How I Choose my Trades

Mark,

First and foremost I want to wish you a very Merry Christmas. I also wish to thank you for your gift to us of the Options for Rookies website. It's helped me learn a lot, along with your O.F.R book. Especially the "lose the pride, take the loss early" lessons.

I would like to ask you to consider a segment that would talk about your thought process in choosing your trades. If possible, I'm curious how you choose your spread widths, lot size, and strikes and what products you trade in overall.

I've noticed before your protocol of striving for a $3.00 premium for IC's. Is that a one-lot price or the total value for numerous contracts? I currently do only paper trading in Paper Money on Think or Swim (6 months now in verticals and IC's)and I see a lot of loss-risk vs. reward on the p/l graph when I try to reach those levels.

I thank you for any help in this area and again wish you and yours the best.

Bob

***

Thanks or the good wishes. I'm having a very happy Chanukkah right now, and hope to enjoy Christmas as well.  Your request is a good one, but my technique is pretty simple and thus, don't on't know how useful it will be to others.

The $3.00 is a one-lot price. I find it much easier to follow discussions when trades are broken down into the lowest common denominator, and so that's the way I write.

 

Market Bias

When making trades, the first thing to consider is whether you want to take a neutral, bullish or bearish bias.  This part is simple for me.  I never know what to expect, so I always choose a market neutral stance. 

 

Strategy

There are always several strategies that suit a trader's market expectations and it's a good idea to experiment with several and maintain anything that works for you as part of your trading arsenal.  I've come to favor iron condors, and use them most of the time.  This is something for each trader to decide for himself – especially when in the paper trading stage.

I'll shift to double diagonals if and when I expect market volatility to be higher over the shorter-term, or when I believe IV is 'low enough' that I do not want to trade short vega positions.  It's important to have a suitable strategy when seeking profits from an option position.  You cannot just go out and'do something' and hope it works.


Underlying

If you have some market expectations – regardless of direction – it's important to choose an underlying that you believe will participate in that directional move.  Other considerations are ease of entering trades, width of bid/ask spreads, satisfaction with fills, ability to adjust when necessary.  Once again, lacking predictive powers, I use a broad-based index, and always trade Russell 2000 options (RUT).  That may not be a good idea for you, but it's how I do it.

 

Specific Iron Condors

I know this is the heart of your question

1) Spread width.  I hope that you understand that this is far less of a big deal than it appears to be.  I choose 10-point iron condors because I find them comfortable to trade.  It's as simple as that.

If you want to trade 20-point spreads, there is one thing that must be understood.  A 2o-point spread is exactly the same as trading two consecutive 10-point spreads.  Here is what I mean:

Selling the 480/500 call spread is exactly the same as selling:

The 480/490 call spread and then selling the 490/500 call spread.  There is nothing 'special' about the 20-point spread.  I consider it to be a compromise and would choose that any time I was not sure which position I preferred to have in my portfolio: The 480/490 or the 490/500.  By choosing the 480/500, I get to sell an equal quantity of each spread.

One major point is obvious, but must be made:  NEVER sell the 480/490 and then immediately sell the 490/500.  That foolishly spends twice as much in commissions and increases slippage (the cash lost when trading due to the fact that we must deal with bid/ask spreads).  Just open the 480/500 spread in a single trade.

However, if you have a position in the 480/490 call spread, there is no reason why you cannot trade the 490/500 call spread at a later time.  Perhaps it would be adding a new trade to your portfolio. Or it may be part of an adjustment.

2) Lot size

If I am ready to be fully invested right now, then I decide how much margin money to have tied up in this trade, and enter an order for the maximum size.

When doing that, I always reserve some margin room for future adjustments, if needed.  If you never use anywhere near your maximum available margin, this is not a consideration.

At other times, I'll enter a portion of my preferred trade size, to get started, and then try to do more an a better price.  So, for example, if I decide to allocate $20,000 of margin to a new February RUT iron condor, I would enter an order to trade 20-lots of my preferred iron condor.  I'd keep the cash generated (let's call it roughly $6,000) available for future adjustments.

Alternatively, I would enter an order to trade two different iron condors, 10-lots each.

Most of the time, I enter an order to trade 4-lots.  Then trying to get $0.05 more for a 6-lot.  Then I try to add the final 10-lot for yet another 5 cents better.  If I cannot get my better prices, I have two choices.  I can go back to my original trade price, find another iron condor, or just play smaller size that month.

I do not take too long to get as invested as I want to be.  Perhaps Monday thru Wednesday after expiration (I'll open March RUT positions once the December option cycle is over)

 

3) Premium (price) and strikes

Each trader has a primary method.  Either the strikes are more important or the premium is moe important.  For me it's the premium.

One good way to choose strikes is by standard deviations.  The trader sells spreads in which the short option is 1.0, 1.5, or any other number of standard deviations out of the money.  This does not work for me, but it truly is a viable method for selecting strike prices.  It has the advantage of keeping the probability of seeing the options expire worthless at the same level (at least on the day the trade is made) each time you open new positions.

I prefer to take in a certain cash premium for my 10-point, 13-week iron condors.  Note:  I am not insistent.  If I find that the strikes chosen don't feel right – because of a market bias (I may not want to be bullish or bearish, but that does not mean I must ignore those thoughts.  If I feel my chosen strikes are just not far enough out of the money, then I'll take less premium and move out one additional strike price).

My preferred price is $3.00.  I always seek higher prices when implied volatility is high and the price of credit spreads is higher.  I could move further OTM, but prefer to collect $3.30/$3.40.  This is fairly flexible.  When concerned with risk, I'll go farther OTM and collect nly $3.00.  My point in offering this much detail is to explain that this is very flexible for me.

When IV is low, and it is lower than it has been in a long time right now, I'll just take $2.60 or $2.70. I'd rather feel safer going into the trade.

I don't always open three-month iron condors.  If I believe IV is just too low to sell extra vega (3-months options have more vega than 2-month optioons), I'll sell those 8- or 9-week options instead.  I prefer to collect just over $2.20 for these trades.  Hwever, as you may anticipate, it's a flexible number.

If you trade a different underlying, they these prices would be meaningless to you because the implied volatility of the options would be very different.

4)  Products.  i do believe diversification is important when selling premium.  Thus, if trading individual stocks, I'd want to have about five positions open simultaneously.  Trading indexes, I feel that supplies sufficient diversification and there is no advantage (for me) in trading more than one product.  This is the main reason:  If trouble looms, if the markets get violent, I want to have the fewest possible posiitions to adjust.  One product ismuch easier to handle than two.  I may lose a bit to diversification safety, but I make up for than in having half as many troubled positions to handle when important decisions must be made.  True my trade plan helps with those decisions, but I prefer to depend on being able to 'see' what's available at the time when others may be in a panic.

5) Expiration months

I'm happiest with 13week iron condors.  But when IV is especially low, or I don't like the premium available from 3-month trades, I'dd choose 2-month positions instead.

I do not trade front-month options,except to exit any front-month positions that I still own.  I do this to avoid positions with so much negative gamma.  yes, I give up the rapid time decay, ut it's safer and I'm happier with less overall risk.  You may feel differently.  that's ok.  Most traders prefer to trade front-month options and love trading the Weeklys. (RUT has no Weeklys as of this writing).

Bob, I hope that gives you enough insight to allow you to find methods that are suitable for you.

848

 

 


 

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