I make my living selling lottery tickets.
I always want to act like the casino, knowing that the probabilities are on my side. But I also understand that sequence risk is a fact that I must combat at all times. And the best way to fight off sequence risk is simply through allowing the law of large numbers to dictate the terms.
But that’s just the foundation.
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I build sound, high-probability options strategies based on the mean reversion of implied volatility. Basically, when volatility is considered high, I use options selling (credit) strategies. And when they are considered low, well, I use options buying (debit) strategies.
That being said, my preference is to sell options because I always have probabilities on my side. I want to be the casino. I want to sell lottery tickets. I want to be the insurance company. Those are the business models we model as options sellers. Probabilities lead the way.
A recent addition to my watch list, due to its high implied volatility, is the current stock market darling, Rivian (RIVN). But it’s just that, a darling. The fundamentals make no sense. But, as a seeker of premium, that’s where the opportunities lie. It’s the heightened volatility that we seek and Rivian is currently offering lots of it.
So, let’s take a look at a few opportunities. If anything, this will be incredibly educational.
Let’s start by looking at a potential iron condor trade. The strategy shines during heightened levels of volatility and allows us to define our risk. Remember, position size (risk management) is the key to being successful over the long-term. I can’t emphasize this enough.
An iron condor is not only one of the most powerful options strategies, it’s also one of the best all-around investments strategies that we, as investors, have at our disposal.
The strategy consists of a short call vertical spread (bear call spread) and short put vertical spread (bull put spread).
If all the aforementioned seems like a foreign language, no worries. This is a strategy I want all investors to learn, so I’m going to go through the strategy and my approach in a four-step process.
Step One – Liquidity
Liquidity is king. The first step when trading iron condors, or any options strategy for that matter, is to make sure you are choosing a highly liquid stock or ETF. Some of the best ways to find out if an underlying security is liquid is to take a look at the open interest, volume and bid-ask spread for the at-the-money options.
I have created a list of highly liquid stocks and ETFs that I like to trade and I rarely stray from that list. Why would I want to trade an underlying security that requires me to make back 5% to 15% on average just to get back to breakeven? It doesn’t make sense. Remember, we want to use efficient products that allow us to get in and out of the trade with ease. Don’t overlook the importance of using highly-liquid securities.
Step Two – Expected Move
Let’s say we decide to place a trade in the newly issued, and highly-liquid options of Rivian (RVN) going out roughly 30 days until expiration.
As you can see below, the expected move, also known as the expected range, is from 105 to roughly 186.
In most cases, my goal is to place my iron condor outside of the expected move.
Moreover, I prefer to have my probability OTM, or probability of success, around 75%, if not higher, on both the call and put side.
Step Three – Choosing Expiration Cycle and Strike Prices
Since I now know the expected range for RIVN is 105 to 186 for the December 17, 2021 expiration cycle, I can then begin the process of choosing the strike prices for my iron condor.
Call Side of the Rivian Iron Condor:
The high side of the range is, again, 186 for the December expiration cycle, so I want to sell the short call strike just above the 186 strike, possibly higher.
As you can see above, the 195 strike, with an 84.70% probability of success, fits the bill.
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 200 strike.
As a result, I am going to sell the 195/200 bear call spread for roughly $0.70. Now, if I’m bearish on the trade I can stop here. This would be the preferred trade. I could make money on the trade if RIVN moves lower, stays flat or pushes as high as 195 per share.
But since I’m using an iron condor, taking a more neutral stance, I need to choose the bull put portion of my iron condor.
Put Side of the Rivian Iron Condor:
The low side of the range is, again, 105 for the December expiration cycle, so I want to sell my short put strike just below the 105 strike, possibly lower.
As you can see above, the 90 strike, with an 85.71% probability of success, fits the bill.
Once I’ve chosen my short 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 85 strike.
As a result, I am going to sell the 90/85 bull put spread for roughly $0.55. Now, if I’m bullish on RIVN this would be the preferred trade. I could make money on the trade if RIVN moves higher, stays flat or pushes as low as 90 per share.
But again, I’m using an iron condor for this example, so the combined premium from my bull put spread and bear call spread is $1.35. More importantly, the probability of success on the trade stands at over 85% on both sides. My range is an astounding 105 points, from 90 to 195, and that doesn’t even include my break-even points, which extend the range from 88.65 to 196.35.
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, with a range of 105 (90-195) and RIVN trading for roughly 145, the underlying stock can move higher 31.0% or lower 37.9% over the next 30 days before the trade is in jeopardy of taking a loss.
Here is the theoretical trade:
Simultaneously…
- Sell to open RIVN Dec21 195 calls
- Buy to open RIVN Dec21 200 calls
- Sell to open RIVN Dec21 90 puts
- Buy to open RIVN Dec21 85 puts
We can sell the Rivian iron condor for roughly $1.35. This means our max potential profit sits at approximately 37.0%.
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 195 calls and the 90 puts.
Remember, when approaching the market from a purely quantitative perspective, 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 success.
Step Four – Managing the Trade
I typically close out my trade for a profit when I can lock in 50% to 75% of the original premium sold. So, if I sold an iron condor for $1.35, I would look to buy it back when the iron condor reaches $0.65 to $0.30. Of course, probabilities and time until expiration will dictate my ultimate decision.
If the underlying stock moves against my position I typically adjust the untested side. Most roll the tested side, but all research states that rolling the untested side higher/lower allows me to bring in more premium and thereby decreases my overall risk on the trade. Moreover, I look to get out of the trade when it reaches 1 to 2 times my original premium. So in our case when the iron condor hits $2.70 to $4.00.
Ultimately, position size is the best way to truly manage an iron condor. We know prior to placing a trade what we stand to make and lose on the trade, therefore we can adjust our position size to fit our own personal guidelines. Iron condors are risk-defined, so it’s important to take advantage of their risk-defined nature by staying consistent with your position size for each and every trade you place. Remember, it’s all about the law of large numbers.