MCTO Blog » options trading

Question about Iron Condor Options and if it will work in the current down environment

bradrr — Fri, 28 May 2010 20:42:00 +0000

Question: I have a question with regard to Iron Condors Options. Generally, Iron Condors are good for neutral to uptrending markets. If this is the case, do you see your system working given the current down climate.

Answer: I’m not sure I agree that Iron condors are good for uptrending markets. Iron condors have both a short put and a short call and we want the underlying stock or index to stay above the short Put and below the short Call through expiration. In general, with the 90% probability type of credit spreads that we open, we can handle the underlying index moving around 9%, but that’s about it….so it could be trending UP or DOWN, up to 9%, but after this we’ll have to make an adjustment.

Right now, we’re not feeling comfortable in opening the June bear call spread since the market recently corrected 15% and it could rally hard if some good news comes in. We just don’t know, but when a market pulls back so hard, it could also rally hard. This is where I’m using more of the volume based indicators to help me gauge the prevailing trend and to predict trend reversals. I’m feeling more comfortable in opening the June bull put spreads right now on the Russell 2000 index, RUT, as long as they are down several strike prices below the 200 day SMA and below the Feb low.

Answering your questions specifically, when sentiment/fear makes a market correct, like it just did where it recently pulled-back 15%, this is when we make some of our best returns; and we primarily focus on one side, the bottom bull put spread. If the volume based indicators continue to show choppiness over the next week, where it’s not showing a “go long” signal, we might consider opening the top spread….but not sure yet.

Question about index credit spreads that go in-the-money (ITM) and possible adjustments

bradrr — Wed, 13 Jan 2010 22:38:39 +0000

Question: If for some unfortunate reason we let a spread expire in the money, will the broker PUT the index shares to us, or because of the nature of the spread, will they only take the entire Maintenance?

Answer: In a very rare occasion that we get stuck with ITM credit spreads, we will usually roll them and keep them alive….and eventually get 50% to 70% of our money back. Unfortunately, and fortunately, I’ve become an expert on rolling because some of my spreads went ITM during the Oct 2008 crash, and after rolling them I got back 65% of my maintenance. Not bad for a total melt-down. (Just as a side note, most credit spread traders, including editor-in–chief’s from other credit spread newsletters don’t have experience in rolling because most just throw in the towel and let their subscribers take a total loss. I personally hate to lose money and will fight to the end to get back at least some of my money)

Answering your question specifically, if some of our spreads went ITM and we didn’t want to roll them but just let them expire, the credit spread on the RUT and SPX (classified as broad based indexes) are cash settled, so cash would be withdrawn from our account. If the spread went completely ITM and we let it expire, we would lose all of our risk capital, which is the required maintenance less the premium collected.

Per options on the SPY and IWM (which are ETFs that track at 1/10^th the value of the S&P 500 and Russell 2000 indexes, respectively) the ETF shares would be PUT to us where we have to buy the shares at the strike price and the shares would be deposited into our account.

Again, in general with this situation, and this is only for the emergency case where the stock market crashes 12% or more in just a few days and we get stuck with ITM bull put spreads, we will roll our spreads month to month and there is a very good chance we’ll get back at least half of our money, and more like 60% to 70%.

Question about available Liquidity on Russell 2000 and S&P 500 index credit spread options

bradrr — Thu, 07 Jan 2010 22:41:16 +0000

Question: Have there ever been any issues with not having enough buyers and sellers to fill our index credit spread positions? I would assume at some point with enough people trading your ideas there would not be enough volume to fill suggested positions…am I wrong in thinking this?

Response: Regarding liquidity.…yes, if too many folks start trading index credit spreads, for example on the S&P 500 and Russell 2000 indexes and ETFs, the risk/reward characteristics of our credit spreads will become less attractive. So far, however, there seems to be plenty of liquidity and the placement of the strike prices are still good. Luckily, credit spreads are a lot harder than they look, so a certain % of participants get hit every month, scaring them and washing them out..…so it’s my guess that there will be plenty of liquidity for a long time to come.

Trade & Market Update – 2009 is complete and it was a very profitable year

bradrr — Mon, 21 Dec 2009 07:47:16 +0000

2009 is complete and we successfully brought in a 92% ROI for the year. We usually achieve between 45% and 65% annually, but because volatility was elevated throughout the year, we were able to bring in a higher return than normal. Because implied volatility (VIX) most likely will remain elevated through at least the first half of 2010, we probably will have another above average year….as long as we continue to do detailed and thorough micro and macro level analysis to give us the highest probabilities of avoiding losing months. For more on the December trades and returns please go to http://www.monthlycashthruoptions.com/ReturnOnInvestment.htm.

