A Beginner’s Efforts
Iron Condors
ITM Diagonals
A Beginner’s Efforts
Disclaimer!
I am a beginner and only offer my currentunderstandings. I make no claim regarding the verity orauthenticity of this presentation.
Iron Condor – What is it?
An Iron Condor consists of a short call and short putvertical that takes advantage of time decay in ahighly liquid range-bound Stock or ETF.
The underlying can move up, down, or sideways andhave a high probability of being a winning trade.
An IC can be used as a primary building block of anoption inventory.
Iron Condor – P, V, T
Selection of the strike prices for an IC is key tosuccess because of the range bound nature of thetrade.
An IC is a Vega negative trade and is best enteredwhen volatility is high.
An IC is a selling strategy and takes advantage ofTime Decay.
Greeks for the IC: Delta Neutral, Gamma Negative,Theta Positive, Vega Negative
Iron Condor – Steps to Entry
Check Open Interest; the greater the better, but aminimum of 20 times the number of trades entered.
Decide on capital allocation for the month and enterin five lots over four to five weeks.
Begin scaling in at 50 – 20 days to expiration.
Scale in on same day each week; accept 30%+ ROR;when 30% minimum is no longer available, go tonext month.
Iron Condor – Steps to Entry
To determine strikes, sell call at or above resistance;sell put at or below support or use 20 – 40%probability of expiring or use Straddle to captureMarket Maker Move.
Do two-point wide spreads as these save oncommissions by including two one-point verticals;they also earn more daily Positive Theta
Iron Condor – Steps to Entry
To illustrate the advantage of two-point spreadsover one-point spreads:
Sell -50 Sept 74/76/62/64 @ .66 credit
Commissions 309.95; Theta +104.96
Sell -50 Sept 74/75/62/61 @ .37 credit
Commissions 309.95; Theta +50.89
Sell -50 Sept 75/76/61/62 @ -.06 debit
Commissions 309.95; Theta +16.27
Iron Condor – Steps to Entry
Comparison
Two-Point Wide Spread
Commissions: $309.95
Theta: (+104.96)
Single-Point Wide Spreads
Commissions: $619.90
Theta: (+50.89) + (+16.27) = (+67.16)
Iron Condor – Steps to Entry
Position Sizing: Use no more than 2% on a Stock IC;Use up to 5% on an ETF IC. ($100,000 portfolio, riskno more than $2-5,000)
Compute IC Trade Risk: Strike width on one sideminus the credit collected; Portfolio Risk/PerContract Trade Risk = # of Contracts to sell.
A Double Calendar, Vega Positive, may be added tothe inventory to neutralize the IC negative Vega.
Iron Condor - Steps to Management
Check trades every day for possible adjustments.
If trade remains within the range of the two shortstrikes, do nothing.
If either side of the IC goes to 10% of the optionchain width, close; then, sell at a strike price withlower probability as long as there are 20 days left inthe cycle. (No extra Buying Power is required as thisis a replacement trade.)
Iron Condor - Exits
If trade moves outside the expected trading rangewith ten days left to expiration, consider
Scaling out: Exit 1/3 or ½ of the contracts at atime
Closing the trade
Staying to the end and trading the probabilities
When 80% of maximum gain is reached, exit.
Close within 10 – 4 days prior to expiration.
Iron Condor – Exits
Some will stay in the trade until the end of the cycle.Their rationale:
the trade was set up with a 30% chance of beingworthless and a 70% chance of being profitable
If the stock moves through both of our strikes, thetrader has experienced maximum loss; howeverin checking the Probability of Touching, there is achance of the stock reversing itself thus providingsome profit.
ITM Diagonal – What is it?
•An ITM Diagonal Spread is one that involves tradingoptions with different strikes prices and differentexpiration dates.
An ITM Diagonal sells a front month option that iscloser to expiration and buys a back month optionthat is further away from expiration.
An ITM Diagonal combines a calendar, in the frontmonth, with a vertical spread in the back month.
ITM Diagonal – Steps to Entry
ITM Diagonals are best done on upwardly trendingor range bound stocks or ETF’s
To select strike prices, begin by determining wherethe stock/ETF will be trading by the expiration of thefront month.
Use Greeks to support your choices.
ITM Diagonal – Steps to Entry
Choose to sell the strike with a Delta of approximately 30-40for the front month, keeping in mind that the stock musthave room to move to the chosen strike and expireworthless. A check of support/resistance and pace ofmovement of underlying can also be of benefit.
Choose to buy a strike with a Delta close to .70 for the backmonth. This needs to be below where the stock is currentlytrading because we want it to behave like the stock.
Choose 40 – 20 days to expiration for the front month and 60– 150 days for the back month. We want to slow down TimeDecay against us and accelerate Time Decay in our favor.
ITM Diagonal – Steps to Entry
It is best to do ITM Diagonals when $VIX is low.
A consideration to help balance an inventory thatincludes ITM Diagonals may be to enter tradeshaving negative Vega like long call and put verticalspreads.
Evaluate the advantages/disadvantages of anintermediate/long term Diagonal.
Greeks for an ITM Diagonal: Delta, Neutral, Gamma,Negative, Theta, Positive, Vega, Positive
ITM Diagonal - Example
Buy +1 IWM Jan 12 60 Call
Sell-1 IWM Sept 11 71 Call
Debit $9.51
Commission: $3.00
Greeks: +38.90 Delta; -3.39 Gamma; +3.27 Theta; +8.46 Vega
Stock/Option Equivalency:
Option: Controls 38.90 shares of IWM stock @ $9.51 = $370
Stock: Owns/Controls 38.90 shares of IWM stock @ $67.50
= $2,626
ITM Diagonal – Steps to Management
Manage the short option as a calendar whichbenefits principally from Volatility and Time Decay.
If the stock trades at the short strike (calendar),within 20-10 days to expiration, roll the position orpart of it.
Roll the short option when it has 10% of strike widthwithin option chain remaining.
Roll the short option within the 10-4 day windowbefore expiration.
ITM Diagonal – Steps to Management
Close the short option anytime you want to make$$$ on the long option without capping your gains.
Bullish, when the stock shows strength (MACD rollinghigher).
Take action if the trade as a whole goes into NegativeTheta.
Because this presentation is limited to ITM Call Diagonals,no attention is being paid to rolling ITM Put Diagonals.
ITM Diagonal – Steps to Management
When an underlying moves quickly, it may benecessary to roll strikes within any one calendarmonth, thus taking money off the table or taking onextra risk. Do this if the trade moves to NegativeTheta.
Keep in mind that the long option is the vertical partof the trade and therefore directional.
Roll down to .70 Delta, when the existing Delta hasmoved to .86 or .90+
ITM Diagonal – Steps to Exit
Keep track of debits and credits throughout thehistory of the trade.
Should the stock have reversed significantly andshould evaluation point to further losses, one mightconsider closing out the entire trade at whateverpoint of gain and/or loss the trade has earned.
ITM Diagonal – Some Observations
Diagonals can take more margin than Calendars
Volatility can work dramatically for and against thetrader; hence, the importance of managing the Diagonalin the context of an inventory.
In a strongly trending market, the Diagonal can be apowerfully profitable trade because it benefits from theDirectional Trend and Time Decay
It is possible to skew the direction of the diagonal in thecontext of a changing trend. However, there areTradeoffs.