Selling put spreads is a fairly simple trade that can generate one of the highest returns on capital of all option trades. The trade is fairly flexible to adjust for higher returns with higher risk, or more consistent, but lower returns with lower risk based on choice of duration until expiration. While I’ve written about put spreads in detail before, I recently did some additional studies to see if my earlier conclusions on best Delta values for entry were still accurate.
I’ve noticed from Google Analytics that many traders are searching for the answer to “What are the best Delta values to use for selling put spreads?” or some variation. While I think my earlier webpage on put spreads covers that fairly well, there have been enough people question me, and enough questions pop up from my own trading to cause me to go back and dig into the data a little deeper. The quick answer that I usually give to anyone on Delta values for a put spread is to sell the put strike with a 20 Delta value and buy the strike with a 13 Delta value. This optimizes position Theta, and also provides a nice, relatively high probability of profit. But is that answer true if the expiration timeframe is short, like just a few days, or really long, like several months?
Readers likely have a hint at results from the featured chart image at the top of this post. I decided to look at all the possible Theta values of short put spreads at different strikes. For the first example, I looked at 7 days to expiration (DTE), and chose 40 point wide spreads on SPX, the S&P 500 index. SPX is generally my go to choice for options on the S&P 500, but as I wrote in another post, there are lots of different ways to trade options on the S&P 500. So, the graph shows the Theta value relative to the Delta value of the short put of the spread of all possible 40 wide put spreads, expiring 7 days from November 18, 2022. The chart shows a very smooth curve peaking around 22 Delta.
This chart shows all possible short put spread combinations around the peak Theta values as a percentage of the spread width.
Here’s a slightly different way to look at the different Theta possibilities of 7 DTE put spreads. The horizontal axis is the long strike value, and the vertical axis is the short strike. The various values are color-coded, where the greener the cell, the higher the Theta value is as a percentage of the spread width, while yellow means lower Theta. As I’ve written elsewhere, this is one of my favorite ways to evaluate decay of a spread. I also drew boxes around all the values where the spread is 40 points wide- the points that are plotted on the earlier chart at the top of this post. If you zoom in on this green-yellow table, you can see that each cell is a percentage value, while the left and top lines show the strike prices and Delta values of each strike price. This table goes out much further than what I’m showing, but this is the part of the table where values are highest, and you can see the values are lower at the edges of this chart.
Note that delta values of between 5 and zero for the long put tend to have lower Theta values. And when the short puts get into the mid-twenties to thirty, Theta drops off. There are a number of combinations in between that have good Theta, and one could make an argument for many different ones.
On this chart each line represents the Theta values of different spread widths at different strike prices.
One more way to look at this is to look at a graph with each line representing a different spread width. Notice that the most narrow width of 5 points has a lot of variation- this is because the Theta difference is so small, yet divided by a small width and a few nickels change in the difference in Thetas doesn’t scale smoothly. I’ve highlighted the 40 wide line that I’ve used earlier. One could argue that another line might be a better choice, but as we go wider, the peak gets closer to the current price which makes the probability of expiring in the money higher and higher.
Since the chart is made based on the short put strike, the curves move higher and higher as the spreads widen. Notice that as the spreads get wider, the peak Theta percentage gets smaller.
Longer Duration put spreads
Let’s go a little further out in time and see if the data is different. At 42 days to expiration, we get somewhat similar results.
For 42 DTE on SPX. I chose 100 wide spreads and Theta peaked right at the 20 Delta short strike.
I also did a similar thing with a table of percentage Theta values, highlighting the 100 wide spreads.
This table shows the Theta as a percentage of the spread width, and is color coded with more green meaning more Theta return. Lines on the chart mark key Delta values.
Even longer duration put spreads?
Let’s look at 90 DTE for an even longer duration.
At 90 DTE, Theta peaks out just under 20 Delta
We can also look at a table of Theta values as well for 90 days to expiration.
The boxed values are 200 point wide spreads.
Again, the highest values have short strikes in the teens and low twenties for Delta. However, it probably is worth noting that the values shown are not that different between the yellow and green cells. So, maybe we should look at different spread widths to see it graphically.
Virtually all spread widths have a lot of combinations of strikes with values over 0.06% Theta per day. Compared to shorter durations, these Theta values are fairly low.
When selling spreads this far out in time, the idea is to have a large buffer from the current price and get much of the premium to decay well before expiration is even close. Let’s look at an example of how this might work.
This chart shows how the premium of a 200 point wide spread is likely to decay over 90 days, assuming no change in underlying price or volatility. The small triangles represent the Delta values of each of the strikes in the spread as time passes.
Starting with low deltas below 20, we can see that much of the decay of this spread happens well before expiration is even close. In fact, the last 20 days have virtually no premium left, which would suggest closing early and moving on. I plan to do a lot more studies on the decay curves of different spread widths and strikes to help identify the pros and cons of different entry points.
Conclusion
I think it is safe to say that the original study on spread width still stands. However, the data shows that there is some wiggle room around our old ideal of 20 Delta short and 13 Delta long strikes. We just need to be in the neighborhood. We don’t have to be exact.
Where’d the data come from?
Readers may wonder the source of the data for all these charts and tables. Actually, it’s a source that anyone can access and replicate. I simply copied an option table from my broker’s site and pasted it into Excel. Then I used a pivot table to organize the data so that it was friendly for the analysis I wanted to do. The option table had Delta and Theta values for each option contract available, and I had to use some formulas to figure out percentages of spread widths, but it wasn’t any really difficult challenge.
I do worry that my broker is changing the format of the option tables it presents, and copying every contract may be a bigger challenge in the future, but for now, I can display all contracts and select all with Control-A, then paste as text in Excel. In the future, I may have to paste a smaller amount of data each time. Readers trying to replicate these studies may face the same problem.
The goals of rolling are to neutralize delta, harvest profits, collect credits, and widen body width of the Iron Condor.
I see four ideal goals for executing a roll of any position, but specifically Iron Condors. First, I want to neutralize the position delta. Next, I want to harvest profits from the existing position. I also want to collect a net credit with the roll from the old position to the new. And finally, I want to improve probabilities of success by widening the body of the Iron Condor. If I can achieve all four, that’s the quadruple crown of rolling.
Often I see posts in social media lambasting rolling positions as a way to lock in losses and having no point. While that can be a possible scenario, I’d like to take a moment to discuss the ideal outcome of a roll, and share a recent example of what we are striving for with a rolling strategy.
For more information on the initial setup of Iron Condors, refer to my earlier post on the subject. This post is meant to build on that earlier post.
Example Iron Condor Roll
Earlier today I rolled an Iron Condor from 36 days to expiration out to 43 days to expiration. I opened the old position 10 days ago when the market was a little higher. Today, I wanted to better center my position to bring in my position Delta, and be less at risk for a move up. So, I rolled both sides up, rolling the calls up 20 points and rolling the puts up 10 points, which widened the body of the Iron Condor from 120 points to 130 points. Here is a summary of the old and new positions, with key points highlighted for further discussion.
Here is the key data from my tracking sheet for the old and new positions involved in this roll.
Let’s look at each goal and see how I did.
1. Neutralize Delta
While I don’t track Delta in my trade records, I do look at it for my open positions every day. For background on what Delta is for an option, a position, or a portfolio, see my posts on the topic. The account with this position was showing a lot of negative Delta, so I wanted to bring that in to a more neutral amount. Specifically, this position had a position Delta of -4.7, which equates to a Beta-weighted Delta of -47. This would be the equivalent of being short 47 shares of SPY. With my short call strikes slightly in the money, I wanted to reduce delta, get out of the money, and get more time. Rolling out a week accomplished all of that.
By rolling up 20 points, I got my short call out of the money. I rolled out a week, so I have more time. But most importantly, I cut my Delta almost in half from -4.7 to -2.5. I’m not zero delta or completely neutral, but it is a move in the right direction. I try not to over-adjust and chase being neutral too much or I can get whipsawed back and forth. So, now my premium value will be less volatile as the market moves up and down. Goal 1 accomplished.
2. Harvest profits from old position
The market has moved the direction I was positioned for, and today seemed like a good time to roll and recognize some profit. I’ve been in this position for 10 days, just over 20% of the life of the option. I’ve had some help from all the main pricing factors- price has moved down while I had negative Delta, time has passed while I had positive Theta, and volatility has come down slightly while I have negative Vega. All good for me. Notice that my put side lost money and my calls made money. I track them separately which helps me see trends, but the goal is for the net profit to be positive. And this position made $611 over 10 days. That’s around 8% return on capital. Goal 2 accomplished.
3. Collect a net credit from the roll
With a roll up on both sides, I had to pay a debit to roll up the calls, but I collected a bigger credit to roll up the puts. So, the net of the transaction is that I collected $0.35 per unit, or $35 overall. I try to collect credits in every roll because this is cash going into my account, while debits are cash leaving my account.
This old position wasn’t centered, and I widened the position while rolling out, factors that limited my net credit. However, I was able to find strikes that accomplished my other goals while still collecting a net credit. My new position isn’t ideal, but it is better than where I was and I got paid to make the change. Setting up a roll is an exercise in balancing many different desires, and I focus on collecting a credit as a way to determine how far I can go with my other desires. It isn’t a lot, but I collected a credit, so Goal 3 is accomplished.
4. Widen the body of the Iron Condor
The body of my Iron Condor is pretty narrow. How do I know? Look at the profit profile and it is clear that the whole position is inside of one expected move either way. Ideally, I’d like to get the expected moves inside my short strikes, but I’m managing a trade that is much tighter. So, every chance I get, I want to widen the body, the distance between the short strikes. Why do I want to do that? Because wider strikes have faster decay, up to a point, and we aren’t near that point. This position has strikes close to the money and the Theta values of the longs tend to cancel out the Theta of the short strikes more than I’d like. And the wider the distance between short strikes, the higher the probability of the price staying out of the money. Over several rolls, I want to get wider to where the position can tolerate moves without getting into the money as often. I went from 120 points between short strikes to 130 points, so Goal 4 is accomplished.
Quadruple Crown!
This roll accomplished all four of my goals for an Iron Condor roll. As I mentioned, I had to make some trade-offs along the way to accomplish all four goals, but this is an example of how I use all the data at my disposal to pick the trade that best suits the current situation.
Not every roll can be hit all four goals. If the current trade is a loser, the best you can do is meet the other three goals. Sometimes, I have to miss one goal to make another. In those cases, I choose based on what goal I’m most concerned with- do I need to neutralize delta more than I need a credit, or do I need to maintain body width more than I need a credit? Generally, I have a good shot to meet most of my goals if the current underlying price is inside the short strikes. As short strikes go deeper into the money, it becomes more and more likely that a roll will miss many of my goals.
This mindset of positive goals for trades isn’t exclusive to Iron Condors, but I thought today’s example would be a good way to illustrate the thought process involved in rolling for positive outcomes.
