Option Trading Strategy: Trading as a Business Video 3 Part 13

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Let’s analyze this trade. This is what an iron condor looks like. At expiration, we make our maximum profit, anywhere between 132 and 142. We’ve got a pretty wide range in which the price of the underlying stock can move. If it stays within this range prior to expiration, we achieve our maximum profit.

Let’s also take a look at our Delta. Our Deltas are negative, because we are selling more expensive options than we are buying. But our Theta is also positive. In other words, we’re going to be collecting, on average, 80 cents a day, for every day that we hold this position.

Is that linear? No, it’s not a linear Theta. Theta does move and tend to get dramatically larger, as we get closer to expiration. That’s why we don’t normally sell iron condors or do our calendar spreads, or do any other type of spreads, prior to 30 to 40 days before expiration. What happens is, we get closer to expiration, and that Theta increases dramatically. We collect greater and greater profits, as we get toward expiration.

We will achieve the maximum profit if the prices stay within this range. Remember, though, that when we took a look at the probability of touching – and we can also do the same probability up here – the probability is that there’s an approximately 50% chance, that it’s going to touch, because we’re at 51.8 here. This is approximately 50% here, that we’re going to touch this 142 strike price.

On the down side, there’s also a 50% chance that we’re going to touch the 132 strike price, which is the maximum amount of profit that we can make in this position at expiration. So, don’t let the fact that the probability of expiring is very high for this position – in fact, it’s 75%. The reality is, that in most cases, the price will butt up against your breakeven points, and your maximum profit points at some time during the life of this trade.

That’s why adjustments are so critical to the success of what we’re doing. Most traders, especially beginning traders, will put an iron condor on like this. As soon as the movement of the price starts to encroach on their breakeven points, they abandon the position, at a small loss.

Now, let me qualify that for a second. Let’s say you put this position on today. Within a couple of days, if suddenly, we get a huge price movement to the upside, and it goes to your break-even point, well, you’re better off taking off the entire position. If it goes to the down-side, toward your breakeven point, within two days of you putting this position on – you’re better off taking off the entire position. There’s something going on in the market that has dramatically changed the tone of the market, and it’s best that you step aside until you figure out what’s going on. Until prices stabilize a little bit.

I’m talking about traders who put these positions on, and then, two weeks later, the price has been slowly going up, slowly going up, until it reaches close to their breakeven point. They don’t know what to do. They don’t know how to adjust it, to continue to make profits in this position. They abandon the position completely, when it could have been saved and made profitable.

Then, they get out of the trade, and they feel like iron condors are not worth it, or they don’t believe that money can be made with iron condors. They don’t realize that there was a 50% chance that it was going to hit one of their breakeven points.

That is the iron condor. You may want to review this video several times, just to understand how we do vertical spreads, how we turn those vertical spreads into iron condors, and what the difference is, between buying a vertical spread, and selling a vertical spread.

Now, let’s do one more thing, before we conclude today. We don’t buy just iron condors. Iron condors do have the potential to make money a little faster when you put those on, because the expirations are all in the same month. So, the options that you sold will begin to deteriorate quicker than the ones you sold, because they are both in the same month. They both have the same expiration date.

The reason we diversify is because of the fact that different positions have different ways of profiting. The way we make money in iron condors is the fact that we have an extremely large Theta. Iron condors have probably one of the largest Theta decays of any of the positions that we’re putting on. It also has a little bit more risk than some of the other positions.

For example, calendars will have a little bit less favorable Theta decay. It also has a much lower risk. With iron condors, your maximum loss is actually close to the same asĀ  your maximum profit.

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