 As option sellers, we're experiencing a premium draught. With this low volatility
environment we've had for quite some time, finding option premium in today's market is like trying to find a curve on Lara Flynn Boyle. There's a little there, but is it worth the effort? It all depends on what's at risk.
Our favorite premium-selling strategy is the Iron Condor. It's a neutral or non-directional strategy that creates a scenario allowing the underlying asset (index or stock) to move up, down or stay the same and still pocket a very nice profit. We need to provide you a way to pay for your option therapy and your attendance at the next OTA options seminar. This could be the answer.
The Iron Condor is a combination of two credit spreads -- a bull put spread and a bear call spread. Since both the bull put spread and bear call spreads are credit spreads, we will be "collecting" premium from the market -- not spending it. The challenge comes in determining the spread sizes, the placement, and the amount of premium to be taken in -- all the while remembering the importance of safety. Over the next several sessions, we'll be taking a closer look at the Iron Condor --
its components and how they work. We're going to start with the bull put spread.
The Bull Put Spread
A bull put spread consists of selling a put and then purchasing a put at a lower level for the same expiration cycle. It's called a "bull put" spread because we are bullish and we're using puts. See, some of this stuff actually makes sense. We will be taking in premium when we sell the put and then spending less premium when we buy the long put. For example, with the RUT trading at 637.44.
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a) sell a RUT March 590 put for $2.10 ($210 per contract)
b) buy a RUT March 580 put for $1.30 ($130 per contract)
If we only sold the 590 put, we would have unlimited exposure all the way down to zero. That's dangerous. Plus, most option traders will not have the trading approval level from their brokerage that will allow them to sell "uncovered" or "naked" options. So, to protect us from the market, and from ourselves, we will have to buy some protection -- in the form of a long put. Think of it as a financial condom that helps prevent traders from prematurely giving birth to empty brokerage accounts.
You'll notice that we have taken in $.80 more than we spent. That's ours to keep. If RUT closes, at expiration, above 590, both the short 590 put and the long 580 put will expire worthless. In most segments of society, the concept of "worthless" has a negative connotation. However, if you're an option seller, you're benefiting from the passage of time. Why? With the passage of time, the value of the option you sold is eroding away -- hopefully to zero. And -- your obligation to perform is eroding away along with the premium. That's a good thing.
Your exposure in a bull put spread is the difference between the strike prices. In the above example, you're exposed for 10 points (590 - 580) or $1,000 per contract. Your real risk is a little less. Remember, you took in $.80 ($80) of premium that you didn't have before. So, your out-of-pocket risk is only $920 ($1,000 - $80). That is the worst case scenario.
In the above example, you will make money if RUT goes up, remains the same, or even goes down 47 points. You have a much better chance of success. Why try to guess a direction if you don't have to?
What If . . .
a) . . . RUT finishes anywhere above 590? This is the perfect result. Both the short 590 put and long 580 put will expire worthless and the $.80 ($80) premium you received is safe and sound and we all live happily ever after.
b) . . . RUT finishes at 550? This is the worst-case scenario. The RUT tanked all the way through the short 590 put and continued on down through the long 580 put. If this happens, without you making an adjustment, you will lose the difference between the strike prices ($10 or $1,000 per contract -- less the $80 premium received).
c) . . RUT finishes at 586.50? The 580 long put will expire worthless, but the short 590 put will have intrinsic value of $3.50. This $3.50 ($350 per contract) will be deducted from your brokerage account on Monday after expiration. Don't forget, though, you took in $80 per contract. Therefore, your out-of-pocket loss is only $2.70 ($80 per contract).
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Always calculate your breakeven point. With a bull put spread, it's the short strike price (590) less the premium received ($.80) -- 589.20. Above the BE point, you make money. Below the BE point, you don't.
Next time: The Bear Call Spread
A Great Seminar
Come join me March 12th & 13th for another fun and educational
two-day
seminar. You've heard about people who have learned to trade options and were able to quit their jobs and work from home and make a fortune. Well, I guarantee that, after you attend my two-day seminar, you will have the tools to work with. What you decide to do with them is totally up to do. As is most any educational scenario, you get out of it as much as you put into it. Let me open your eyes to the possibilities and give you the tools necessary to turn possibilities into realities. Do you have what it takes to be a successful trader? Come and find out.
In January, we had another terrific two-day option seminar in Irvine. The students were attentive, perceptive and receptive to learning the finer points of the option trading process. It was a great group of people who now know how to make money. They left, having learned some new strategies and trading techniques – ones they’ll be able to use for the rest of their lives to generate a healthy income.
I invite you to come join me and other astute traders who want to learn new concepts, hone their trading skills, and to acquire knowledge that could conceivably change their financial lives.
Many Online Trading Academy students are taking advantage of the Online Trading Academy policy of free retakes of my option seminar. A number of familiar faces show up on Sunday to go over my "special" strategy discussions one more time.
Give us a call at 1-888-841-8418 and ask get the details about our March 12/13
Options
seminar. I guarantee that it will open your eyes, open your mind -- and possibly fill your wallet.
The Option Therapist
Mike Parnos, the "Options Therapist," has been trading, consulting and teaching option strategies for over 10 years. He specializes in exploring conservative and non-directional strategies while providing therapeutic guidance to individuals, brokers and institutional traders. He welcomes new patients. Five couches, no waiting. Questions and/or comments are welcome and can be sent to
OptionsTherapist@TradingAcademy.com.
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