Like all the front ratio type trades I have shared, this trade is a defined risk version of a very similar front ratio trade featuring naked short puts. My versions hedge the trade with long puts to limit the risk. However, in this trade, I will also discuss the unlimited risk version of the trade, the 1-1-2, because the additional risk isn’t that much from a practical standpoint.
I’m a big fan of front ratio type trades. I’ve written about my success with Broken Wing Butterflies and Broken Wing Put Condors. Another trade that fits in the group is the 1-1-2-2 Put Ratio. I don’t know of a named reference to a bird or insect for this trade, so I’m going with 1-1-2-2. Like all the front ratio type trades I have shared, this trade is a defined risk version of a very similar front ratio trade featuring naked short puts. My versions hedge the trade with long puts to limit the risk. However, in this trade, I will also discuss the unlimited risk version of the trade, the 1-1-2, because the additional risk isn’t that much from a practical standpoint.
I picked up the concept of this trade from one of my favorite traders, “Sweet Bobby” Gaines, who I have mentioned previously in at least one other page on this site. Bobby is a big proponent of the 1-1-2 trade, and has posted numerous videos on it on his YouTube channel, including his recent rising star appearance on Tasty Trade. But really, the trade is the next level of evolution moving from broken wing butterfly to broken wing condor to “one louder” as they say in the mythical group Spinal Tap.
What all these trades have in common is selling an out of the money debit put spread, and financing by selling further out of the money puts or wider credit put spreads. The combination delivers a net credit, but also sets up an interesting dynamic of extra rapid decay of the premium involved. The farther out puts or put spreads decay faster than the closer debit spread, and often lead to the debit spread having more value than the credit spread. These trades take in a credit to open, and often can take in a credit to close. At least that’s how I set them up and manage them.
All these trades are a variation of a front ratio spread, where more options are sold than bought with hedges added to define risk. I’ve also written about back ratio spreads where more options are bought than sold. Front ratios are designed for maximizing decay, while back ratios set up multiple long positions paid for by a costly short position.
The previously discussed broken wing condor could also be called a 1-1-1-1 trade. In that trade we buy a put spread and then sell another put spread further out for more money, collecting a net credit. Four different strikes, 1 contract each. So what is a 1-1-2-2?
1-1-2-2 Basic trade setup
The 1-1-2-2 takes this a step farther, because we use two credit spreads very far out of the money to pay for the debit spread. The 1-1 part is buying a put around 25 delta and selling a put around 20 delta. The 2-2 part is selling two puts at around 5 delta and buying two puts around 1 delta. The goal is for the 2-2 to sell for about twice what the 1-1 cost. I like to set these up with 45-55 days remaining to expiration, quite a bit longer than the other ratio trades I’ve discussed.
What is the advantage of this? Well, because each of the two short strikes are further out, we greatly improve the odds of being profitable, and increase the initial rate of decay of the total position. We end up with a big gap between the debit spread strikes and the two short put strikes. Lots of good things happen with this setup. The biggest upside is that there is no upside risk- if price goes up, the trade makes money. The downside of this trade is that it can consume a lot of capital and has significant tail risk, which we will get into before we are done. Let’s look at a typical example.
In this example, each of the two low delta puts collect about what the debit spread costs (~$10).
The first thing I want to point out in this example is that the 3100 short put is 900 points below the current price of $4000. For that strike to get in the money, it would take a 22.5% decline in the market in 55 days. That won’t happen very often. To be fair, this example uses values with VIX at 25, a historically higher than average value, but for the timeframe of 2020-2022, a fairly middle of the road level. The higher that implied volatility is, the farther away the short strikes can be and still collect meaningful premium.
The next thing to point out in the setup numbers is the Greeks. Delta is fairly flat at +3. For a credit trade, that isn’t much and means that the position can handle some movement in price. Theta is $69/day, and we collected $805. So, the position is expected to lose 1/12 of its value each day. But we have 55 days, so how does that work? Quite well, I’d say.
Finally, we can’t ignore the capital risk of $115,000. How can this be? If the price drops below $2500 at expiration, a 47.5% drop, the loss would be $115,000. While extremely unlikely (we didn’t lose that much in the Covid crash of 2020), it is possible in some disastrous scenarios. We’ll discuss this later as it impacts capital requirements and how one perceives risk. At the end of this post, I’ll explain how we can get into this trade for a fraction of this buying power.
Numbers are one thing. A picture or three might help make this all more clear.
The dotted lines represent expected moves. This trade is profitable at expiration if the market doesn’t go down more than two expected moves.
This chart shows how changes in the underlying price will impact the profit and loss of the trade. We evaluate at four points in time. The green diamond shows our initial position at 55 DTE, underlying price is $4000, and the P/L is zero. The curvy lavender line shows how price would likely impact the position with 35 DTE. The green curve shows the likely profit at 14 DTE, and the sharp purple lines are the expiration values. We know exactly what expiration values will be at any price, but the curves are estimates based on likely impact to implied volatility as time passes and prices change.
I’ve put in dotted lines to show the expected move and multiple expected moves down. If you need a refresher, check my earlier post on expected moves. It is likely that price will end up inside of one expected move, the dotted lines on either side of the current price of $4000. There is approximately a 2% chance that price will move two expected moves to the second dotted line below the current price, which would still be max profit for this trade at expiration. And there is approximately a 0.3% chance of moving three expected moves to the far left dotted line. We can go further, but the odds keep dropping as we go to lower levels. However, as history has shown, moves down tend to have somewhat higher probability than theoretic probabilities once we get beyond two expected moves. The bottom long puts are a final defense to limit losses for going even more extreme in a rapid crash. The point is that this trade is very likely to end up profitable, but there is risk that an extremely big move down could lead to an extremely big loss. We’ll talk about ways to reduce exposure later.
Now that we’ve talked a bit about the very unlikely outcomes, let’s zoom in and discuss the most likely scenarios. Here’s the profit chart showing prices down to 25% below the current price with profit and loss zones highlighted.
Zooming in allows us to see the profit levels in the timeframes referenced above. Notice that down moves initially can drive the position to a loss, but if the move doesn’t go below the two short puts at 3100, the position will be highly profitable at expiration. In fact, this trade does best in the very wide range of a price drop between 6 and 22 percent, bringing in up to $5000 additional credit.
If price goes up or drops less than 200 points, we can keep our initial premium at expiration. We may be able to collect more. The profit curve at 14 DTE is actually above the expiration profit if the price remains the same. How is this possible? Because the 1-1 debit put spread decays slower than the 2-2 credit spread, eventually the 1-1 part is worth more than the 2-2 part, even though the 2-2 part started out worth twice as much as the 1-1.
Let’s look at this another way. Prices don’t generally move immediately to a new level, but have probabilities of moves that get bigger over time. Again, going back to expected moves, let’s compare how we might expect price to move during the duration of the trade.
This chart shows expected moves day by day from initiating the trade until expiration, and compares to the put strike prices.
In this chart I’ve shown several outcomes. The zero move is if price doesn’t change at all, a baseline. I’ve shown a +1% move which is in line with the positive drift of the market. There’s also a line for the positive expected move and the negative expected move, where price is likely to be within at any point in time. And finally I’ve shown a curve for a price move of two times the expected move down. Notice where the strikes are relative to the price curves are. The negative curves take time to get below the upper 1-1 put strikes, and never reach even the short put of the 2-2 credit spread.
Now let’s look at what happens to the value of our premium if price were to follow each of these curves. This is a view that you don’t see much because it is based on lots of assumptions for the pricing models. Since implied volatility is not predictable in the future, the chart makes assumptions for how price and time will most likely impact volatility and premium value.
This chart shows how different underlying price trends would likely impact option premium over time.
Initially, this position collected $8.05 in premium, so we start with a negative or short value of -8.05. From there the price moves shown in the previous chart drive the premium up or down along with time decay. If price is flat or going up, premium decays and moves quickly toward zero premium. If the price goes down, the positive Delta pushes premium to more negative values. The price move of negative two expected moves really does a number on our premium initially, driving it down to below -30.
But, remember our profit chart at expiration? The flat and positive moves end up with a profit of our initial premium (all the puts have zero value at expiration, and the negative expected move and negative double expected move end up at maximum profit. Since our debit spread is 50 points wide, the negative moves would leave it fully in the money for a premium value of +50 points. And that’s in addition to the initial premium collected to open the trade. The challenge is that to get that max profit, we likely will have points in time where our position loses money.
The probability of getting to max profit is low because it would require a price drop between 6 and 22%. Based on our put strike Deltas we can estimate that we have about a 20% chance of that. Most of the other 80% is expiring with all strikes out of the money. So, it might be wise to zoom in and understand what happens with the vast majority of trades.
In most situations, the premium of the 1-1-2-2 front ration decays quickly, maxes out, and then levels off before losing value.
I used this chart as the featured image of this post because I thought it best illustrates how this trade plays out most of the time. If you remember when we discussed the Greeks, I pointed out that Theta is very high compared to the premium. From this chart we see that if price stays the same or is slightly up, premium will decay to zero by 35 DTE, or just 20 days into the trade. This is an example that Theta isn’t 100% accurate by itself as it looked like 12 days of Theta should move us to zero value. It could be that IV modeling is slightly off or the Theta was off, but still we have very rapid decay that I don’t think anyone can complain about.
Like all ratio style trades we have discussed, this trade has the possibility of switching from negative to positive premium. The difference with this trade is that it is actually quite likely, and as such we need to plan for it and manage our profit accordingly.
I’ve colored in the area under our three flat-to-positive curves with three zones each. There is a green zone where positive premium is growing, a yellow zone where premium is topping out, and a red zone where positive premium is being lost. Notice that the curve of the 1% up move and no price move are fairly close together, and that’s because the price movement is relatively close to the same compared to the other moves we are analyzing.
Let’s review how this happens. This trade essentially has two spreads, a slow decaying debit spread (1-1), and a fast decaying credit spread (2-2). The credit spread decays faster because it is farther out from the money, is much wider, and has twice the value to start with. All these factors help decay happen more quickly. As long as the price stays fairly stable, this relationship will hold. Theta will be the primary driver of the premium value, and the wide credit spread will get to be worth less than the narrow debit spread.
The most likely scenario is that we stay inside the expected move and travel somewhere close to the no price move or 1% up move. Let’s realize that the market doesn’t move in equal amounts every day like this chart, so think of it as a smoothed out version of what premium would do. In the real world, premium would bounce up and down with price. However, if our price is close to where we started with 20 days until expiration, we would expect that the premium switch to positive has about maxed out, and it is probably a good time to close out the trade. Hopefully,your trading platform has a analysis feature that lets you look at your position and see how profits are changing day by day to help determine when the position is as high as it can go.
Without a chart, another way to determine how close the trade is to switching direction is to watch the position Theta. At the beginning of this trade, Theta was 0.688, or $68.80 for the full contract per day. As the trade progresses, Theta will decrease and at some point when the premium goes positive, Theta will turn from positive to negative. As it gets close to zero, that is the peak premium value. I generally try to exit the trade a few days before Theta is projected to turn negative. A big up day for the market could quickly change my very positive premium to not as positive premium, so it isn’t a time to get greedy.
