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TIME FOR EXPERIMENTATION

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TIME FOR SOME EXPERIMENTATION

I haven't forgotten what happened last month. I won't for a long time. Losses are something we accept in our trading business, but the memories linger - as well they should. We need to learn from them.

It has motivated me to explore alternatives and to refine our methods - to try and reduce, and/or further define, our trading risks. One of the thoughts that come to mind includes a minor change in philosophy. What would you think if we didn't have such a stellar monthly profit record? What I mean is that there may be months that we took minor losses, but, on the other hand, there would be months that would have potential for very large profits.

On the surface, the showbiz aspect wouldn't be so compelling. It wouldn't be so glamorous. We might have three out of five profitable months. However, instead of taking in $1.20 of $1.50 on a position, we would have the potential to make 20-30 points on a single position. A 20 or 30-point profit would make up for multiple small losses with a bunch of points left over for the good guys (us).

How might we achieve this? By using on of our other strategies - a variation on the iron condor - the Siamese Condor. Most Couch Potato subscribers are familiar with the Siamese Condor. We have, in the past, used them when trading our one-week quickies.

What if we were to put on a Siamese Condor with three weeks left in the option cycle instead of only one week? Now, with substantially higher volatility, we can establish a much wider range - increasing our probability of a healthy profit. But, because the range is smaller than our typical Iron Condor, we'll also increase our chance of a controlled loss. It's a tradeoff.

Now, we're just going through the thought process at this point. We're certainly not abandoning our bread and butter - the Iron Condor. But, we need to keep an open mind and not stagnate. If this concept works out, we might incorporate it as part of our portfolio in the future. It's worth taking a closer look - plus, it's a good reminder of another strategy in your trading arsenal.

For those of you who are new to Siamese Condors, below is a reprint of an article I wrote a long time ago.

The Siamese Condor (Reprint From Less Volatile Times)

Once upon a time there was an index of 100 companies - consisting of mama stocks, papa stocks and even some baby stocks. It had floundered around for a period of time - unpredictably moving up and down. It finally appears to be calming down. Maybe the whole index is back on its meds.

For whatever reason, indexes have a tendency to trend and then consolidate, trend and consolidate. Statistics indicate that they consolidate about 80% of the time. At this writing, they appear to be going through a consolidation phase. Sometimes this phase lasts for months - sometimes only weeks - until the baby stocks act out and have to be disciplined. Occasionally the mama and papa stocks get a little over excited. The results? Usually more baby stocks. For us to make money, we don't need to cure the disease, we only need to identify and observe the symptoms - then, position ourselves for profit.

With a week remaining before expiration, and a short-term consolidation seemingly at hand, let's explore how we can take advantage of this temporary sideways trend.

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.

The Siamese Condor -- 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

Friday, the OEX closed at 535.42. Over the past 2-3 weeks it has established resistance near 545 and support near 525. There's a high likelihood that OEX will stay within that range, and, probably, pretty close to 535. How do we take advantage of that prognosis?

How can we take in some money, give ourselves some room for error, limit our risk and make a few bucks at the same time?

The Favored Position

We can take in the most premium by selling the near term at-the-money puts and calls. 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 535 calls @ $5.00 (x 1000 = $5,000)
Sell 10 contracts of the OEX 535 puts @ $4.60 (x 1000 = $4,600)
Our total credit is $9.60 ($960 per contract) x 10 = $9,600

Thus far, we have taken in $9.60, 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 550 calls and 520 puts. Now we will:

Buy 10 contracts of the OEX 550 calls @ $.45
Buy 10 contracts of the OEX 520 puts @ $.55

The cost of giving birth to any unwanted financial dependents is $1.00 x 10 contracts = $1,000

Our net credit is $8.60 or $8,600 ($9,600 less $1,000).

Basically, what we have is a bull put spread and a bear call spread with the short puts and calls at the same strike (535). 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 $9.60 and our protection cost us $1.00. Therefore, we have $8.60 in our pocket. The closer OEX finishes to 535, the more of the $8.60 we'll be able to keep. If OEX finishes exactly at 535, all the time value would have eroded away in the week 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 we keep.