Question about what price we use when filling our RUT, SPY and IWM credit spreads

bradrr — Thu, 26 Nov 2009 07:43:55 +0000

Question: In your advisories you usually provide a range of prices ( e.g. “open this spread if it’s filling for between .45 to .70 credit). So when you place an order in my account (this subscriber is enrolled in the MCTO auto-trade program) what price do you use?

Answer: As long as the recommended spread is filling for between 45 and 70 cents, we open the recommended spreads using the price that it’s currently filling at on that particular day, and we use about 20% of the available cash for that day. We then pause and wait for the next day when it’s filling again betwen 45 and 70 cents. (i.e. we collect premium over time, which helps reduce risk) If at any time it starts to fill for 71 cents or more, the spread no longer has a 90% probability of expiring OTM and profitable, but it has an 83% (just a guess…but probably close) probability of expiring profitable. Because we have the goal of opening 90% probability credit spread options, we then would move our strike prices away from the underlying index ”one-click” so we can bring the probability back to the 90% level.

Question about if we can use the MCTO signals on the RUT to trade the IWM

bradrr — Thu, 26 Nov 2009 07:13:28 +0000

Question: Can I open credit spread and iron condor options on the IWM using your RUT signals?

Answer: Yes, you can use our analysis and signals on the RUT (Russell 2000 Index) to trade the IWM (and ETF that tracks at 1/10th the value of the Russell 2000 index – RUT). Just make sure you select the same short leg. For example, if we issue a signal to trade the RUT Dec 650/660 bear call spread, you could also trade the IWM Dec 65/67 bear call spread and the risk/reward profile for both trades is very similar. It’s best to stick with 2 point or 3 point spreads on the IWM. (i.e. either a 65/67 or 65/68 bear call spread….per this example) For more on why we use 2 point or 3 point spreads on the ETFs, please go to the Monthly Cash Thru Options Learning Center at http://www.monthlycashthruoptions.com/LearningCenter.htm and read the entry “why we usually open 3 point spreads on the SPY”

Question: Which one do you prefer to write credit spread and iron condor options against….the SPY or IWM?

Answer: Both have similar risk/reward profiles. Sometimes, however, we can get better placement for our strike prices on the IWM, but it does vary from month to month. That’s why we have to analyze the trades on each underlying ETF each month to see which underlying offers the best placement of our strike prices.

Trade Update – RUT and SPY bull put credit spread options

bradrr — Thu, 19 Nov 2009 16:52:58 +0000

The stock market is pulling back where the DOW is down 155, the SPY is down 1.97 and the RUT is down 17.6. The Philly Fed Index came in higher than expected (manufacturing output) and the Conference Board’s Leading Economic Indicator also rose, which is great news for the economy. However, one of the semiconductor analysts cut his rating on the chip industry and this is what spooked the markets. (the market was also overextended and investors were looking for any reason to sell and take some profits)

Today is the last day for our November RUT bull put credit spreads where they cease to trade today after the close and they settle tomorrow, Friday. No action is required, assuming you have the RUT Nov 530/540 bull put spread, or lower. Let’s let them settle tomorrow and expire worthless.

Per the SPY option trades, they will continue to trade through tomorrow, Friday, and we’ll keep you posted. So far they are safe and no action is required, assuming you have the SPY Nov 100/102 bull put spread, or lower.

And of course all of our top Nov bear call spreads are safe. Let’s hold onto everything and let them expire worthless.

Question about “rolling up” from a profitable SPY credit spread into a new credit spread that is closer to the underlying index

bradrr — Fri, 06 Nov 2009 08:38:04 +0000

Question: In situations where we click “up” to new Bull Put spreads, what is your opinion of taking the profit on the bull put spreads that are already showing profit and essentially “rolling up” into the new, and closer, bull put spread per today’s advisory? Does this increase risk too much for the amount of profit potnential?

Answer: Rolling-up by taking the profit of a spread that already generated profit and rolling the profit into a new spread that has strike prices closer to the underlying index can be a good strategy. However, the new spread is a separate trade and it has to make sense per all of the analysis that we do. So when you ask the question - “Does rolling our profitable spread into a new spread that is closer to the underlying index increases risk?”, as long as the new spread stands on its own per fresh analysis, the risk/reward will be balanced and acceptable.