So that brings us to the curve for the positive expected move. This is the curve that assumes that the price follows the one standard deviation move up. The good news when this happens is that premium decays very quickly because Delta and Theta team up. The not so good news is because the price move gets so far away from the strikes, the total position won’t get to a very high positive value. This is because all the options will drop in value quickly, approaching zero, and the upper debit spread won’t have much value. A big move up means that the probability of any of the strikes going into the money will be very low, so there is very little premium. As a result, it is likely we won’t be able to get out for much positive premium if any at all, but we will be able to keep most, if not all the premium from the opening trade. This is the least stressful outcome of the trade. If the price moves up faster than the expected move, premium will likely drop to very close to zero and may not ever go positive. So, if price is up a lot and the trade can be closed for a credit, I take the money and run. I’m happy to have a quick, winning trade.
The risky outcomes
Looking at the position vs time value chart, there are two lines that represent what happens if price goes down. One is the move down one expected move and the other is down two expected moves. Interestingly, in this example, both end up at max profit by the end of the trade. So, it would appear that the trade can’t lose, which is far from true. Notice that these premium values may go very negative if prices drop quickly after opening the trade. This is because the narrow debit spread doesn’t pick up as much value from increasing delta as the wide credit spread does in a down move. We know that if price stays above our credit spread short strike at expiration, we will make money, but when price moves quickly down, it isn’t clear that price will level off.
So, as a trader, we are left with a choice when the market drops, We can take a loss and get out of the trade, or wait to see if the market quits dropping before it tests or violates the credit spread strikes. If we are a week or two into the trade, a decent down move will not make a huge impact, but initially the trade can take a big hit from a down move. The longer we are into the trade without a big down move in price, the less the risk is of a loss. On the flip side, a big move down opens the possibility of additional big down moves that can lead to a very big loss. We reviewed the odds earlier- about 4% of the time the trade will lose based on the far short puts having an initial Delta of 4. If this trade is done enough times, there will be some losses. Let’s look at some management actions that could be taken.
1. Set a stop based on premium price. In this example, we collected just over $8 premium to open the trade. So, we could set a stop to avoid losing twice ($16) or maybe even three times ($24) our initial premium. This would mean a stop loss if premium climbs to $24 or $32, given that $8 premium is our starting break-even point. This is the simplest risk mitigation strategy. Using this will lower the overall win rate as many negative scenarios would end up fine if not closed, but this management technique will prevent huge losses that might impact the account dramatically.
2. Close the trade if the underlying price goes below a trigger point. We know this trade has a lot of cushion. We can handle much more than one expected move and be profitable. But if the move is much more than expected, we have to consider that the move is very unusual and dangerous for us. Perhaps our point to get out is when the debit spread is in the money, or when we are half-way between the debit spread and credit spread. Or maybe it is the short strike of the credit spread that is the final trigger to get out. The further down we allow price to go down, the more we stand to lose. Pick the underlying price where it gets too uncomfortable and use that as the trigger point to get out of the trade.
3. Roll out in time if premium or price triggers are hit. If the position is rolled before the credit spread is in the money, it can be rolled out for a credit. This gives more time for the market to turn around. However, it gives more time for a losing trader to lose more, because we likely can’t roll down that far and still get a credit, and we will likely have to pay to roll the debit spread or narrow the distance between spreads, making the trade less attractive. If the price move continues down, there will be much less room to maneuver going forward.
4. Simply hold on and hope the probabilities play out. With 55 days in the trade, we just need to move down less that two expected moves by expiration. If the capital is available, and the conviction is there, holding can bring max profit with a big down move. Note that as time passes and the credit spread stays out of the money, the premium has to go away, so the value can evaporate very quickly with very high Theta as expiration approaches. This can be observed in the value vs time graph for the -2 EM curve. It can also result in max loss. As expiration approaches, the difference between max profit and max loss is just a few percentage points of price movement and max loss is much more than max profit.
In this example we can see that a move down of one expected move really doesn’t challenge our position, while two times the expected move is playing with fire. So, one approach might be to hold as long as the move stays within the expected move to the downside and switch to closing or rolling once the move exceeds that or some other multiple of expected moves. In any case, a trader has to know their risk tolerance and have a management plan for both winning and losing trades.
What about calls?
A logical question might be- if this works so great for puts, why not double up and do it for calls as well? Well, there’s one problem- skew. On indexes implied volatility is higher as strikes go to lower values and declines for higher strike prices. As a result, out of the money puts have higher implied volatility than out of the money calls. More importantly, far out of the money puts have higher implied volatility than puts closer to the money.
Look at our setup for this example. Implied volatility of the single long put is around 25, while the two short puts have implied volatility of 39. This helps two ways. The short puts have more of their premium tied to volatility, bumping up their price compared to the long put. Also, the higher implied volatility pushes the strike price further down to get a matching premium to the debit spread, making the trade a higher probability of success. We are selling more of the higher implied volatility and buying lower implied volatility, a key reason to use front ratio spreads.
A similar setup for a 1-1-2-2 call trade would reverse the dynamics. The long call closest to the money would have the highest implied volatility and the two short calls would have the lowest. To collect similar amounts to the put trade, the call strikes would be much closer between the debit spread and credit spread, and the difference in the deltas of the strikes would also be closer together, meaning a narrower window of max profit, and a higher probability of max loss. While still a trade with positive probability, it generally isn’t as attractive as the put side.
1-1-2 vs 1-1-2-2
I haven’t talked much about the two long puts bought at less than one Delta to open the trade. They are very unlikely to ever be in the money, and most traders would opt to close or adjust the trade well before they came into play. So, why have them? The simple answer is that they define or limit the risk of the trade, potentially reducing the capital required for the trade, and protecting from absolute disaster in the event of a market crash of over 37.5% in under 55 days. It could happen, like it did in February and March of 2020 during the Covid pandemic. We are giving up 20% of our premium to protect for a once or twice in a lifetime super crash.
So, what if we eliminate the long puts and do a naked 1-1-2 ratio spread? Is it different in outcome or probabilities? The answer is that it is very similar in most ways, and we will also see that a lot depends on the type of account you are trading in as to what choices there are. First, let’s start with the setup of the 1-1-2 trade.
The 1-1-2 trade has two naked puts sold short, but way out of the money.
While this table shows the risk as unlimited, it is actually $618,855, the value of two 3100 puts if SPX went to zero by expiration ($620,000) less the $1,145 collected to start the trade.
Some accounts and some brokers require all trades to be defined in their risk. For example, retirement accounts generally aren’t allowed to use option margin and so any naked put would have to be cash secured. For this trade, eliminating the two long puts would mean the max loss would go up to $618,855, assuming that SPX went to zero, while we are holding two short 3100 puts. SPX will only go to zero if we see modern society end, and in that case, we’ll probably have bigger problems than our option positions. But rules are rules, and so if you want to trade without the long puts in a retirement account, you would need $620,000 capital to make a likely $800-$1200 or less than 0.2% return in 55 days or less. We’ll discuss other alternatives after we review the details of the 1-1-2 trade.
The profit profile for the 1-1-2 is very similar to the 1-1-2-2 other than the virtually unlimited loss.
Remember that our starting underlying price is $4000 and the trade is profitable at expiration as long as price is above 3100. The chart above doesn’t show losses all the way down to zero price, but just imagine zero price and -$618,855. Our probability of profit is 96% if held to expiration based on the Delta of 4 for the naked puts.
Most scenarios show a profit with 1-1-2
Looking at 1-1-2 values over time at the same price moves that we looked at for the 1-1-2-2 trade, we can see that the premium changes are fairly similar. Staying within one expected move keeps the trade moving in the direction of decay.
Zooming in on most likely outcome’s value over time
If we zoom in on the likely outcome, we see that premium behaves very similarly to what we saw with the 1-1-2-2 trade setup. We just have more premium collected to start with, taking a bit longer to fully evaporate and have the premium turn to a credit for closing. The concept is the same.
Summarizing the differences between the 1-1-2-2 trade and 1-1-2 trade, the 1-1-2 trade collects about 20% more premium in exchange for more loss if the market drops more than 37.5% in the 55 days of the trade. How likely is it for the market to drop more than 37.5%? Is buying the long puts for protection worth it? That’s up to each trader to decide.
Buying power requirements
I usually don’t spend much time talking about buying power because most trades I do are defined risk credit trades where the amount collected is a significant portion of the capital at risk. This trade is not so much, whether defined risk (1-1-2-2) or a naked ratio spread (1-1-2). In non-margin accounts, we collect 0.7% or 0.2% respectively, which isn’t much.
Below is an analysis of different possible ways to trade. I looked at trading each of these strategies three different ways. First, I looked at a cash secured account, like a retirement account. Next, I looked at an account with margin for naked options. Finally, I looked at a much different approach, trading futures options with span margin. The margin and span margin amounts came from entering this trade into the tastyworks trading platform.
Comparing buying power impact of different account types for the two strategies
I highlighted some key takeaway points. First, is how leveraged span margin with futures options can be for this trade. Our most capital efficient trade would be doing the 1-1-2-2 on futures span margin where we would collect 100 times the premium as a percentage of buying power (20%) than the non-margin account of the 1-1-2 trade (0.2%). Of course, with leverage comes much more risk. I chose to consider a loss of 10 times the initial credit as a practical worst-case scenario. The span margin would end up costing huge amounts more in a disaster and could potentially wipe out an account if the trade used a high percentage of the account’s capital.
A couple of weird margin anomalies to point out. In my margin account, the defined risk 1-1-2-2 trade required almost twice the buying power as the undefined 1-1-2, which is weird because clearly there is more risk in the naked 1-1-2. I think it may be that the calculation for defined risk is normally much less than undefined and the software may just assume that margin is not useful in defined risk. On the other hand, defining the risk on the futures version cut the buying power by 1/3. Different brokers may calculate their margin requirements differently, so don’t take this as universal truth. Similarly, remember that while defining risk usually increases the return on capital, it makes outsize losses more likely, especially when scaling up. Notice that the highly leveraged futures 1-1-2-2 would lose twice as much as a percentage of capital that the futures 1-1-2 setup in a 10x loss. I discussed this phenomenon in detail in my post on comparing risk.
Remember that margin and span margin change as the trade progresses depending on the market behavior. Span margin is subject to big swings when prices go against a position. A broker may force a position to close much earlier than a trader would want to get out due to expanding capital requirements. So, while initially the position is cheap to enter, a trader needs to limit each position to a fraction of the overall account size.
But the good side of this is that this trade can be entered for a very small cost. The trade is very high probability. We can also make more than the premium collected. I didn’t include it in the chart, but maximum profit for the most leveraged choice above would be $5,805 profit on $4,000 buying power, a return on capital of 145%. And there is over a 20% probability of that happening.
