Covered call alternatives; part V.
I had intended the series that I named 'Covered Call Alternatives' to end with four posts, but received two excellent questions and am reproducing those comments and replies to share with all readers.
I'm looking for a good name for these 1 x 3 x 3 spreads, first described here. Suggestions welcome.
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Mark,
Thanks for the excellent series! There is just one thing I don't understand.
In my own paper plotting, using the example where you write 3 SPY 106/109 call
spreads, it's pretty clear that profit decreases as you move through the 106 to
109 range at expiration. This makes intuitive sense, since in that range, you're
losing 3 for every 1 you gain.
If you instead write 1 call spread, that should result in the profit curve
being flat as you move through spread at expiration. Profit is the same at 106
as it is at 109 and every point in between. It picks up again after clearing the
upper strike.
So my question is why do your P/L charts show a monotonically increasing
profit? I would expect the example using 1 call spread to show the profit curve
go flat between the strikes of the spread, and anything with more than 1 call
spread should show a decline as we move from lower to upper strike.
Thanks for clarifying,
Rob
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The charts are drawn as of the day the trade is made.
As expiration nears, your idea of how the charts should look becomes reality. Thus, if SPY moves higher now, profits grow. Nearer to expiration that is no longer true in the 106 to 109 range.
Why?
NOW, the 106/109 spread does not approach it's full value of $300 until SPY is far past 109. In other words, the spread carries time premium. That's reasonable because the more time remaining, the greater the chance that SPY will again move lower. That's just another way of saying the spread isn't worth the maximum until time is very short or the options are deep ITM. Thus, the single long option has enough delta to overcome losses associated with the three spreads - at this point in time.
At expiration, the 106/109 spread reaches nearly $300 much sooner, and time decay has hurt the value of your long option. Thus, the longer you hold, the less profitable the bad range. But the spread is still good on the big move, never loses money (other than original cost) at any price, and affords excellent protection.
This is just an adjustment, not a cure-all. Thus, it is still necessary to be careful with original iron condor and not allow it to get anywhere near the maximum loss - unless your protection is so good that most of the loss is canceled by the adjustment.
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Mark,
Thanks for writing these articles. I am new to the blog and really enjoying them.You mention that this strategy may be a way to adjust an iron condor. Of course, I realize that you could not give specific advice, etc, but what would be the best way to utilize this strategy?
Would you wait until price moved to your short strike, then place the entire trade? Would you trade your original IC with an extra long at the wing, then place the additional credit spreads when price moved to the short strike at the wing?
Thanks again!
Jon
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As I say repeatedly, there is no 'best' way because we each have our own needs and comfort zones.
1) I invest by buying insurance before it's needed. For many traders, that's a waste of money.
So I add these spreads when prices are favorable. I BUY the PUT version on rallies. I buy CALL version on dips. I prefer to buy only one or two of these at a time, adding more (only as needed) when prices get better.
Sometimes I go for a better strike price. For example, bought the RUT Jan 620; 640/650 spread earlier. Today I added the 610; 640/650. With RUT lower, I bought a position with better protection at an acceptable price. I cannot recommend prices. You will readily develop a feel for how much you want to spend on insuring your portfolio.
2) Something else I like, that may not appeal to you: adjusting in stages. That means I do an early adjustment before my position is in trouble. Thus, I would adjust a RUT IC when the short is 20 or 30 points OTM. I would buy the strike that is 10 to 20 points OTM and choose an appropriate spread to sell three (or four) times.
3) If you prefer to wait, then I suggest using your risk graph to help you choose which options to buy and sell. You want acceptable risk at a reasonable cost.
One rule that suits me: The option bought should be nearer to the money than your short option. The longer you wait as the stock moves against you, the more the adjustment costs.
4) Many people like owning extra longs at the wing. I do NOT. Repeat: I do not. But if you do, this is an option I suggest buying early - as a separate insurance play. I do not recommend making a 'wing' purchase as part of this 1 x 3 x 3 play.
I want an extra long that will always be good to own, and that includes the time when expiration nears (if you still own position). OTM option lose their power as time passes. They turn into insurance against a disaster only, instead of providing gains or reducing losses in the more common situations.
This isn't a strategy in which you add to wings. This play is to buy an option that affords REAL protection at all times and the cost is reduced by selling the extra spreads - with appropriate strike prices. If you are not sure which strikes work - or just how many to sell - use those risk graphs to give you a good idea of portfolio risk.