For me personally, when I feel confident that the underlying index will hold above, or below, my short strike prices of my spreads, and if I have reasonable buffer between the short leg and the underlying index, and if I don’t need to free up the cash, I’ll just let the credit spreads expire worthless. But if I have any hesitation at all, I’ll close them out early to take the profit and to reduce risk. Therefore on this trade, I’m probably going to hold onto my SPY Nov 92/94 bull put spreads, and I’ll start bringing in additional premium with the new SPY Nov bull put spread that we recommended in the November 6th advisory

What’s better, a 2 point, 3 point, 5 point or 10 point credit spread options on the S&P 500 Index?

bradrr — Sat, 22 Aug 2009 16:05:29 +0000

This trading tips case study analyzes and compares 1, 2, 3, 4, 5, 7 and 10 point credit spreads on the SPY, an ETF that tracks at 1/10th the value of the S&P 500 index. We make the case that the 3 point credit spread is optimum and provides an excellent risk-adjusted return, minimizes the commission hit, it gives us flexibility to make adjustments when needed if the spread “gets under pressure”, and it keeps the required maintenance level low enough to allow investors with different account sizes to participate in the trade.

By Brad Reinard, Editor-in-Chief, monthlycashthruoptions.com

Here are the assumptions we use when making our calculations:
1) Commission = $1/options contract or $2/spread. (we show additional commission rates in the spread sheet summary below)
2) $5000 of cash is available to open the spreads
3) Per technical analysis, the trade stays out-of-the-money (OTM) and profitable, and we let the spread expire worthless, which is 100% profitable for us, the seller. Thus, we only pay commission to open the spreads and we call this “one-way” commissions. (in contrast to round-trip commissions where we pay to open and close the trades)
4) All spreads have 31 days until expiration
5) We simplify the number of spreads that we can open by dividing the available $5000 of cash by the required maintenance.

Below is the SPY Aug 89/90 bull put spread which has the following characteristics:

1) It’s a 1 point spread (i.e. 1 point between the sell leg and the buy leg)
2) Required maintenance by the broker is $100 per spread (1 point spread * $100/point)
3) 50 spreads can be opened ($5000/$100 of required maintenance per spread)
4) Premium collected is $15 credit x 50 spreads = $750
5) Risk capital is $5000 in maintenance – $750 of premium collected = $4250
6) One-way commission at $1/contract is 50 spreads x $2/spread = $100.
7) Commission as a % of premium collected is 100/750 = 13.3%
8) ROI after one-way commission is (750-100)/4250 = 15.3%

Below is the SPY Aug 88/90 bull put spread which has the following characteristics:

1) It’s a 2 point spread (i.e. 2 points between the sell leg and the buy leg)
2) Required maintenance by the broker is $200 per spread (2 point spread * $100/point)
3) 25 spreads can be opened ($5000/$200 required maintenance per spread)
4) Premium collected is $25 credit x 25 spreads = $625
5) Risk capital is $5000 in maintenance – $625 of premium collected = $4375
6) One-way commission at $1/contract is 25 spreads x $2/spread = $50.
7) One-way Commission as a % of premium collected is 50/625 = 8%
8) Return after one-way commission is (625-50)/4375 = 13.1%

Below is the SPY Aug 87/90 bull put spread which has the following characteristics:

1) It’s a 3 point spread
2) Required maintenance by the broker is $300 per spread
3) 16 spreads can be opened ($5000/$300)
4) Premium collected is $35 credit x 16 spreads = $560
5) Risk capital is $5000 in maintenance – $560 of premium collected = $4440
6) One-way commission is 16 spreads x $2/spread = $32.
7) One-way commission as a % of premium collected is 32/560 = 5.7%
8) Return after one-way commission is (560 – 32)/4440 = 11.8%

Below is the SPY Aug 86/90 bull put spread which has the following characteristics:

1) It’s a 4 point spread
2) Required maintenance by the broker is $400 per spread
3) 12 spreads can be opened ($5000/$400)
4) Premium collected is $44 credit x 12 spreads = $528
5) Risk capital is $5000 in maintenance – $528 of premium collected = $4472
6) One-way commission is 12 spreads x $2/spread = $24.
7) One-way commission as a % of premium collected is 24/528 = 4.5%
8) Return after one-way commission is (528 – 24)/4472 = 11.2%