One final note on the buying power analysis table. To keep the quantities an apples-to-apples comparison, I used double the number of /ES futures options because futures options only control half as much value as SPX index options. So, technically, those futures options trades listed are 2-2-4-4 and 2-2-4 because they use twice the number of contracts to get the same notional exposure. I reviewed differences between index options and futures options in detail in my post about different ways to trade options on the S&P 500 index.
What about small accounts?
Readers looking at this may be thinking, “Gee, this is great for multi-millionaires, but what if the account is too small to consider any of these buying powers?” Great question- there are other alternatives. First off, a trader could use half the buying power listed by just trading options on one contract of the Mini S&P 500 futures (/ES). The 1-1-2-2 example would only take $2,000 buying power for $402 premium received. But, if that is still too much, we can make it a lot less.
Many traders are more familiar with options on the SPY exchange traded fund, which trades at approximately 1/10 the value of the S&P 500 index. For futures options, there is also options on the Micro S&P 500 futures contract (/MES), equal to 1/10 of the /ES contract size, or 1/20 of the size of an SPX option. By using SPY or /MES, we cut the size of the trade down by 1/10 compared to the above table. If the account is taxable, another choice would be the $XSP index, a 1/10 value index of the S&P 500 with favorable tax treatment, but lower liquidity. Again, all these alternative versions of S&P 500 options are discussed in my post on different S&P 500 choices.
So, for an account with futures trading capability, this trade could use /MES futures options and get into the 1-1-2-2 trade for just $200 buying power. An account with options margin could use SPY or $XSP and get into the 1-1-2 trade for $6,800 buying power. A trader doesn’t need a million dollar amount to trade this.
Concluding thoughts
I know a number of people who have traded versions of this trade during the bear market of 2022 without any issues. In fact, it could be argued that this trade, like most trades that collect credits from selling puts, works best if entering when the market is already down and implied volatility is high. Bad scenarios are already priced into option premium and there is a lot of cushion between strikes. This trade is most dangerous when volatility is low and prices are high- the probabilities are not as good, because a move of more than two times the expected move down is not nearly as far.
While not for everyone, the 1-1-2-2 and 1-1-2 trades provide a very high probability of success with a nice payout when used with leverage. The trade requires monitoring to maximize profit and to prevent catastrophic loss, so it really is not a set it and forget it trade. The key is to have a plan to manage the position if the market goes against the trade and stick to the plan.
This post lists recent additions and changes to the website. For frequent users, this change log might be helpful to see what has changed from past visits.
The following is a listing of recent additions and changes to the site. For frequent users, this change log might be helpful to see what has been added new or changed.
January 13,2026: Added a new post on using a household balance sheet. Slightly off the topic of options, but something every trader should use in some form or another.
December 1, 2025: Added a new page on Best Option Order Entry Practices. Sometimes, it’s good to get into the nuts and bolts of trading a bit.
October 14, 2025: Added a new page on Rolling Credit Put Spreads. While I’ve written about this before, this is a more thorough version explaining how rolling works mechanically with put spreads.
September 17, 2025: Added a short post explaining that the site was back up after a week down. I appreciate the patience of all who had to wait, and the persistence of those who found ways to reach out to help get the site back up.
August 2, 2025: Added a page comparing the 111 and 112 put ratio trades. It’s been a year since the Implied Volatility blow-up that crashed so many naked traders, so it seemed like a good time to re-visit.
June 26,2025: Based on popular demand, I’ve added a page on selling covered call spreads. This strategy allows a trader to collect premium on existing shares without giving up all the upside potential if the stock goes up a lot.
March 13, 2025: Added an update to the Very Long and Very Short Diagonal Put Trade. This trade becomes truly unmanageable during extended down markets, making it an interesting concept to study and test, but not viable as an ongoing practical strategy.
February 9, 2025: Added a page with an updated write-up of the Delta Neutral Back Ratio Call Spread, as featured in the new YouTube video interview with John Einer Sandvand from ThetaProfits.com. This is an updated analysis from an earlier page on the same topic.
January 14, 2025: Added a new page on the Daily Diagonal Covered Put trade. This is similar to the earlier Very Long Very Short Diagonal, but with much shorter duration and less capital required. I even included a backtest.
December 16,2024: Added a new page for the Very Long Very Short Put Diagonal Trade. This trade, also a version of a “Poor Man’s Covered Put” has much more to than what one would expect at first glance. However, this trade has elements of almost every aspect of options there is, so a lot to study for every option trader.
October 2024: Lots of new comments from readers and responses on various pages of the site. Keep those questions and ideas coming!
August 24, 2014: Added an update to the page about 100% success in the 112 trade to highlight the issues with the August 5 volatility debacle that did wiped out many 112 traders.
July 23, 2024: Added a new post sharing results from the 112 trade in the first half of 2024. 100% success.
July 2,2024: I added a new page contrasting debit vs credit option trading strategies. It’s one of a few considerations traders should consider when picking strategies that work best for their style of trading.
May-June 2024: Lots of new comments and replies came in from readers. Always good to hear from folks with their questions and comments.
December 30, 2023: I added a couple more books to the Resources page. I also updated Tasty links for their new TastyLive.com URL.
December 20, 2023: Made a number of changes and additions to the home page of the site. With all the new content, it seemed like it was time to highlight some of the content that isn’t as obvious.
November 22, 2023: Added a duplicate post on the 1-1-2 Put Ratio Trade. I did this to capture the search engine traffic from the numbers of traders looking for information. So, whether it’s 112 or 1-1-2, there’s a write-up. Just read one or the other- they are the same.
November 14, 2023: Added a page on the 112 Put Ratio Trade. While I mentioned it a bit in the post on the 1112 Put Ratio Trade, I decided the naked option version deserved a write-up of its own.
September 19, 2023: Added a page on Covered Calls. Yes, I know I just wrote a post on the same subject. (Secret note: the write-ups are exactly the same. This is actually a test to see if pages do better than posts in getting search engine connections. Universally, my most read articles are always pages, but maybe that’s just a coincidence. Most readers would never recognize the difference between a page and a post, but posts are supposed to be part of an ongoing blog, while pages are more “permanent.” I’ve used them interchangeably, and I want to make a data-driven decision on what the impact of that choice is.)
September 18, 2023: Added a post on 5 Bullish Call Trades. This is the culmination of a series of trades that I felt like I had overlooked regarding data driven ways to utilize calls in a bull market without absorbing too much time decay. With the market in what appears to be a bull market, it was time to focus in on this topic. 4 of 5 of these trades have recent extensive write-ups that were completed in the past 3 months.
August 4, 2023: Added a post on Buying Out of the Money Call Spreads. This is a strategy that would appear to most option traders who mostly sell options to be a sure loser, but back-testing shows it to be quite profitable over time.
July 26, 2023: Added a post on the Poor Man’s Covered Call, a low cost variation of a Covered Call, based on selling a call against an in the money long call that acts as a replacement for stock. So, a bit of a cross combination of the two most recent previous write-ups.
July 25, 2023: Added a post on Covered Calls. Not sure why I never wrote one before, but given it is one of the most popular option trades around, I thought it was time to weigh in on it with a level of detail that isn’t available many places.
July 5, 2023: Added a post on Replacing Stock with a Call Option. When markets are going up and IV is low, buying calls can be a good way to get in at a low cost. This post goes into more detail.
June 19, 2023: Added a post on Underlying Security vs Risk Permission. There are a lot of factors to picking the type of security to buy or sell options for a specific type of trade. This post digs into what to consider and why some approaches may be better than others.
May 24, 2023: Added a post on Trading Options while working a Full Time Job. I went back to work this year and changed my trading routine. I know many readers can relate, even if they just want to make better use of their time.
May 20, 2023: Added a chart to the 1 DTE Straddle post to show profit and loss at various times of the day.
May 17, 2023: Added a post on Covered Strangles, a conservative options trade that reduces volatility with higher probability of profit than owning an equivalent amount of stock outright. It’s my first deep dive into Level 0 option trades, something I’ve had a number of requests to address.
February 27, 2023: Added a new Phone Stock Charts page with stock price charts formatted for a smart phone, and potentially screen-cast onto a monitor or TV. Not for everybody, but if this is something you are looking for, like I was, you’ve found it.
February 27, 2023: Updated the Current Prices page with more interactive charts, replacing those from a previous provider that had security flaws.
February 26, 2023: Added a post on the topic of 0 DTE trades.
January 16, 2023: Provided responses to a couple of great reader comments and questions regarding the 1-1-2-2 trade.
January 13, 2023: Added a new post on my 2022 learnings.
December 23, 2022: Added a post regarding the best Delta for ROLLING put spreads. This is a new topic that I had curiosity about from years of observing that some rolls do better than others, and I couldn’t figure out why.
November 28, 2022: Accepted an extended comment to the page Rolling Iron Condors and added a response. Comments are always welcome and appreciated. Note that comments from first time commenters must be reviewed and accepted to keep those crazy spammers from ruining the site.
November 9, 2022: Response added to a comment about how to roll a back ratio call spread up or down to get back to Delta neutral.
November 3, 2022: Added a new page on Options Margin Usage. In this page, I compare different types of margin available for option traders and the benefits and risk of each.
October 15, 2022: Worked with the ad provider to reduce the number of ads on the site and make them less obnoxious. Should be no more pop up adds when changing pages, and less ads per page.
September 30, 2020: Added a new page explaining how brokers permit different levels of risk in option trading.
Understanding and charting expected moves based on implied volatility and option pricing can be a helpful tool for option traders.
The expected move is a concept that is important for option traders to understand and use. It took a while for me to grasp this when I started trading options, but now it is something I consider in trading on a regular basis. Expected move allows a trader to put into context what implied volatility and option prices are predicting for the future. While expected move isn’t a Greek, I’m including it in the group of Greeks because it is derived value from option prices and is closely related to some of the Greeks and the ways they are calculated.
Option prices increase and decrease with changes in implied volatility. Actually, since implied volatility is just an “implied” concept, Implied Volatility is the explanation of why option prices go and down after taking into account the other key pricing factors of time and price movement. Implied volatility is a percentage that represents the standard deviation of price movement for the next year, as implied by an option’s price. In any normally distributed data set, approximately 68% of the data will be within one standard deviation of the mean of the data. Stock prices aren’t typically normally distributed (they won’t perfectly fit in a bell curve), but for simplicity most people make the assumption that they are and understand the differences in outcomes to consider. I won’t dig any deeper down this hole, because for most purposes the statistics work pretty well for stocks and options, despite the simplifying assumptions that most traders make.
Options have the unique ability to express how the market in general expects prices to vary between the current time and option expiration. This is possible because the market of buyers and sellers settle on prices that balance risk and reward for future outcomes based on all currently available information. The result is that we can determine how much the market is expected to move in any timeframe, based on option prices. It is kind of like sports gamblers betting on the over/under of a game score- the betting line is determined by the cumulative expectations of those wagering based on what is known about the scoring and defensive ability of each team.
