We recently told you about a GS Butterfly we entered. The thesis behind entry, chosen legs, etc is explained in the video embedded into this post.
This GS Dec 95/100/105 Butterfly position was entered at 0.70, meaning for every spread entered there is a capital risk of $70 for a max potential reward of $430. Today, the market price on the spread was between 1.45-1.60. We decided to take profits on half of the position in order to recoup the initial capital investment and let the remaining 50% of the position ride for free. Our half position was exited earlier today @ 1.50, a gain of $80 per spread or 114% return on risk!
This was a low probability of success trade entered to skew our high probability portfolio down a bit, so it made since to recoup the initial capital since all the the previous high probability trades in our portfolio have since been exited.
So far we have nailed this trade, and Members are happy with the results. If we peg 100 on Friday, the other half of the position will be closed for a substantial profit on the trade.
I have been using Technical Analysis for many years. To me, Fundamental Analysis is great but takes too long to pan out. Technical Analysis can provide the short term perspective needed to logically enter a short term Options trade.
That said, I have a theory about Technical Analysis. The more basic the better. The way I see it, there are tons of people watching basic technical items such as defined support & resistance, trend lines, bull flags, head & shoulders, 200 day simple moving average, and the likes. All of these people react accordingly to these basic technical parameters, which in turn is why they often work!
When you try to get fancy with fibonacci arcs, linear regression channels, and all the other technical studies that no one pays attention to…that’s when you start to win less.
I have been doing this for many years and have tested all sorts of technical studies. In the end, I always come back to basics. Now I don’t even try to get fancy. The craziest things I use are MACD and RSI (Wilder), and I don’t pay much attention to them unless I am somewhat “iffy” on a technical price level and am looking for some secondary confirmation.
All in all, I am a firm believer in the power of technical analysis. I should be, I’ve made a lot of money because of it. This stuff works, as long as you keep it simple.
Next time you form a technical thesis on something, ask yourself “Is this basic enough? Is there a high probability that tons of active market participants see this too?” If the answer is yes, create a logical high probability Options trade that compliments your technical thesis. My guess is you will be happy with the results.
Hopefully you didn’t get the wrong idea with yesterday’s post on how to survive volatile markets. The word “survive” may have given you the impression that volatility is a bad thing, but that is not true at all.
Volatility provides opportunity if you know what you’re doing. A good place to start is by comparing historical implied volatility to current implied volatility. If you’re a thinkorswim user, you can accomplish this by adding “Historical Volatility” under Volatility Studies on TOS Charts. Pull up a one or two year chart and you will get a quick idea as to the historical IV average.
Let’s use SPY as an example. The historical volatility is approximately 15%. Current IV for January is 29%, meaning IV is approximately 2x historical levels. That means premiums are rich and, with the proper strategy, you can take advantage of that.
SPY is just one example. In today’s high implied volatility market environment there are several liquid derivatives trading at 2x, 3x, and even some higher than 3x historical IV levels. This is best taken advantage of by being a net seller of Options. High IV markets are great for selling Strangles, Iron Condors, Naked Puts & Calls, Credit Spreads, and a few other less common strategies.
In the case of Short Strangles and Iron Condors, you are able to go much wider than usual on your range further increasing you odds of profitability in a range bound trade strategy. In the case of Naked Puts & Calls and Credit Spreads, you are able to give yourself a little more cushion to be wrong and still make money on the position.
Bottom Line: Do not be scared away by volatility. Embrace it and apply strategies that allow you to capitalize because of it.
No matter how good a setup looks to us, we will pass if the underlying does not have a liquid derivatives market. By liquid, we mean a bid ask spread no wider than 0.05 on the front month closest to the money Call or Put.
We make exceptions to this rule in high priced stocks like GOOG & AAPL, but anything priced 200 or less falls in the 0.05 liquidity standards.
2. Keep duration on your side
Time is a beautiful thing when trading a volatile market environment. Reason being, a trade can look awful one day and be just where you want in two days later. If you are short on time, you may not be able to hold long enough to see the position move in your favor.
That’s why we have been avoiding Weekly Options for the most part as of late. We tend to focus on monthly Options, entering new back month positions 10-14 days prior to front month expiration. Plenty of time for volatility to revive your position if the trade goes wrong.
