Option Trading Strategy: Trading as a Business Video 3 Part 12


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How did you pick those? How did you determine which options to sell, and which ones to buy? How did you determine where to place your iron condor?

Generally, what we want to do, is we want to have a good probability that the iron condor will be profitable. In order for us to do that, we have to take a look at each individual side of the vertical spread.

Since we’re selling the 142, and it has a Delta of 25, that means that if the price were to move against us, there’s a likelihood that this isn’t going to rise much in price. In fact, for every dollar move in the underlying stock, this is only going to go up by 25 cents.

If we were to sell the “at the money” vertical spreads, then we have Delta risk, which means that we’re going to be moving our short option by 55 cents for every dollar move in the SPY. In addition, we can also determine – let’s keep our Delta up there. But also, let’s take a look at the probability of expiring.

You can see that the probability that this option will expire – we’re doing the 142s, here. We’re selling the 142s. The Delta will help prevent us from increasing the value of this option dramatically, if the SPY goes against us and moves toward our position. Also, it’s very close to the actual probability that this option is going to expire – the probability that it will expire is 23.74%, “in the money.”

That probability of expiring is actually the probability of expiring “in the money.” There’s only a 24% chance that it will ever be “in the money.” We want this to expire absolutely worthless. That’s how we capture the majority of our profits.

The actual probability that it will expire worthless is just the opposite of this. Out of a hundred, if we subtract 23.7 from a 100%, it would be 76% probability that it’s going to expire completely worthless. Those are pretty good odds. You have a 70% chance of making a profit on this position, because there’s a 70% chance that it will expire worthless.

There’s only a 23.7% chance that it will ever be in the money. If this goes in the money, then we will lose some money, potentially. Let’s take a look at a different statistic, which is even more telling. That is the probability of touching. See, prices do tend to fluctuate. That’s the whole basis of our training. Prices will fluctuate.

What is the probability that, during the time that we’re holding this position, that the price of the underlying stock will actually rise up to the 141, 142 level? The probability of it actually coming to touch this 142 strike price is 48%. There’s a 50/50 chance that this stock will actually rise, to the point that it’s going to touch that 142. If it does touch that 142, we’re going to be in a less profitable position.

You can choose options to sell, that are extremely far “out of the money,” and that only have a 10% chance of ever being touched by the price. However, you’re not going to get the premium that you need to make a profit. If you were to sell this 147 option for 12 cents, and you bought protection for 8 cents, you’re only making 4 cents on that vertical spread. Or, if you were to sell the next one up – let’s say you sold this for 12 cents, and you bought the next one up for 10 cents. You’re only making a 2 cent profit on that position. That’s why, if I’m doing vertical spreads and I’m doing iron condors, I do a 25 Delta as my sold position. That gives me a probability of expiring of close to 76%.

That’s why I choose these particular options. It’s the same thing on the put side. Normally, what I want to do, is I want to take a look at the probability of expiring close to 75%, or having a 24 Delta, because the Delta will protect us if the stock does move down. The increase, for every dollar that that SPY moves down, is only going to be 24 cents. It’s not going to kill us.

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