Ways to measure the expected move
One very quick way to determine how far the market is expecting the market to move by a given expiration is to add together the put and call premium of the option strike closest to the money. As I write this, the S&P 500 index (SPX) sits at 4108.54. The closest option strike is 4110. Looking 40 days out, the midpoint value of the 4110 call is 125.60, and the 4110 put is 123.15. Adding these together, we get 248.85. Why is this significant? Let’s say one trader buys these two options (a straddle) and another sells the two options. The break even is a move of plus or minus 248.85. Both the buyer and seller would feel like this is a fair trade. The market of buyers are hoping that the market moves more than expected, and the sellers are hoping it moves less. As a balance, it is a measure of the expected move.
Studies by TastyTrade.com show that this at the money straddle pricing often over estimates actual future moves slightly. For their TastyWorks.com trading platform, they use a modified formula that takes the at the money straddle and the first two out of the money strangle prices in a weighted average to calculate an expected move that historically is closer to the moves that actually end up happening. For the same timeframe, Tastyworks has an expected move of +/-263.83, so for some reason at the moment their calculation is slightly higher than the at the money straddle. Only a few trading platforms actually show an expected move calculation, and it is done differently at different brokers as there is no default standard.
How does this relate to implied volatility? Well, as it turns out the implied volatility multiplied times the price of the underlying stock can match fairly close to expected moves calculated by at the money straddles. The straddle or similar TastyWorks method come out to approximately a one standard deviation move. So a very quick calculation is to take implied volatility multiplied by underlying price multiplied by the square root of the fraction of a year until expiration. The square root part is a little much to begin with, but it is based in statistics and math. So, for our previous example, we will use the current VIX value for volatility of the S&P 500, which is currently 24.79. We have 40/365 of a year for 40 day move, and the square root of that fraction is 0.33. With the current SPX price still at 4108.54, we multiply by 24.79%, then by 0.33, and get 336.10. This would imply that the market is expecting something less than a one standard deviation move in the next 40 days. However, the calculated one standard deviation move is just 27% more than the TastyWorks expected move. For something that is “implied” from option prices and calculated in a couple of different ways, that actually is fairly close- close enough for us to have a ballpark estimate of what the market is likely to do in the future.
So, what is the best way to determine an expected move? Well, there is no right answer because no one really knows what the future holds. But, we know that more often than not, options are overpriced for the moves that eventually happen, so implied volatility will typically be more than realized volatility, so methods that show smaller expected moves will likely be closer over time. But to use the straddle method, a trader must have access to option tables for every expiration of interest and do calculation after calculation to see how the move evolves with time. Using the calculation of volatility and the square root of time allows a quick way to estimate moves over a broad range of time. For option sellers looking to “play it safe,” this calculation may encourage the choice of wider short strikes.
Charting Expected Moves
Once a trader understands the concept of the expected move, it often helps to see how this works out on a chart over time. Let’s look at a chart for early 2022 for SPX.
At the beginning of April 2022, we can see the expected moves for the next few months.
After a week we can see that the moves stayed inside the expected move. With another week of information, we can update our expected move chart.
As time passes, the expected move changes as well with new pricing information.
As it turned out, this period of time included a fairly strong bear move down that was outside the expected move for a while, but then returned inside.
Using the original expected move, we can see how the realized move played out.
This example illustrates a point worth noting. The longer the time duration, the more likely that the realized move will stay within the expected move. Time allows probabilities to play out more.
Another factor with expected moves to consider is that implied volatility can vary significantly over time and those variations can dramatically impact expected moves of the future. Consider that an expected move when VIX is 30 will be twice as large as when VIX is 15. When implied volatility is high, the market is expecting big moves in the future. When IV is low, the market is expecting calm in the future. When the market gets volatile, it tends to take a lot of time to calm down. On the other hand, when markets are very calm, sudden changes can cause sudden spikes in implied volatility and future expected moves. It is far from an exact science, but it is the best real time future indicator of movement we have.
Regardless of how we calculate the expected move, it gives us a good idea of what the market currently collectively thinks the future movement of pricing will be. For planning option strategies, this can be very helpful.
In the bear market of early 2022, I re-discovered a strategy that I had mostly discarded during the bull market of the preceding years, the Iron Condor. The Iron Condor is primarily a neutral trade that when managed with aggressive rolls can provide good returns in choppy, down-trending markets. My goal is to maintain a position that can tolerate fairly big market moves up or down, while benefiting from time decay.
I had discarded the Iron Condor trade because I found I was always losing on the call side of the Iron Condor. Initially, I liked the idea of making money on both sides, but I found in a constant up market, I often lost more money from calls than I made from puts. So, I switched to mainly put spreads and other short put strategies, which did great. But then 2022 came along, and it was clear that the market was no longer going up, and that we were heading for a bear market. I started adding credit call spreads to my credit put spreads to balance risk and have a neutral strategy. Over time I saw that some of my set ups and management strategies were working better than others, so I investigated and came up with a process that now works well in the current bear market environment.
The basic setup of an Iron Condor
Selling Iron Condors is an extremely common option trading strategy. The strategy is a combination of two calls and two puts, four separate options working together. Usually, an out of the money put and out of the money call are sold, and then a further out of the money put and call are purchased to define the risk and reduce cost. The trade wins at expiration if the price ends up between the short strikes, and hits max loss if the price moves beyond one of the long strikes. However, I rarely if ever hold to expiration and roll my position way before expiration is a concern.
Here is an actual California Condor with a profit curve of an Iron Condor option trade drawn over it.
An Iron Condor is named after the shape of the profit curve at expiration, which kind of looks like a condor with a bit of imagination, kind of like how star constellations are named. The iron part of the name designates that it is made up of a combination of puts and calls, as opposed to a put condor, or call condor which has four legs of the same type of contract. An example of a put condor is the broken wing put condor strategy I have described in a separate post.
To build on the condor metaphor, the difference in option strikes are often referred to as the body and wings of the combination trade. The body is the difference between the short put strike and the short call strike. The wings are difference between the call strikes or between the put strikes. The wings on the puts may be equal in width to the wings on the call, or they may be different. Wings that are different widths might be call unbalanced, or broken wings, as the profit profile will no longer be equal levels each end of the price ranges of the trade.
My preferred Iron Condor setup
What I have determined works best for my management strategy is to use the S&P 500 index options (SPX), targeting a starting point 28-35 days from expiration, with option Delta values of 30 for the short strikes and around 20 for the long strikes. I like equal width for the put side and call side, so the Delta values for calls will be a bit wider than the put side, and the net Delta of the Iron Condor will be slightly negative. With implied volatility between 20 and 30%, I generally target 100 wide wings, with the body between the short put and short call of around 15o points on SPX.
Here is the setup of an actual trade from early 2022 on SPX using the criteria from this post. In this example 30% of the wing width was collected, and a little lower deltas were used.For the above example trade, the goal is to keep in the profit zone for the first several days of the trade- the positive area under the 21 DTE curve.
I use SPX because it is the least likely underlying to have outsized moves. It is also very liquid to trade, has tax advantages in taxable accounts, and has expirations multiple times per week in the timeframes I trade. Depending on account size or type, other option products for the S&P 500 may be appropriate and can be used instead with essentially the same strategy. Other indexes or even individual stocks can be used, but managing can tougher with bigger moves, less expirations, and less liquidity.
I use 28-35 days to expiration (DTE) because my position can tolerate most reasonable moves while still having decent decay. I’ve used timeframes as low as 7 DTE, but find that many one day moves can push a position out of the profit zone, and I find myself fighting a losing battle too often. Longer durations of up to up to or over 100 DTE can work, but decay is slower, and there are very few expiration choices to roll to for the way I like to manage. All that said, my plan can vary to different timeframes, with the goal that I will only hold the position for somewhere between 1/10 and 1/5 of the time left to expiration- for example, a 30 DTE would be held 3-6 days before rolling, while a 100 DTE position would be held 10-20 days.
I choose 30 delta for short strikes and 20 delta for long strikes because they are the most forgiving in a move, while still offering reasonable decay as a spread. Higher deltas allow for more premium to be collected, and price movement will often be well tolerated as the long strike of the tested side will increase and the short strike of the untested side will decrease in value, compensating for much of the increase in value of the tested short strike. The goal of my management strategy is to keep this relationship intact, so that price movement has little impact on my option position value. I think of the area where deltas of the four options balance each other out as the profit zone. Staying in the profit zone allows Theta, or time decay, to do its work and deliver profits. I have used strikes with a bit higher delta values, but if too high, the two sides will get tested more often and then require more management. In the past, I often used lower delta spreads for safety and better percentage decay. However, I have discovered that low delta positions don’t actually tolerate price movement well because the untested side of an Iron Condor quickly runs out of premium to offset any of the movement of tested side. This observation has been a game changer for my use of Iron Condors.
I use equal width wings on the Iron Condor for a couple of reasons. Equal width seems to tolerate price movement, both up and down. Equal width also leads to a net negative Delta position, decreasing the total position profit when prices go up and increasing profit when prices go down, which is good in a bear market where downturns are frequent. Negative delta actually is somewhat neutral if the value is only slightly negative- Iron condors also have negative Vega, or decrease profit when implied volatility goes up. So, typically when prices go down, implied volatility goes up, and impacts of the negative Delta and negative Vega cancel each other out.
My Iron Condors are opening somewhere around 50% of the width of the wings. For example, if I have 100 wide wings, I would expect to collect $50 premium. I initially resisted this, thinking that the probabilities would be too low. However, since the time in the trade is so short, and I plan to actively manage moves against my position, I find that the risk reward ratio becomes favorable. However, the example trade that I’ve used is a little wider body and collected only 30% of the width.
This chart shows previous market movement at the time of entering a trade, along with the expected move based on implied volatility and boxes to illustrate the strikes of the Iron Condor. The dates are the opening date, the expiration date, and the planned target date to close. This trade used long strikes that were at the expected move at expiration.
I have devised a graphic that may help to visualize this setup in regards to the expected move and time frame of the trade. The graph has several components- a historic rendering of what the index has done for the past several weeks, a curve showing the expected move for the next several weeks based on current implied volatility, and two boxes to represent the put and call strikes shown from the time of opening until expiration, and the target date to take action. My point with this chart is to show that while the strikes chosen are within the expected move at expiration, they are outside the expected move through the time I expect to be in the trade before I manage it. Said another way, if the position were held to expiration, it is very likely it would be breached on one side, but because the plan is to manage early, a breach is not likely- it would take an outsized move beyond the one standard deviation expected move.
Managing the trade with rolls
I manage my Iron Condor with what I think is a fairly unique rolling strategy. I roll my positions out in time and change all strikes in the direction that price has moved. If price goes up, I roll all the strikes up. If price goes down, I roll all the strikes down. I just roll whichever way the market goes. Here’s the interesting part- if I keep in the “profit zone,” I can roll up or down for a net credit with each roll, and my existing position will have a net profit. Usually, one side will be sitting with a profit and one side with a loss. The losing side is being tested- its strikes have higher deltas than when the trade started. The profitable side will have lower deltas than when the trade started. My profitable side should have a bigger profit than the loss of losing side. When I roll, I will likely have to pay a debit to get my losing tested side back to a good set of strikes at the new expiration. However, I should be able to collect a bigger credit on the profitable untested side than my tested side cost. Ideally, every roll is closing a profitable trade and collecting a net credit to open its replacement. All of this sounds great, too good to be true, but there are a number of details to unpack.
