By Josip Causic, Online Trading Academy Options Instructor
It is interesting to observe the range of knowledge of our Online Trading Academy community members. We have amongst our graduates some very dedicated and sophisticated option traders, though small in number. We also have at the other side of the spectrum many absolute novices. As an instructor teaching option classes nationwide, I am often faced with a challenge of having both groups in the very same classroom. How do I keep the "experienced" option traders engaged while I am laying down the foundation for the beginners? (One of the core policies of Online Trading Academy is that every student has lifetime retake privileges, so it happens quite frequently that a class of twenty students could have several who are "retakes/experienced" traders versus the rest who aren't). Repetition is the mother of all learning. Reinforcing the basics is the way of doing it, yet there always comes the point when there is enough basics and it is time to move on to the next level. This article is aimed with that intent in mind.
In my recent class in North Carolina, some of the students were big on trading Potash Corp of Saskatchewan, and every time I asked for a ticker, POT was given to me. Thus, when we got to the topic of Iron Condors, guess what ticker I was given? Anyhow, when the trading environment is suitable, I often trade Iron Condors on indices and their ETFs. Placing this trade is an exception. Seldom do I place an I.C. on optionable stocks. However, prior to the trade we walked through many of the steps that I use. We looked at the fundamentals of the company and concluded that POT was currently undervalued. Then we looked at everything else.
By the way, please read the disclaimer in fine blue print at the bottom of this article. This is written for educational purposes only and neither I nor Online Trading Academy would assume any responsibility for the action taken by the reader. My entry was based off the POT current price; where POT will be at the time of the publishing of this article will be revealed in the future.
Having said that, I turn my attention to the trade that I am currently in, for it is an open position which could go wrong at any given time. It is so easy to theorize after the fact where it would/could or should have been a perfect entry into a trade. We are NOT trading the left side of the chart after the fact. In the real world, we are always trading the right side of the chart which is literally uncharted territory. The main reason why we utilize the left side of the chart through our technical analysis is to forecast the possible outcomes. Hence, when I did the analysis of POT with the class on 02-24-2009, the chart was identical to Figure 1.
Figure 1
As you can observe on the chart (Figure 1), I have marked clearly an ascending triangle. The blue line represents resistance at 95-level ($94.06) while the diagonal shows the creation of multiple higher lows. Creations of higher lows indicates an uptrend; also on the chart, I have marked with a horizontal line, previous support around the 66-area.
Having done the technical analysis, the North Carolina students and I turned our attention to the implied volatility examination of POT. (Due to the scope of this article, I will not get into the discussion of it now). Our scrutiny suggested that we should be sellers of premium so we selected the credit spread. At first, my gut feeling was telling me that a Bear Call is the perfect strategy for POT. In fact, you might observe on Figure 2 that I have indeed placed a Bear Call trade on the 24th, but due to the limit order, it expired without ever getting filled.
Figure 2
The next day, 02-25-2009, we were covering Iron Condors and again the same ticker was suggested and that is exactly what we worked on: an I.C. on POT. (A high flying Condor). Below are the specifics of it. For those who need a refresher of how this trade works, I suggest that you reread my article, I.C. Explained, before diving into this one.
POT $82.01
Bear Call side
BTO + 1 Mar 110c @ -0.63 (deeper OTM)
STO – 1 Mar 105c @ + 0.98 (deep OTM)
Bear Call Max Profit (difference) + 0.35
Bull Put side
STO – 1 Mar 70p @ + 2.72 (deep OTM)
BTO + 1 Mar 65c @ - 1.82 (deeper OTM)
Bull Put Max Profit = + 0.90
Combined Max P = 1.25
Max Risk = (spread width of 5 point minus the combined Max P of 1.25) = 3.75
Figure 3
Looking at Figure 3 above, it could be observed that I have first sent a "foot soldier" and then the rest of my contracts. The single contract, or a foot soldier, was sent to find out where the true market is and as soon as it got killed (filled), I sent my troops in. Observe the difference in fill times. The point is that rather than jumping in with the big contract sizes all at once, it is wiser to gradually leg into your trade, for you are bound to get a better fill, just as I did. Once again, it is better to receive 1.32 on nine contracts than to receive 1.25 for all 10 because of impatience. When combined, my credit on all ten contracts was just slightly less than 1.32, to be exact it was 1.313 or $1,313, while at the same time I was risking $3,687. If we divide our maximum reward with our max risk, we get 35.6% return on our money within the next 3 weeks. Now do not forget that is our maximum return and that in the current trading environment we are in, we might have to exit early.
Here are the five possible exit strategies we could utilize if POT goes out of our "box" that we have marked for it by selling the 70 put and 105 call. Once again, when we placed the I.C. trade, we made a couple of conditions: POT must stay below our sold 105 call and also above 70 put, which means that it has 35 points of dancing room. In case it does not, then we need to fix either our call side or put side. The five options, besides simply closing the trade and being done with it, are:
Strategy Name |
Month |
Action |
Roll out |
Next month |
Next call up or next put down |
Roll up |
Same |
One call higher |
Roll down |
Same |
One put lower |
Roll out and up |
Next month |
Next call up |
Roll out and down |
Next month |
Next put down |
In one of my future articles, when the third week of March expiry takes place, I will come back to this chart and explain which exit I utilized for my current POT trade, but for now, we will leave it at this chart of possible exiting I.C. strategies.
In short, in this article I have gone over one of my open trades with the intent of pointing out the existence of multiple exit strategies for an Iron Condor in case it goes bad. Those exit strategies were meant to be taken in the case of an emergency. Rolling out, up, or down are done when things go bad. In a normal scenario, we close our I.C. during the week of expiry collecting the majority of our maximum premium and move on to our next trade. If by any chance it happens that the stock is exactly in the middle of the range, then we might select as one of our options/choices not to even buy back our obligations but to let both Bear Call and Bull Put expire worthless. Again, how we exit depends on what the underlying has done, yet the choices are there. Having those multiple choices is the very reason why an option trader trades options.
Good Trading and keep safe with your position sizing.
- Josip Causic
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