Making Lemonade


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Yesterday’s trade turned into a lemon about 30 minutes before expiration. Today, I’ll try to make some lemonade. Although the call side of the iron condor lost money, the over all credit we received for the iron condor provide a small profit of $16.10 after deducting the transaction fees. We had risked $300 on each side of the trade. It would have been possible, but unlikely, to lose a total of $600. If we use the higher risk level, we received a return on risk of 1.78%. Annualized that would have been 652%. Contrast that return with a market that has been dipping in bear territory since the beginning of year, and I think I’m tasting some lemonade.

Yesterday’s trade also has provided an experience that can teach us something. Why did yesterday’s iron condor do OK, while the iron condors we opened the previous week leave us with a significant loss when one side of those iron condors failed? Maybe we can find answer this question by consider how intrinsic and extrinsic values function in an option contract. Recall that intrinsic value is simply the difference between the strike price and the price of the underlying. When a strike is ITM, it has 0 intrinsic value. It’s price consists totally of extrinsic value, which is mostly time value. When we had to buy back the short call, it had only a half hour left, so its extrinsic value was fairly low. When we closed the call spread, the short leg was priced at $1.80 and the long leg was at $1.00, giving us a net debit $1.80 on that spread (80 cents more than the credit we’s recevied for the call spread when we opened the trade). A half hour before expiration we were entering the region with high gamma risk. Had we not exited the trade when we did, we may have lost a lot more on the trade. It’s somewhat calling that before close, SPX returned to levels below our short call strike, and had we stuck with the trade, we’d have achieved max profit. But that’s Monday morning armchair quarterbacking. The secret to success on this strategy lies in minimizing risk. If we do so effectively, we should expect to see long term profits. At least that’s what we’ll try to do as we continue to experiment with this trade.

Another reason that we were able to hold the line on our loss lies in the highly liquid nature of SPX options. Having tight bid-ask spreads as well has high open interest levels means that we can exit quickly when we need to without losing too much to the spread.

Today we’ll try another SPX trade. I’ll add to this post after it opens.

Here’s a copy of the fill we received:

SPX IC

My limit orders filled a couple minutes after I submitted them. I set the limit price 5-10 cents above the mid price. Because the volume is so high on SPX, you can usually get a pretty good fill on it. I priced both spreads at $0.50, hoping to get a total credit for $100, and got a favorable fill on the call spread and a total credit for $105. Max loss on each side is $395, yielding a ROR a little above 26%. The short strikes were selected at 20 delta. The stop losses were set at the short strikes.

Stay tuned.

Trading is closed. Our contracts have expired worthless, and we earned $105 less $2.60 transaction fees, net gain is $102.40. Take a look at today’s price chart for SPX.

SPX 1-day, 5-minute Chart

The bottom horizontal line is our put short strike; the top line is the call short strike. Entering the trade about 1:30 ET appears to have served us well. Throughout the trade we stayed in pretty safe territory. Maybe it’s a good idea to wait until the market day is well established before ordering our trades.

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