The first challenge is to stay in the profit zone. My general rule is that if I keep my untested short strike must never drop to a Delta value below 15. The reason is that when the Delta of the untested side gets below this point, it quickly stops being able to meaningfully contribute to offsetting price movement in the tested direction. For example, if the price drops, the short call will get further out of the money and drop in value, while the puts will go up in value. For a while the Deltas will mostly balance each other out, but as the Delta of the short call drops below 15, the put spread will start increasing much faster and the calls decreasing less. If this happens, it is time to act and roll all the puts and all the calls down to where there is again premium on both the put and call side. If price has gone up too much, it’s time to roll up all the puts and calls.
Actually, I try not to wait until the untested side gets to 15. I think of my position of having three possible states, green, yellow, or red. Green is when both short strike’s Deltas are above 20- everything is great and there is nothing to do. Yellow is caution, one of the short strikes are between 20 and 15, and probably will need to roll soon. Red is stop and take action, one of the short strikes is 15 or below, so it is time to roll immediately. So, my choice is clear for Green or Red, but I need to use some judgement in the Yellow state. If the day starts in the Yellow, I am more likely to let it ride for a while and watch to see if it recovers or gets worse. If the market has trended throughout the day and moved into the Yellow, I am likely to roll before the end of trading so I don’t end up deep in the Red overnight. If there is a strong trend pulling the position quickly toward Red, that may also be a good indication to act. Yellow is a judgement call.
I find that it is harder to have a profitable, credit roll when tested on a quick up movement. As mentioned earlier, equal width wings means that there will be a negative delta overall, and while volatility reduction can help, big up moves can be hard to stay on top of. That’s why this strategy works best in a bear environment, when the market is trending down.
Don’t over manage. Markets bounce around a lot, and it can be tempting to want to act on each little trend that happens. If I have the right strikes- the right body width and wing width for the market conditions, my position should be able to tolerate price movement. If I’m trading at 30 DTE, I want to wait 3-6 days between rolls, so I need to be choiceful about not rolling too often. If the market moves a huge amount in a couple of days, I may need to roll early, but then I’ll want to try to go longer before the next roll. The other thing to consider is that often the markets overshoot in one direction or the other, so I try not to move too far to chase moves that go on for days, and stay patient that the market will counter the trend.
If a position isn’t winning regularly and isn’t holding its premium in control, that’s a sign that the strikes aren’t right for the market and the duration. For a while I was trading 7 DTE Iron Condors on SPX with around 100 wide bodies and 50 wide wings. I would adjust nearly every day, but I couldn’t keep the position in the profit zone, and I often took losses. There wasn’t enough space in the body and the wings weren’t helping enough. By widening out the body and wings and adding more time, I found the position much easier to manage, and more likely to be profitable, and much less likely to take a big loss.
One way I can tell if I have a forgiving position is to compare my premium to the premium of the same position a few strikes higher or lower. For example, with Schwab StreetSmart Edge, I can pick Iron Condor as a strategy, pick an expiration date, pick a body width and a wing width. The application will then give me a list of strike combinations and premiums for those parameters. If all the choices around my preferred strikes have similar premium, then I know that price movement will have minimal impact on my chosen position. If there is a rapid change in premium for other strikes above or below my choice, it means my Iron Condor parameters are not very forgiving, and I should adjust time or widths or both. Other brokers will have similar ways to compare prices by shifting up or down all the strikes.
I have updated the earlier graphic to illustrate how a change in price over time will dictate the choice of a new position to roll to. The new price now dictates a new expected move, and new ideal strikes and expirations. Hopefully, this chart will help those that are fond of graphical illustrations.
After 7 days of mostly down moves, I decided to roll down my positions and roll out to a later expiration. In this image, the old position and expected move are there along with an updated expected move and new strikes.
Eight legs in the Roll
Since an Iron Condor has four legs, rolling involves closing four legs and opening four new ones. I don’t think any broker or exchange allows a eight-legged trade, so at a minimum this will take two trades to complete the roll. My preference is to roll the puts as a trade, and roll the calls as a trade. I usually start with the side that is being tested and might need a debit to roll to a new expiration and strikes. Then I do the other side, usually moving the same amount and keeping the same width, expecting to collect more to roll the untested side than I pay to roll the tested side.
At times, I may have a situation where I don’t have enough buying power to roll one side while the other side remains in place. If that happens, I’m probably using more of my buying power than I should, or the position is just too big for my account. It isn’t that big of a deal to manage the situation, however, I just close the untested side out and roll the tested side, then open a new position on the untested side. Worst case scenario, I can close the whole Iron Condor at once- freeing up its buying power, and then open a new one with the same buying power. As long as the wing widths are the same and the new Iron Condor collects more to open than the old Iron Condor cost to close, there should be a net gain in buying power. But again, any time buying power restricts a trade, it is probably time to pare down some positions in the account.
How Iron Condors tolerate price movement
Probably the best way to explain how an Iron Condor tolerates price movement is with an example. Earlier in this post I showed an opening trade from April 1, 2022. Let’s look at it again and look at how it fared after 7 days.
Here is the setup of an actual trade from early 2022 on SPX using the criteria from this post.
Notice that the premium collected is approximately $15 each on the put side and the call side.
After a week, price has dropped to 4500, but the premium has dropped for a profit.
The premium on the put side has gone up to around 16.50, while the call side has dropped to just under $6.
After 7 days the premium increased on the put side but decreased on the call side, as illustrated by the larger and smaller strike position arrows, and the result is a net profit.
So, after 7 days, the trade made about $800 on $10,000 risk, an 8% return. But, that’s just the start- the plan is to roll, and so the closing trade above was combined with the following opening trade:
On April 7, this trade was opened while closing the old position for a net credit and strikes that are back at the edge of the expiration expected move.
The combination of closing the old trade and opening the new trade is a net credit of just under $14 premium. This is the result we are looking for- a profit on the trade being closed, and a credit to move out in time and get to better strikes for the latest situation.
And just to finish the example trade, let’s look out another week and see what happened to the market and the trade that was rolled to.
After rolling down, the market kept going down, but stayed within the new strikes with plenty of space to spare.
By April 13, the market had dropped even further, approaching where the puts from the original position had been. However, the roll down gave the new position plenty of space and the trade was sitting at a profit, and ready to roll again.
After 6 days, the rolled position had decayed even after a market move. Again, puts lost money, but the calls made the position profitable.
This trade made $1430 in 6 days, a 14% return on capital. Since the market went down, the put side of this trade lost money, although not that much since the price didn’t end up that close to the put strikes since our new strikes were lower than the old ones. Time decay helped counter the price movement against the puts. The money was made on the call side through both price movement and time decay. In the end time decay, represented by Theta, eats away premium as long as price doesn’t get too close to the strikes.
These are examples of trades I did during the Spring of 2022 in the face of a bear market. Not every trade faired this well. Some market moves were too fast and too far for me to be able to roll before the position went too far to one side. But more often than not, this rolling methodology has kept me from having positions blown out, and keeps day to day portfolio value from varying out of control.
You may notice that the example trades shown here don’t exactly follow all the mechanics I’ve described. Since those trades I’ve become a little more likely to intervene early, although it’s a balance with avoiding over-adjusting.
Finally, I don’t always get my rolled positions re-centered, like I did in the example I presented here. Often, I’m happy to just move in the direction of the market and make sure my new strikes are a bit out of the money on the tested side. In this crazy bouncy market, we get lots of reversals, so I let my positions stay a little off when the market has moved a long way and technical indicators suggest the last several days move may be about finished. However, these choices come down to individual trader preference and market outlook. No one knows what is happening tomorrow or next week, so we each have to decide what trade is best based on the information available. For a real life example of this type of decision making in action, see my post on the Goals of Rolling an Iron Condor.
the S&P 500 index is very appealing but most traders don’t know there are at least 7 different great choices for options tied to the index
For many new options traders, trading the S&P 500 index is very appealing for a number of reasons. But most new traders are not aware that there are at least 7 different great choices for options tied to the index. Most have multiple expirations each week and are very liquid. Each choice has unique differences from the others that may make it appealing in certain circumstances. For a long time I was only aware of one way, and when I now tell others about these additional choices for options, it’s usually a pleasant surprise.
Background
The S&P 500 index is the most quoted benchmark of the stock market for good reason. It is made up of the 500 largest US publicly traded companies. The index is weighted by market capitalization of each firm, so the largest companies have more impact on the index than smaller ones. In fact, as of this writing, the seven largest firms are responsible for 30% of weight of the index. While the news media often leads market reports by sharing the Dow Jones Industrial Average, most traders and asset managers pay little to no attention to the Dow because it only includes 30 stocks and has a bizarre price weighted averaging system that gives the most weight to companies with the highest price per share.
If a trader can choose only one investment to own, some form of the S&P 500 index would be the most logical choice. When selling options, unexpected moves outside of expectations can lead to large losses. Many studies have shown that the S&P 500 index is much less likely to have an outsized move than individual stocks or even other indexes. TastyTrade has done numerous studies on this that are free to review. So options on the S&P 500 index can be a large part of a trader’s strategy. Understanding the variety of choices for trading options on the S&P 500 can be very helpful for traders of all experience levels.
Mutual Funds?
Almost every employee retirement account offers a mutual fund that mimics the S&P 500 index. While mutual funds are great for retirement accounts that rarely change holdings, they aren’t that useful for trading in general, and specifically not for options. There are literally dozens of mutual funds based on the S&P 500, but they share the same trading issues- they only trade at the closing price of the day which isn’t known until after a trade is submitted, and there aren’t options on any of them. Active traders want to be able to buy and sell at any point in the trading day and have options for hedging or amplifying returns, so mutual funds just won’t cut it.
Exchange Traded Funds
In recent years, exchange traded funds (ETFs) have grown in popularity. These funds are structured to match the holdings of underlying indexes or other trading strategies. The funds actually hold shares in the index that they are matching performance with. By far the largest ETF is the SPDR S&P 500 ETF Trust, which goes by ticker symbol SPY, and follows the S&P 500 index. It is priced at approximately 1/10 the price of the index per share. So, if the S&P 500 index is priced at 4500, the SPY ETF will be priced around 450. The SPY price isn’t exactly 1/10 of the S&P 500 index price, but slightly less by varying amounts. The variations are due to fees that come out of the ETF, and the impact of dividend payouts. SPY pays dividends once a quarter, and the price of SPY gets closer to 1/10 of the S&P 500 index as the dividend payment approaches and then drops after the dividend is allocated. Generally, the variation is less than one dollar in SPY, so if the S&P 500 index is trading 4500, SPY is likely to actually trade at somewhere between 449 and 449.50. For most traders, this difference isn’t a big deal, but just a minor factor to be aware of when comparing SPY to the S&P 500 index. Because of its name and ticker, SPY is often referred to as the “Spiders.”