3. Eliminate Stop Risk
When trading Equities or Futures, the best way to define your risk is to put a stop on. Well, in volatile markets stops do one thing…they hit. A defined risk Options strategy allows you to define the amount of capital you are willing to lose without having to place a stop on the position. This means that the underlying can move against you (which is likely will in any market, but especially in a volatile one) and you will not be forced out of the trade.
Options are amazing for many reasons, defining risk without a hard stop is one of them.
We’ll keep this one as simple as possible. There was a nice defined range between 50 support & 59 resistance in QCOM per the one year chart.
The overall market was bullish, and QCOM was approaching the 59 resistance level. We noted implied volatility levels of approximately 2x historical levels, and saw an opportunity to place a Short Strangle on the stock in an effort to profit off QCOM within a very wide range.
We sold the Dec 50/60 Strangle @ 1.29 (purple oval), giving us an upper breakeven of 61.29 and a lower break even of 48.71.
After only a few days, QCOM sold off and was sitting in the middle of our range. The spread value decayed over 30% in just a few days on the move, and we didn’t like the price action we were seeing in the overall market. To be safe, we decided to take profits on this undefined risk spread. On November 21st (just three short trading days later), we covered the Strangle @ 0.85 (green oval), a gain of $44 per spread. A 34.11% decay in the Strangle price in three days…beautiful!
The beauty of this high volatility market is that you can go super wide with these Short Strangles and still get paid a decent amount to sell them. This trade is a great example of just how wide you can get.
For educational purposes, here’s the trade analysis video we sent to members along with the detailed written trade alert.
As noted in our “Most Recent 15 Trades” post earlier today, we are recapping some of our recent trades for educational purposes. Let’s talk about the SPY Iron Condor we exited on Wednesday.
Reason for entry: There had been a very nice range in SPY between 110 & 122.50. Here’s a visual…
Once SPY broke above resistance, it quickly moved to 130 then began showing signs of range bound action in a tighter range. We noticed this range and, given the high implied volatility, saw an opportunity to sell a wide Iron Condor based on the new found range.
What was the trade: We sold to open the SPY Dec 118/120/130/132 Iron Condor on November 7th @ a fill price of 1.15 (credit).
What happened?: Things went well until the market started selling off heavily on November 17th. By November 25th, we were starting to get concerned about this spread. The good news was we had plenty of duration (time) left in the trade and there were several technical indications across the market indicating a potential short term pop. We decided to continue holding rather than cutting our losses, which proved to be a good decision.
End result: The market rallied, taking SPY back to the middle of our range. We saw this huge upside move as a gift, and sent an exit alert to members the morning November 30th after the +3.5% bull gap opening in the S&P 500. We covered the spread 0.68 for a gain of $47 per spread, or +55.29% return on risk! A beautiful trade!
Can a brotha get a few more visuals??
Here’s a visual of the tightened range we based entry on. Purple oval indicates entry, green oval indicates exit, and the small blue ovals indicates the break even price points on the spread.
Here’s a shot of the chart below zoomed in to a 30 day chart, gives a better perspective of entry & exit.
Last but not least, here’s the analysis video that members were provided with along with the detailed written trade alert!
We posted this trade idea on TLT on November 18th. Today would be a great day to exit the trade for a healthy profit. Let’s do the math…
Entry price on 120/121 would have been 0.38. That trade could easily be covered @ 0.20 here for a gain of 0.18 or +$18/spread.
Entry price on the Short 125 Calls would have been 0.80. Those can be covered here @ 0.15 for a gain of 0.65 or +$65/spread.
The overall gain (based on current pricing and assuming the fills mentioned in the original post) is +0.83 or +$83/spread
The trade did not go in the optimal direction initially, but part of trading is getting “gut checked”. The beauty of options trading is the ability to hold through moves that go against you without having to deal with stop risk (the risk of a hard stop in an equity or futures position being hit). Duration is a beautiful thing, as proven with this excellent trade!
Here’s a look at a 20 day chart of TLT. The blue oval indicates the entry on the day we published the trade idea article. The green oval indicates today’s exit. Gotta love it!