Below is the SPY Aug 85/90 bull put spread with the following characteristics:
1) It’s a 5 point spread
2) Required maintenance by the broker is $500 per spread
3) 10 spreads can be opened
4) Premium collected is $50 credit x 10 spreads = $500
5) Risk capital is $5000 in maintenance – $500 of premium collected = $4500
6) One-way commission is 10 spreads x $2/spread = $20
7) One-way commission as a % of premium collected is 20/500 = 4%
8) Return after one-way commission is (500 – 20)/4500 = 10.6%

Below is the SPY Aug 83/90 bull put spread with the following characteristics:
1) It’s a 7 point spread
2) Required maintenance by the broker is $700 per spread
3) 7 spreads can be opened ($5000/$700 required maintenance per spread)
4) Premium collected is $58 credit x 7 spreads = $406
5) Risk capital is $5000 in maintenance – $406 of premium collected = $4594
6) One-way commission is 7 spreads x $2/spread = $14
7) One-way commission as a % of premium collected is 14/406 = 3.4%
8) Return after commission is (406 – 14)/4594 = 8.5%

Below is the SPY Aug 80/90 bull put spread with the following characteristics:
1) It’s a 10 point spread
2) Required maintenance by the broker is $1000 per spread
3) 5 spreads can be opened
4) Premium collected is $65 credit x 5 spreads = $325
5) Risk capital is $5000 in maintenance – $325 of premium collected = $4675
6) One-way commission is 5 spreads x $2/spread = $10
7) One-way commission as a % of premium collected is 10/325 = 3%
8) Return after one-way commission is (325 – 10)/4675 = 6.7%

Below is a grid that summarizes our analysis. For a larger view of this grid please visit the Monthly Cash Thru Options Learning Center at http://www.monthlycashthruoptions.com/LearningCenter.htm and read the entry “Why we usually open 3 point credit spreads on the SPY”. If you would like access to this spreadsheet, please contact us at support@monthlycashthruoptions and we’ll forward it to you.

Conclusion: From the analysis above, we like the 3 point spread where it gives us an excellent return, minimizes the commission hit, gives us flexibility to make adjustments when needed if it “gets under pressure”, and the required maintenance is low enough to allow investors with different account sizes to participate in the trade. When we say that we need “flexibility” to make adjustments, when the spread gets under pressure from a fast moving underlying index (the SPY in this case) we implement the “stay ahead of the wave” strategy by “clicking-down” our strike price to move further away from the underlying index and we open more spreads to bring in more premium. If we use the 3 point spread we have the flexibility to “click-down” 3 times if needed. (in this case we are talking about the bottom, bull put spread) For example, let’s say we have a SPY 90/93 bull put spread and 10 days after we open this spread the SPY sells-off putting our 90/93 bull put spread “under pressure”. In this situation, we would not yet close-out the SPY 90/93 spread but we would watch it closely, and in parallel we would “stay ahead of the wave” and click-down a strike to the SPY 89/92 bull put spread (in the same month) and open some to continue to bring in premium. And if we need to click-down again, we have the flexibility to click-down one more time to the SPY 88/91 bull put spread to allow us to keep bringing in premium. If we need to click down even further, we won’t be able to open the SPY 87/90 bull put spread until we close-out the original SPY 90/93 bull put spread because the 90 strike overlaps and will cancel each other out; however, this is ok because if the underlying SPY is dropping this fast, and just by the fact that we’ve already clicked down 3 times, we probably will need to close out the original SPY 90/93 anyway to cut our losses and to minimize any further downside. With this said, and especially for bull put spreads, we would not engage in the “stay ahead of the wave” strategy unless the “market timing” indicators were giving us the green light that the economy and the market are “healthy” and therefore it’s ok to keep clicking down and bringing in premium. For more on how we Market Time, please go to http://www.monthlycashthruoptions.com/WhyMarketTiming.htm. For more on the “staying ahead of the wave strategy”, please read the entries “what if the market surges, how do we protect ourselves”? and “what if the market crashes, how do we protect ourselves?” in this Learning Center.

About The Author
Brad Reinard is Editor-in-Chief of Monthly Cash Thru Options LLC, a leading index credit spread & iron condor options advisory newsletter, which has the following track record: 69% YTD 2009 (thru Aug); 33% 2008; 63% 2007; 42% 2006; 50% 2005. For more information on the technical analysis that we perform on the S&P 500 and Russell 2000 (RUT) indexes, along with how to trade trading tips on iron condors and credit spreads please visit www.monthlycashthruoptions.com or call Brad directly toll-free at 877-248-7455. Monthly Cash Thru Options LLC is located in San Jose, California, the heart of Silicon Valley.