SPY option contracts are based on 100 shares of SPY. If an option is exercised or assigned, the option seller will either be forced to buy or sell 100 shares of the SPY ETF. Because SPY pays a quarterly dividend, traders who sell calls on SPY need to be aware of the risk of having the call option exercised on dividend day. If a trader has a call near expiration that is at the money or in the money, it will likely be exercised because the dividend can be captured by the owner of the stock. If the call seller doesn’t have shares to be called away, and the option is executed, not only will the seller be short shares of SPY, but the seller will have to pay the dividend to the broker that they are borrowing the shares from. Only call sellers have to worry about this, but it is a real consideration four times a year.
Both SPY and options on SPY are extremely liquid with bid-ask spreads normally at one penny. I’ve found option trades that include four legs, can usually be filled immediately for two cents away from the mid price of the combined bid-ask spreads of all the legs. Options are priced in increments of one cent, so pricing can be fairly precise. SPY options have 3 expirations per week, with contracts for every Monday, Wednesday, and Friday. Adjustments are made for holidays when markets are closed. Every expiration has dozens of strikes, going several expected moves above and below the current price of SPY.
While SPY isn’t the only ETF to track the S&P 500 index, it is the predominant one, and really the only ETF to really consider for trying to match the performance of the actual index. There are a couple of other ETFs to consider that are designed to magnify or reverse the performance of the S&P 500 index. For some strategies, these might be helpful.
UPRO is an ETF from ProShares that is leveraged to deliver 3x the performance of the S&P 500 index. Officially, it is called the ProShares UltraPro S&P 500 ETF. So, if the S&P 500 index goes up 1% in a day, UPRO will go up 3%. However, the reverse is also true- if the S&P 500 index goes down 1% in a day, UPRO will go down 3%. To keep this relationship working, the holding in the ETF are adjusted each night, so over time the ETF won’t exactly keep pace at 3x the performance. The ETF relationship is more precise day by day than longer term, but will be relatively close to 3x. UPRO has options expiring every Friday and is somewhat liquid with wider bid-ask spreads than SPY. Because of large swings in price, the ETF has occasional splits to keep the share price reasonable, and the daily adjustment of holdings can alter the precision of the leverage factor, so the share price isn’t consistently convertible to a multiple of the S&P 500 index.
The opposite effect is achieved from the SDS, or Proshares Ultrashort S&P 500 ETF. SDS is set up to delivery -2x the performance of the S&P 500 index. So, if SPY goes up 1%, SDS goes down 2%. Over time the price of SDS tends to get lower and lower, and a reverse split is needed to get the price up to a reasonable level. Options on SDS also expire weekly. Both SDS and UPRO options are based on 100 shares of the corresponding ETF.
Options on leveraged ETFs are much more volatile than on non-leveraged ETFs. Because traders of these options know that there is multiple times price movement, options are priced accordingly. Because of this, strategies with options can perform very differently than with options based on the non-overaged SPY. The switch from SPY options to UPRO or SDS options is not as simple as it might appear, so research thoroughly before jumping in to these unique options.
There are other ETFs that follow the S&P 500 index as well as others that leverage the S&P 500, but they don’t trade with as much volume, and their options trade less frequently. Why trade a product that is less liquid, with fewer options, and much lower option volume when a better choice is available? I see no reason to use anything but SPY, UPRO, and SDS.
There are also ETFs that represent sectors or portions of the S&P 5oo, or weight the 500 stocks of the index equally. So, for value vs. growth, or Finance stocks or Utilities, there’s are ETFs with options of every flavor. But none of those represent trading the full S&P 500 index, so we won’t dig in any further into those products, because the point of this discussion is ways to trade the benchmark index.
For most traders, SPY options are the only options on the S&P 500 index they use, and many traders aren’t aware of any other choices for trading options on the index. But, we’ve only just begun.
Index Options
Why trade options on an ETF based on an index when you can simply trade options on the actual index? Index options remove the ETF from the mix and link options directly to the index. For the S&P 500, there are two index options available, SPX and XSP. SPX is literally the S&P 500 Index, and XSP is the Mini S&P 500 Index.
Traders are often not aware of these ticker symbols or the fact that options are available for these two indexes. There are a couple of reasons for this. There is no way to actually buy or sell the actual S&P 500 index directly, a trader can’t buy or sell shares of SPX. Additionally, since SPX is an index and not a stock or ETF, many brokerages don’t show it as SPX. For example, Schwab lists it as $SPX. Other sites may show it as ^SPX or .SPX. The point is that you have to know what you are looking for to even find it. Since SPX is literally the S&P 500 Index, it is priced at the full price of the index. So, if the S&P 500 Index is at 4500, SPX is at 4500. They are exactly the same.
Okay, SPX is the S&P 500 index. But, what is the Mini S&P 500 index, you may ask? XSP, or the Mini S&P 500 is simply an index that is 1/10 of the S&P 500. However, unlike SPY, which is approximately 1/10 of the S&P 500 index, XSP is exactly 1/10 of the S&P 500 index. Why do we need an index that is 1/10 of another index? It’s all because of options and sizing of positions.
Options on SPX don’t represent 100 shares in SPX because SPX doesn’t have shares. Instead, SPX options represent a value of 100 times the value of SPX. Think of it as if SPX had shares and the options represented 100 shares, even though there aren’t any shares. XSP options represent 100 times the value of the XSP. So, in both cases we still have a multiplier of 100 as we do with ETF options. This is where the similarity in options end.
One difference is that dividends are not part of the S&P 500 index. Many of the 500 stocks in the index pay dividends at various times throughout each quarter, and those payments have an impact on the individual stock price, which will then impact the price of the index. But the index has no mechanism to pay dividends because it is just an average of the prices of the 500 stocks it tracks and isn’t tradable itself. So, option buyers and sellers of SPX and XSP don’t have to consider dividends as an event, like traders in the SPY ETF.
Since index options can’t be settled in shares, they settle in cash when they expire. In many ways, this can be a lot easier. If an option expires $5 in the money, a call buyer will receive $500 from the account of the call seller at expiration because of the 100 multiplier. If an option expires out of the money, it is worthless and there is nothing to settle.
Cash settlement can be a bit confusing at first, so just realize that there is nothing to actually buy or sell from assignment- a put seller that is assigned doesn’t have to buy 100 shares, they just have to pay the difference in the current price at expiration from the strike price of the option. If the trader sold a put on a stock or ETF, they would be assigned shares that they would buy for more than the current price, which they could turn around and sell at a loss. Index options eliminate the step of buying and selling shares, and just settles the difference in price with cash.
Index options use European style option assignment, while stock and ETF options use American style options. American style options can be executed at any time by the option buyer, and this becomes a consideration for option sellers that have positions in the money before expiration. However, European style options can only be executed at expiration. So, sellers of index options don’t have to worry about having an early assignment before expiration, and buyers don’t have that option. And since index options are cash settled, there really isn’t an “option” at all. In the money index options are simply “settled” at expiration.
SPX options have lots of different expirations. Originally, these options only had expirations once a month on the third Friday of the month. Later, month end and quarter end expirations were added. Then weekly expirations every Friday were added. And now there are Monday and Wednesday expirations. Soon, maybe by the time you read this, there will be options expiring every trading weekday when Tuesday and Thursday are added.
One holdover from the original monthly expiration is that monthly index option expirations are different than all the other expirations in a couple of ways. First, and most importantly, monthly index options expire in the morning (AM) of expiration, while all other expirations expire at the close (PM) of trading. For SPX, there are actually two option expirations on the third Friday of the month, the monthly AM expiration, and the Friday PM weekly expiration. The settlement price for AM expirations of SPX is based on the opening trade price of each of the 500 stocks of the S&P 500 index. After each of the 500 stocks has traded on expiration morning, the prices are calculated to determine a settlement price for expiration. However, trading on the expiring option is stopped at the close of trading the day before. So, SPX option sellers and buyers are stuck with their positions from Thursday afternoon until Friday morning not knowing what the index price will be for settlement until the market actually opens and sets the price. For PM expirations, it is simpler, when the market closes, option trading stops and expiration settlement is based on the price of each of the 500 stocks in their last trade of the day. If you watch the price at the closing bell, you will see it change slightly by several cents after the close as all the different orders that execute at the market close get accounted for. The second way that AM and PM expirations vary with index options is that when the option contract is listed, monthly contracts use the ticker symbol SPX, while all other expirations use SPXW. The W is for weekly, even though the expirations may be quarterly, monthly, Monday, or Wednesday, and soon Tuesday or Thursday. So for S&P 500 Index options, just know that SPX listed options expire in the morning (AM) and SPXW listed options expire in the afternoon (PM). Either way, when you are searching for option listings, most brokers list SPX and SPXW options together under SPX.
XSP options are a more recent creation, and only have PM expirations. There aren’t different naming conventions either. Settlement works the same, with prices set by the final trade of each of the 500 stocks of the index when the market closes.
Another difference between SPX and SPY options is that SPX options are traded in increments of 5 cents. Since SPX is 10 times the price of SPY or XSP, trading increments or tick size is actually more precise on a percentage basis for SPX. XSP trades in increments of one cent like SPY. SPX options are also very liquid and orders can usually be filled 5 cents away from the mid price, even in multi-leg orders. There is a little difference based on trade volume of different expirations. Monthly expirations typically have the most volume, followed by Friday PM expirations and month-end expirations. Monday and Wednesday expirations have the least volume and can sometimes be slightly harder to fill, especially for strikes away from the money with more than a week until expiration.
XSP have a lot less volume than SPX or even SPY options, so they can be a little less liquid. Because of their pricing, they trade very similar to SPY, but with a little less liquidity. Since XSP is an index option, there is no worry of assignment, and dividends are not a consideration.
Some brokers don’t allow trading of index options in their accounts, and some strategies are not allowed with index options in certain types of accounts. Some brokers charge higher commissions and fees for index options than for stock and ETF options, so watch out!
Finally, index options get a different tax treatment and have a different accounting treatment at the end of the calendar year. Index options fall under Section 1256 of the tax code which allows a trader to classify 60% of the gains from trading index options as long term, while only 40% are short term. For taxable accounts of traders in mid to high tax brackets, this can be a significant advantage! It doesn’t matter if the option was held for a minute or six months, the 60/40 tax assignment applies. The other part of 1256 treatment is that index option positions are “marked to market” at the end of the year, meaning that a trader considers the option to be a profit or a loss at the end of the year even if the position is still open based on the price at the end of the year of open positions. In stocks and stock options, only positions that have been closed are evaluated for a profit or loss. Using mark to market can be a bit confusing the first time around, but most brokers do all the calculations and provide them in a year end tax statement.