Our bailout point in this strategy on the topside is 543.60 - calculated by adding the $8.60 net credit to the strike price (535). On the bottom side, our bailout point is 526.40 - calculated by subtracting the $8.60 net credit from the short put strike price (535). 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 535, 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 options market, strange things happen. Although rare, stocks and/or indexes 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.

What If Scenarios

What if . . . OEX finishes at $537? The short $535 put will expire worthless along with the 520 put and the 550 call. We will have to buy back the 535 put that will have an intrinsic value of about $2.00. We took in a net credit of $8.60. The cost to buy the 535 call is about $2.00. Profit is $6.60 (x 10 contracts = $6,600).

What if . . . OEX finishes at 531.50? The short 535 call, the 550 call and the 520 put will all expire worthless. You will have to buy back the short 535 put for about $3.50. We took in $8.60. Profit is $5.10 (x 10 contracts = $5,100).

Bailout Points

What if . . . OEX moves up to 543.60 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 526.40. Remember, 543.60 and 526.40 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 535 calls and long the 550 calls. That's 15 points or $1,500 per contract. Our exposure is the difference between the strike prices (535-550 or 535-520). Our maintenance is the same for the put side as it is for the call side -- $1,500 per contract. We already have the $8.60 ($860 per contract). So, our actual out-of-pocket exposure is only $6.40 ($640). 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 526.40 to 543.60. That's a $17.20 range.

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 540/550 bear calls spread and a 530/520 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 530 to 540. 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 $8.60 if the OEX finishes near 535. That's substantially more than the maximum of $1.20 we would have made based a normal Iron Condor with a 530 to 540 range.

Lower Risk
Pay attention -- this will take some extra focus. With the normal 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.

With a Siamese Condor, for every dollar OEX moves away from the short strike (535), 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 $8.60, once the OEX reaches the 543.60 bailout point, there won't be much time value left in the 535 call - maybe $1.00 or less (depending on when the move occurs). You might have to pay $9.60 to close the short 535 call.

Then, if the OEX continues to move up, you might recoup $.25-$.40 (or more) when you sell the long $550 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 535/520 bull-put spread. With only days remaining until expiration, the value of the 535 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, if the OEX suddenly reverses and moves back below 535, you'll 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 535 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 550 calls and 520 puts for your protection, you can go out further and purchase the OEX 555 calls and 515 puts. The cost might be only $.40 compared to the $1.00 we paid for the 550s and 520s. Our final credit would become $9.20.

That would make our OEX profit (safety) range from 544.20 to 525.80. 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 an account size to accommodate the extra maintenance that 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 have your account with a brokerage firm that requires maintenance on only one side of the trade. Why would you want to tie up $10,000 for the bull put spread and another $10,000 for the bear call spread? A broker that holds only $10,000 for one side frees up the other $10,000 to use elsewhere - productively. Also, your broker should allow you to trade these strategies in your IRA account.


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Let's Give It A Try - Hypothetically, Of Course

We'll put on this virtual trade and monitor it. This market environment is certainly not ideal for the Siamese Condor strategy. The huge market swings can take us out of the trade. However, if we see a huge swing, we may come up with an interesting alternative adjustment. We'll talk about that more as the trade progresses. For now, let's put on our Siamese Condor.

Sell 4 XEO September 685 puts
Buy 4 XEO September 635 puts

Sell 4 XEO September 685 calls
Buy 4 XEO September 735 calls

Net credit of about $24.00

Total net debit of about $24.00. Our profit range is 661 to 709 (48 points). Based on current delta readings, there's about a 67% chance that the OEX will close below 709 and about a 71% chance OEX will close above 661. Without doing all the math, that would be about the same as one standard deviation in either direction. Our maintenance is $5,000 per contract = $20,000 (50 points x 4 contracts).

The appeal of this trade is that, after three weeks of market gyrations, the OEX might end up at (or around) 685. We have a potential of 24 points of profit ($9,600). The chances are pretty slim. But, remember, we're used to going through all this B.S. for $1.20. So, we might as well sweat it out for a possible 24 points. The closer OEX finishes to 685, the more we make. It should be interesting.

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SEMINAR DATE

Charlotte (Sept. 22nd & 23rd)
Don't wait to make your reservation. The seats go quickly.

