Option Trading Strategy: Trading as a Business Video 3 Part 10


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spreads are preferred by professional traders, over the selling of naked options. To collect Theta.

I wanted to show you one more thing here. That is true for both the upside and the downside on this position. The most we can lose on the downside is 110. It doesn’t matter how low the stock goes. What happens if the stock suddenly collapses, completely? You would still lose only a maximum of $110.

That’s why we prefer spreads to the purchase or sale of individual options.

Even so, even though we have limited upside potential, we have extremely limited downside potential, because our maximum loss on this position is only 110. Look at our breakevens. We have breakevens at 71, and we have breakevens at 79. We have a tremendously wide breakeven on this position.

In fact, we cannot lose on both sides of this position. We can only lose on one side. The other side will actually make a profit.

Let’s do this as a learning lesson, here. We have a fairly wide range in which the stock can move. We can achieve our maximum profit if the stock moves within this range, at expiration. Remember that this green line represents the maximum profit that we can achieve, at the expiration date. This white line is the amount of profit or loss that we can achieve, at this particular moment in time.

As of today, if we put this spread on, we would have an immediate loss of $3.83 on one contract. Remember, on credit spreads, we’re always going to have a loss immediately, when we put it on. That represents the market makers’ spread, and their actual profit when they sold it to us. It also includes the spread between the bid and the ask, which theoretically, the market makers also make money on. I’m not saying they actually do, because sometimes they don’t, but that is their theoretical profit.

What happens when we take one of these side spreads off? If you go down here to the Analyze tab, under the positions and simulated trades – if we just unchecked one of these boxes, what it will do, is it will take that position off our profit picture here.

Let’s take that off. You can see that now, if we only have the one vertical spread on there – if the stock stayed the same or went up, we would receive the maximum credit. If it goes against us and goes down, then we will achieve the maximum loss. The maximum loss, in this case, is $325. The maximum gain is $175, because we sold this spread for a $1.75 credit.

You can do that. If you have a strong belief about the future potential of the stock, you can, in fact, do just one side of the vertical spread. However, in most cases – and I know that this includes myself – I’m not very good at predicting price. Although I do have some unique tools and experience doing technical analysis, many times, you just don’t know. You think something is going up. It doesn’t, or it just stays the same, and it wears away at your position.

That’s why we tend to do double spreads. In this case, a double vertical spread. This is very similar to an iron condor. This is actually the sale of a straddle, with protection. The protection is the call that we bought, at a slightly higher strike price, and the put that we purchased, at a slightly lower strike price. You can see exactly what this looks like.

Now, let’s take a look at what an iron condor would look like. We’ve already talked about how we do vertical spreads, to collect a premium. Normally, an iron condor is the sale of a vertical spread on the call side, and the sale of a vertical spread on the put side. It’s the sale of two “out of the money” vertical spreads. That’s all an iron condor is.

If we analyze these trades together, we can see that we have a slightly different profit picture, than the one we had before. Instead of a very tall peak in the center of our profit picture, we actually have a long horizontal line here, that indicates our potential profit in this position. Our breakevens are extended to 68 and to 82. It’s a bit wider of a profit range in which we can move. The majority of professional traders like this better than the sale of a straddle with wings as protection, because they do have this very wide profit potential picture.

In the case of the sale of the straddle, I think our breakeven on the low point was around 71, and around 80 on the high end. This gives us a little bit wider profit potential and breakeven points, at 82 and 68. So, a lot of people, and a lot of professionals, would prefer this, as a potential trade.

That is an iron condor. That’s all it is. An iron condor is the sale of an “out of the money” vertical call spread, and the sale of an “out of the money” put spread.

Now that you’ve seen what an iron condor is, let’s take a look at a calendar. You’re probably thinking, “Well, if we’re doing iron condors,” and let’s say that we’re doing one on the SPY. That’s the SMP 500 ETF. I did an individual. Rather than setting these as individual sales or vertical spreads, you can also set these as a single order. You can go ahead and sell iron condor. It’s right here. You don’t want to buy an iron condor.

The purchase of an iron condor is an “out of the money” bullish call spread, and a bearish put spread. I’ll show you the difference, here.

Sometimes it makes sense to buy an iron condor, which are “out of the money” vertical spreads. Let’s take a look at the profit picture for this. In the Think or Swim platform, the option that you want to put your spreads at – when you right click, it automatically defaults to that particular strike price on the call side, but on the put side, you have to change it.

Let’s say we want to go down to the 133, 132. Let’s analyze this, for a second. With the purchase of an iron condor – you can both purchase an iron condor, and you can sell an iron condor. With the purchase of an iron condor, the graph is completely opposite of the sale of an iron condor. Because at expiration, if the price were to remain stable, you would achieve your maximum loss, if the price did not move. If the price moved dramatically, then you would achieve your maximum profit.

The only reason that you would want to buy an iron condor is if you think there is going to be dramatic price movement in the underlying stock, ETF, or whatever it is that you’re buying. If the price moves within a very narrow range, you will have achieved your maximum loss. Also notice that Theta is negative, on the purchase of an iron condor, and Delta is positive. That’s because you’re buying a call option, and you’re selling one at a lower price. So your Delta is going to be positive.

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