One saying you’ll hear often here at Cabot Wealth is, “No one has a crystal ball!” And it’s true, there’s no shortage of market prognosticators out there, but the fact of the matter is none can accurately predict the future.
That’s part of the reason that I don’t understand why investors flee to the safety of cash when the market heads south.
I mean, on the surface, I understand the move, but oftentimes there are far better alternatives, especially if you know how to properly incorporate risk-defined options strategies. And if not, well, it behooves us as self-directed investors to learn as much as we can about how to make money in all market environments, not just bullish ones. And that’s the beauty of options strategies—they allow us to make money regardless of the overall market trend. It’s all in the approach.
So, as investors we have to open up our toolbelt and use strategies that make sense given current market conditions. Since starting my trading service one year ago, during what were tumultuous and challenging times for investors, our Quant Trader strategies had a track record of 87.9% (29 out of 33 winning trades) for a total return of just under 150%. Our average trade lasted only 20.2 days.
And one of the three strategies that led me to that performance was an options strategy known as the iron condor.
Iron condors using highly liquid ETFs are one of my favorite defined-risk, non-directional options trading strategies. It’s a strategy that will allow us to make 10% to 20% over 30 to 60 days while the market forever vacillates between bullish and bearish trends. Remember, we are placing trades that only last, on average, around 20 days. As a result, intermediate to longer-term trends don’t really factor into our decision. Our decisions are based on a series of statistically based factors, starting with probabilities.
Let’s walk through a brief example.
A High-Probability Options Trade Example
Iron Condor S&P 500 (SPY)
With SPY currently trading for approximately 437, let’s say we decide to place a trade in the highly liquid S&P 500 ETF (SPY) going out roughly 59 days until expiration.
As seen above, the expected move, also known as the expected range, is from roughly 419 to 455 for the August 18, 2023, expiration cycle.
In most cases, my goal is to place the short strikes of my iron condor outside of the expected move to increase that cushion, thereby increasing my probabilities of success. I prefer to have my probability OTM, or probability of success around 75%, if not higher, on both the call and put side.
Choosing Expiration Cycle and Strike Prices
Since I know the expected range for the August 18, 2023, expiration cycle is from 419 to 455, I can then begin the process of choosing my strike prices.
The low side of the expected range is, again, 419 for the August 18, 2023, expiration cycle, so I want to sell my short put strike below the 419 strike. In this case, I have the ability to go well below the 413 put strike and increase my probabilities of success on the downside, by choosing the 404 put strike. Statistically speaking, a very conservative approach to the trade and it increases my margin of error.
Now, once I’ve chosen my short put strike, in this case, the 404 put strike, I then begin the process of choosing my long put strike. Remember, buying the long put strike defines my risk on the downside. For this example, I am going with a 5-strike-wide iron condor, so I’m going to buy the 399 strike.
Again, it’s all about the probabilities when using options selling strategies. The higher the probability of success, the less premium you should expect to bring in. But as long as I can bring in a reasonable amount of premium, I always side with the higher probability of success, as opposed to taking on more risk for a greater return.
So again, with SPY trading for roughly 437, the underlying ETF can move lower roughly 7.6% over the next 59 days before the trade is in jeopardy of taking a loss.
As to the call side, the high side of the expected range is, again, 455 for the August 18, 2023, expiration cycle, so I want to sell the short call strike just above the 455 strike, possibly higher.
The 465 strike fits the bill. By choosing the 465 call strike I am able to give myself a cushion of 6.4% to the upside over the next 59 days.
Once I’ve chosen my short call strike, I then begin the process of choosing my long call strike. Remember, buying the long strike defines my risk on the upside of my iron condor. For this example, I am going with a 5-strike-wide iron condor, so I’m going to buy the 470 strike.
So, with a range of $61 (404-465) and SPY trading for roughly 437, the underlying ETF can move lower by 7.6% and higher by 6.4% over the next 59 days before the trade is in jeopardy of taking a loss.
Here is the theoretical trade:
Simultaneously…
- Sell to open SPY August 18, 2023, 465 calls
- Buy to open SPY August 18, 2023, 470 calls
- Sell to open SPY August 18, 2023, 404 puts
- Buy to open SPY August 18, 2023, 399 puts
We can sell this SPY iron condor for roughly $0.70. This means our max potential profit sits at approximately 16.3% over the next 59 days.
Again, I wanted to choose an iron condor that was outside of the expected move and has a high probability of success. This is why I sold the 465 calls and the 404 puts.
Remember, when approaching the market from a purely quantitative approach, it’s all about the probabilities. The higher the probability of success on the trade, the less premium I’m able to bring in, but again, the tradeoff is a higher win rate. And when I couple a consistent and disciplined high-probability approach on each and every trade I place, I allow the law of large numbers to take over. Ultimately, that is the true path to long-term success. I’m not trying to hit home runs. I understand that true, consistent opportunities, particularly when seeking income, come with using high-probability options strategies coupled with a disciplined approach to risk management—the latter being the most important.
Again, to reiterate, by using a combination of bear call spreads, bull put spreads and iron condors we have managed to win 29 out of 33 trades since starting our Quant Trader service.
And that’s why now is the time to start selling options premium using risk-defined strategies.
Now, if you need help doing it, and want to learn about some of my other options selling strategies, you’re in luck. I recently recorded a webinar about our Quant Trader service, which is available here. I discuss all things Quant Trader including a detailed look at each strategy, risk-management techniques and much more.