There is one "retake" spot remaining for the Charlotte seminar. These retake spots are free for those who have paid to attend one of my previous seminars and who want to retake the seminar a second time. They're reserved on a first come first serve basis.

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CURRENT SEPTEMBER CPTI PORTFOLIO POSITION
CPTI September Position #1 - RUT - Bull Put Spread - 792.86

On 7/24, with the RUT at 822.70, we sold 20 September RUT 700 puts and bought 20 September RUT 690 puts for a credit of $.70 ($1,400). Total net credit and profit potential (so far) of about $.70 ($1.40). Our maintenance is $20,000. We'll look for opportunities to complete our Iron Condor if/when the market pops up.

CPTI September Position #2 - SPX - Bull Put Spread - 1473.99
On 8/3, with the SPX at about 1463, we sold 20 September SPX 1260 puts and bought 20 September 1250 puts for a credit of $.50 ($1,000). Our maintenance is $20,000. We'll look for opportunities to complete the Iron Condor if/when the market bounces.

CPTI September Position #3 - RUT - Iron Condor - 792.86
(Formerly August Position) On 6/29, with the RUT at 844, we sold 20 August RUT 740 puts and then bought 20 August RUT 730 puts for a credit of $.45 ($900). Total net credit and profit potential of about $.45 ($900).

Adjustment: On 7/26, we closed the original 20-contract bull put spread position and established a 30-contract Iron Condor consisting of the 670/660 bull put spread and the 840/850 bear call spread. Maintenance is now $30,000 and the new maximum profit range is 670 to 840. The profit potential of $900 remains the same.


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ONGOING STRATEGY - THE ZERO-PLUS Strategy
In the past, I outlined a strategy based on an initial investment of $100,000. At that time, $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. We are not compounding our profits by dramatically increasing the number of contracts we trade. With the July profits, our new cash total is $55,060 ($52,210 $2,850).

ZERO PLUS POSITION -

On 6/21, with the RUT at 839.81, we sold 30 July RUT 770 puts and then bought 20 July RUT 760 puts for a credit of $.55 ($1,650). Then we sold 30 July RUT 900 calls and bought 30 July RUT 910 calls for a credit of about $.40 ($1,200). Total net credit and profit potential of about $.95 ($2,850). We were 100% profitable and pocketed $2,850.

Watch for new Zero-Plus position to be announced soon.

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CPTI SEMINAR SCHEDULE!

SEPTEMBER 22nd & 23rd - CHARLOTTE, NC


Take your trading from a "hobby" to a profitable "business." You need the information you'll learn at my CPTI seminar. You'll learn more than the "how to's" of trading our strategies. You'll learn a new lifestyle - one that can last a lifetime.

DO YOU HAVE PROFIT-ABILITY?
It's always a challenge (and a pleasure) for me to have a roomful of bright people who have a passion for, and are excited about, learning. We go over everything imaginable - from the non-directional strategies to the psychology of trading. We cover a lot more than the mechanics. Inquiring minds want to know the whens and the whys -- not just the hows. That way, they're prepared for the best (and the worst) - and know the best way to handle either situation. Contact me and I'll personally call you with all the details.

If you're a SERIOUS options trader, 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. Send me your phone number. I'll personally call you with all the pertinent information. The price is a bargain - ONLY $995.00 -- less than the profit from one Iron Condor trade. Take advantage of the "early bird special" and save $100. You'll have a two-day experience that you'll remember, and profit from, for a lifetime. I limit my CPTI seminars to ONLY 25 ATTENDEES. And, as a bonus, if you attend one of my CPTI seminars, you are entitled to RETAKE the seminar a SECOND TIME at NO CHARGE!

52 OUT OF 57 PROFITABLE MONTHS!!
WANT TO ACHIEVE SUCCESS WITHOUT STRESS?
OF COURSE YOU DO!!
USE OUR CPTI WEALTH-BUILDING TECHNIQUES!

You should definitely attend one of my seminars. 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?

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HAPPY TRADING!
Remember the CPTI credo: Our remote batteries and self-discipline should 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

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Couch Potato Trader 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 (though many often do) 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.

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