I can hear the groans. You've heard enough about Keltner channels. You don't use them and don't intend to use them and they look like gobbledygook to you.
I didn't intend to write another article about them so soon, either, but a question from a member of my trading club prompted me to reconsider. Most of us in our small group trade condors, and that member wanted to know how I used nested Keltner channels in my condor trading. A fair number of our subscribers also trade condors or other types of combination trades, so they might like a look at how Keltner channels or other types of channeling systems such as Bollinger bands might be used to establish entries.
For those of you new to the site and options trading, condors are a type of combination options trade. They involve selling a put and a call, usually but not always out-of-the-money ones, and then hedging risk by buying a put with a lower strike and a call with a higher strike. For example, for the May option expiration cycle, I had condors on the SPX with sold strikes at 1505 for the call and 1120 for the put. I hedged those by buying a 1515 call and an 1110 put.
The person establishing the condor takes in a credit since the sold strikes are closer to the action and therefore more expensive than the strikes bought to hedge the position. The credit is deposited in that person's trading account. This is an example of a high-probability condor, a kind in which the trader bets on a high probability that the SPX will not trade across the sold strike at expiration. In that case, the entire credit stays in the account. I don't let my condors go into expiration, closing them out earlier and locking in a lesser amount of profit. For example, I closed out those May condors on 3/31 and 4/02. Exit strategies are a discussion for another forum, however, so let's move the discussion back to entries.
Other types of condors can be established, but any trader considering a condor or a credit spread of any type should know its pitfalls well. The risks are high in relationship to the credit one takes in. Mike Parnos' Couch Potato site is a sister publication devoted to trading condors and is the site I studied for two years before changing the proportion of my trades devoted to such strategies. Dan Sheridan's webinars on CBOE.com also often are devoted to strategies related to condors, so you can listen to those for extra information.
I use nested Keltner channels to optimize my entries for each leg of a condor. Some condor traders enter the whole condor--the bear call spread and bull put spread portions--at once, but most times I don't. Each method of entering can have its pros and cons, but I like to wait for wide swings to the upside to establish the bear call portion and wide swings to the downside to establish the bull put portion.
One of the cons to that method is that I sometimes don't get the swing I expected to get me into one side of the condor. I end up with the side only in the direction of a trend. That's not fun. Most times, though, this method provides me with sold strikes that are perhaps farther apart than they would otherwise be.
Nested Keltner channels can be utilized to find optimum entries for each leg of a condor, times when it appears that the markets may be at a turning point and a swing one direction about to reverse. They also give the technician some idea of potential targets, suggesting where the sold contract should be placed.
A couple of weeks ago, I snapped a chart showing what had happened over the last couple of cycles. Unfortunately, however, I typed the annotation incorrectly, and if I correct it now, the chart will look doctored with respect to the top annotations. What I should have written in the bottom annotation was "Here is where I was looking for May BULL PUT spreads," not BEAR CALL spreads.
Annotated Daily Keltner Chart of the SPX:
Here's another chart also snapped a couple of weeks ago that shows the procedure I was going through at the time I entered those June 1530/1540's. It's the chart that had shown the potential upside target near 1550, mentioned in those previous annotations.
Annotated Three-Day Chart of the SPX:
Intraday charts can be used to fine tune the entrance, and I used them that way to enter the June 1530/1540's.
Annotated 30-Minute Chart of the SPX:
Annotated 15-Minute Chart of the A/D Line:
What about the bull put spread? Remember when I talked about one of the cons of not establishing both sides of the condor at the same time? The risk is that you won't get an opportunity to establish the other side, that there won't be a swing in the direction of the other side. So far, that swing toward the downside that I feared has not occurred, but the next chart depicts what I was watching for as of two weeks ago.
Annotated Daily Chart of the SPX:
That downturn never occurred and the chart setup is different now, if it did, but I had turned to intraday charts to fine-tune my expectations two weeks ago. They allow traders to set up if/then scenarios. Let's see what they were showing and why I was still hesitating a couple of weeks ago, perhaps missing for good my chance to get into bull put spreads for June.
Annotated 15-Minute Chart of the SPX:
As of about 1:00 pm on April 25, those if/then conditions had not been met. The SPX looked as likely to rise up toward 1397-1404 as it did to fall toward 1375.40, and that's exactly what it did.
As of today, May 9, I'm out of those 25 June 1530/1540 bull put spreads that I had established as the SPX began testing what I thought might be strong resistance. I had collected $0.50 credit for those and got out for a $0.17 debit, so kept $0.33 per contract minus the commissions. If the SPX should rally again, perhaps I'll have the opportunity to put those bear call spreads back on again. If not, if next week brings a sharp downturn to the 30-sma, I'll be watching how the downturn acts and deciding if I can find some bull put spreads that interest me. That 1354-1358 potential support level has now risen to 1375-1376, so if the SPX should roll over next week and hit that level, you'll know I'm bent over the computer, deciding whether I can get enough premium on strikes low enough below the action to interest me in June bull put spreads. I've got my wish list sitting right by the computer monitor.
The Keltner setup used on these charts was as follows:
Smallest blue channel, based on the 9-ema, with a multiple of 1.4.