Air it Out

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From the vast spaces of North-central Montana– the Rocky Mountain Front

A Trade and a Method

I trade the weeklies.  One has 52 trades a year.

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SPX, one-year daily with the two most recent trading ranges highlighted.

I set up the trade on Sunday. I consult the weekly average true range; the implied volatility and volatility skew in SPX; the open interest at key support and resistance points; the volume profile of the previous week; the oracle-like pronouncements of Charles Kirk and the Shadow Trader; my own charts; and my friend Bert.  I settle on a range and add some on either side to make sure I’m hiding my short positions south or north of a thick shield of open-interest resistance or support.

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The JAN4 2014 SPX option chain. Notice large open interest at the 1825 and 1800 strikes in the puts and 1850 and 1860 strikes in the calls.

On Monday, I try to place the trade. Lately the implied volatility has been very low; the lowest credit I’ll settle for is .25. I’d like to make 3% in the account every week; but this is more difficult to do when implied volatility is low– essentially, there are more sellers of options than buyers (so watch out).  If filled, I intend to sail the condor through expiration entirely out of the money.

A. How do I defend the trade?

1. Control delta. I don’t want to be long or short more than the SPY equivalent of 100% of my account size in SPY delta. For instance with SPY trading at 184.18 per share and if my account were 18,418.00 USD, I would not allow my delta to grow or diminish to more than 100 delta (shares) long or short.  By keeping the delta in this range, I make it comfortable to hold the position– knowing that if I had the same money in a mutual fund, I’d be exposed to the same theoretical price risk. To keep the delta within range, I buy or sell long options.

2. If my short strike is hit with one day to go until expiration, I’ll try to get out at 1 USD loss per contract.

3. If I’m within .5 standard deviation of a short strike prior to settlement on Friday (monthly options), I’ll probably bail out on Thursday.

4. This is a better safe than sorry trade; for the risk to reward is poor and the risk of ruin is higher than other spreads. In compensation, the likelihood of profit is high. One should not over play one’s hand and sell too many iron condors.

Capture

The expiration graph of a short delta, long theta ratio spread

Note: I do not like negative theta (i.e., to lose money holding long options due to time decay); for this reason, I try to spread my long positions as soon as possible. I like to establish some equity in the long option and then sell something, either to continue the trend or against the trend, depending on my general view of market direction. Because I tend to spread longs whenever possible in this manner, I usually build up a collection of long and short option spreads that can be closed for profits.  A spread with open short positions can also form a ratio spread with its own expiration graph. (I consider this a side business of sorts).

B. How do I determine market direction?

1. The major direction is determined by Fed policy and the global reaction to it. If the American public forgets 2007 and 1999, then things could really go parabolic.

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A short-term inverse head and shoulders appears in the S and P 500 futures; it corresponds to a range trade and to key levels in a Fibonacci retracement graph. Frequently, I find such overlapping technical patterns.

2. The short and intermediate terms, however, are more subject to chart patterns that the big players and their computers are also watching.

C. What do I do if I can’t get the trade filled on Monday?

1. Pick a side of the trade that buys the weakness or sells the strength of the market, and sell that credit spread. The benefit is that commissions are lower.

2. Use calendar spreads to obtain a position that is theta and volatility positive. One can control the delta in a similar manner as described above.  If oriented correctly, calendars can turn profitable in 24 hours.

badger two medicine

Summer in the Front Range

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