars, if you can. With what you learn, you'll see a substantial increase in your trading results. Contact me at mparnos@optioninvestor.com. If you've already signed up, I'll see you there. If you haven't signed up, what are you waiting for?

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

HAPPY TRADING!
Remember the CPTI credo: May our remote batteries and self-discipline last forever, but mierde happens. Be prepared! In trading, as in life, it's not the cards we're dealt. It's how we play them.

Mike Parnos, Your Options Therapist and CPTI Master Strategist

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

Couch Potato Trading Institute Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what? It isn't the fault of the strategies.

Couch Potato Trader Updates Archives