The CBOE has announced another index option on the S&P 500 index to start trading very soon, call Nano options. This index will be 1/1000 of the SPX, or 1/100 of XSP, to allow very small option trades on the S&P 500. Supposedly the ticker symbol will be NANOS. Stay tuned for more details.
Futures Options
There are two futures contracts on the S&P 500 index that offer options. The primary one is called the E-Mini S&P 500 Futures, which uses the symbol /ES at most brokers. In listings of futures contracts and futures options the symbol will be followed by a letter to designate the month the future expires and a number for the year of expiration- for example /ESH2 represents the future contract expiring in April of 2022. The other futures contract is called Micro E-Mini S&P 500 Futures, and uses the symbol /MES. Some brokers may use other characters to designate futures instead of the forward slash, and some may require approval of futures to even see the ticker symbols. Consult with each broker for details.
Futures are tradable contracts based on the price of the underlying index at the expiration of the contract. Futures contracts in general expire at a variety of times in the month with /ES and /MES expiring on Wednesday mornings and settling to opening prices of the S&P 500 index. Since the futures contract is based on what the market expects the price to be at expiration, the price of the future is usually a little less or sometimes a little more than the current value of the S&P 500 index. However, it generally doesn’t vary that much because the current price is one of the best indicators of what the future price might be and futures buyers and sellers won’t let the prices to diverge that much because it presents an opportunity for arbitrage between the different values, knowing that at expiration they will converge. At any given time, there are many different contract expirations available to trade, going months out in time. The contract month closest to expiration is called the front month. Buying a front month futures contract is as close to directly owning the S&P 500 index as you can get. The value of the futures contract goes up and down with the index.
A single /ES contract is valued at 50 times the S&P 500 index. One might think of it as owning 50 shares of the S&P 500 index if the index price were the price of a share. A single /MES contract is valued at 5 times the S&P 500 index. These values are known as the notional value. However, futures contracts are priced at prices similar to the actual S&P 500 index, regardless of the notional multiplier.
Let’s take an example. Let’s say that the S&P 500 index is currently at 5010, and front month futures contracts for both /ES and /MES are trading at 5000 as they are slightly less. The /ES contract would have a notional value of $250,000, and the /MES would have a notional value of $25,000. If the market went up 100 points on the S&P 500, and both /ES and /MES went up to 5100, the owner of one contract of /ES would make $5000, and the owner of /MES would make $500. For most people $250,000 for one contract is too expensive, but futures contract owners aren’t required to have the full amount in their account, but just a fraction due to the assumption that the price will only move within a small percentage of the index price. If the price moves more than expected against a contract owner or seller, additional capital will be required. This practice is called span margining, and can be very helpful to allow traders to leverage a position, but also very dangerous if over-used and the market moves against a position. For example, if a trader buys an /ES contract priced at 5000 and has $50,000 in their account, a 20% decline in the market to 4000 would wipe out the account. While /MES is one tenth the size, the problem can be the same for a trader with a smaller account.
So far we’ve talked just about the futures contracts themselves. The topic of this post is trading options on the S&P 500 index, not trading futures on the S&P 500 index. So, let’s talk about how options on futures work. In particular let’s look at options on /ES and /MES. One key difference from other options we’ve looked at is that /ES and /MES options don’t use a 100 multiplier, like stocks or index options. Instead, futures options are an option to buy or sell one single futures contract. Which futures contract is the option associated with? Typically, it is the futures contract that is next to expire after the option expires. So, an option on /MES expiring on the first Friday in March is tied to the March futures contract, which will still have time remaining when the option expires.
So, buying an /ES call gives the buyer the option to buy one /ES futures contract at option expiration, and buying a /MES put gives the buyer the option to sell one /MES futures contract at option expiration. So, settlement of the option at expiration doesn’t settle in stock or in cash, but in a futures contract. The price paid for the futures contract is the strike price of the option. For example, if a trader buys a call option for /ES with a strike price of 5000, they would get to buy an /ES futures contract at options expiration for $5000, multiplied times the /ES futures multiplier of 50, or a total of $250,000, assuming that /ES is trading above 5000, making the option in the money. On the other hand if the price of /ES is below the strike price of the call option, the option would expire worthless. Similarly, if a /MES 5000 put expired in the money, the settlement would be to sell a /MES futures contract for $5000 multiplied times the futures multiplier of 5, for a total of $25,000.
There are futures options for /ES and /MES that expire every Monday, Wednesday, and Friday, so there are plenty of expirations to choose from. And futures and futures options trade virtually around the clock, from Sunday afternoon until Friday afternoon. In fact, the price of /ES in the overnight hours moves around quite a bit based on news and as the opening of the market approaches, it is a fairly accurate indicator of where the market will open. Meanwhile the S&P 500 index stays the same during the overnight, because it is based on a calculation from the trading of the 500 stocks in the index, which don’t broadly trade at night.
The span margining ability to trade using the buying power associated only with a calculated expected move applies to futures options as well as futures contracts. As a result, traders can put on highly leveraged trades without consuming a lot of buying power. With this capability comes significant risk. Traders have to be very aware at all times of the true total risk that comes with trades in futures options. With futures options, the buying power used is not a good indicator of the capital at risk in the case of a very large move of the market up or down. Some brokers allow selling of naked futures options for very little buying power, where selling the same notional value of SPX or SPY could easily require ten times more capital even though the true risk is the same. Many trading strategies with futures options may seem very safe because they are high probability trades- perhaps they win 90% of the time- the problem is when the losing 10% happens and the trader is not prepared for the damage that occurs to the account. Risk management is critical in all options trades, but particularly in futures options using span margin. Stops and hedges become the difference between staying solvent and going broke.
Like index options, futures and futures options also use section 1256 tax treatment with 60% long term gains and 40% short term gains, and are marked to market at the end of the year. There are no dividend risk issues.
One final unique advantage to futures options is that they are exempt from the Pattern Day Trade rule. For accounts under $25,000 where trades are opened and closed the same day, a trader can have severe limitations placed on an account. Generally, the limit is five day trades in a rolling seven day week. This can be stocks or options. Futures and futures options are governed by different regulations, so many day traders favor futures.
Many brokers have significant approval processes to be allowed to trade futures or futures options. Some limit them only to standard taxable margin accounts. Other brokers don’t allow them at all. Go to the office of your broker and see if anyone there has any experience trading futures or futures options- it is likely no one there has a clue and they will tell you not to do it. If you have friends that trade in the market, chances are that almost none have ever traded a future or futures option, so you are likely on your own. Your best source for help will be specialist from your broker’s headquarters, specialized training materials, or online resources from your trading community as I discussed in an earlier post.
If trading futures options is so complex, hard to understand, and risky, why do it? For many strategies, futures options can fill in gaps at a low capital requirement. Some hedging strategies can be too expensive with stock or index options, but more affordable with index options. Because of the unique multipliers, futures options for the S&P 500 index may be just the right size for a particular need. And finally, because the futures prices move and trade all night, futures and futures options allow trading on that information at some brokers.
Review of choices
After a lot of discussion and explanation, we have come up with seven choices for trading options on the S&P 500 index. Five of these are directly correlated to the index, and two are leveraged. Remember that the UPRO ETF moves up and down with the S&P 500 index, but three times as much each day. SDS, the UltraShort ETF not only moves the opposite direction of the S&P 500 index, but twice as much in the opposite direction on a percentage basis each day. Because of this leverage, the options on these two ETFs behave in unique ways which can be helpful for some strategies. However, most traders are more likely to want options that are based on underlying entities that move on a 1:1 basis with the S&P 500 index. So let’s review those choices.
Ticker
Type
Index vs Strikes
# of Shares or Multiplier
Notional Value @ SPX = 4000
Settle as
Tax Treatment
SPX
index
1 : 1
100
$400,000
cash
60/40
/ES
futures
1 : 1
50
$200,000
one contract
60/40
SPY
ETF
1/10
100
$40,000
100 shares
short term
XSP
index
1/10
100
$40,000
cash
60/40
/MES
futures
1 : 1
5
$20,000
one contract
60/40
This table lists key differences in the five main choices for options on the S&P 500 index, listed in order of notional size. In this table notional value refers to the amount of capital controlled by a single option with a strike tied to the S&P 500 index being at 4000 (SPY and XSP would have strikes at 400, while SPX, /ES, and /MES would have strikes at 4000).
While SPY is the simplest choice because it is most readily available, there are reasons to consider each of the other listed choices to best meet the needs of a specific account or strategy. From biggest to smallest, SPX controls 20 times as much capital as /MES, and the other choices provide increments in between. I was personally reluctant to trade futures options at first, but for no good reason other than I wasn’t familiar with their nuance. As I write this, I currently have at least one contract of each of these five choices open amongst the various accounts I manage.
For all of our choices, we currently have the ability to select expirations three days a week, and potentially five days a week in the near future. Each choice has an extensive selection of strikes available at each expiration, although one can expect Friday expirations and month end expirations to have more choices and more trading volume than Mondays and Wednesdays. We expect third Friday (monthly expirations) to have more choices and trading volume than any other expiration in the month.
My personal preference in most situations is SPX due to its large size. Even though commissions and fees are more on a per contract basis, the fact that SPX is 10 times bigger than SPY or XSP makes commissions and fees almost negligible in most trades of SPX, where they can be a substantial consideration with SPY and XSP in some strategies that deliver narrow profits. For futures, I like /ES over /MES for the same reasons. However, when I’m trying out a new strategy or working with a small account, I often have no choice but to use SPY, XSP, or /MES. For most new traders, SPY is the first and easiest choice, but eventually there may be a need to use another choice. For example, if you start trading 10 option contracts at a time, it might make sense to use SPX. If SPY is too big, you may want to get approval to trade futures and trade options on /MES. If you have a taxable account and are in a higher tax bracket, XSP may be a good alternative to SPY to reduce short term capital gains. So, learn the differences and make the choice that makes the most sense for the situation.
If you want to investigate strategies for trading options on the S&P 500 index, take a look at some of my favorite strategies. You may also want to read my page on how different option strategies have very different risk profiles.
Traders need access to other traders to share, learn, and teach each other. Online social media groups can provide that type of community.
Let’s face it. Trading options can be a lonely task. It’s just a trader and the computer screen. Whom can a trader turn to with questions, for encouragement, or to share success and failure? Virtually every person who I dare to tell that I trade options as a primary activity either have no idea what I’m talking about, think I’m crazy, or both. Most people who do a lot of their own investing don’t even know what a put or call is. Traders need a community of other traders to keep their sanity and keep moving forward.
When I stop and think about it, I personally know seven option traders that I have met in person. Only seven. Four of them I met through one of the others. And only a few of them regularly do the same kinds of trades as me. And I feel lucky to know that many. So, personal connections can only help so much.
There are lots of online services that traders can pay a small fortune to join to help learn to trade options. Some are follow the leader- buy or sell what the guru says and exit when the guru says. I tried a few of those and found it hard to time it right and even then I didn’t get the results that were promised. So, I’m not a big fan of spending a lot to watch others trade.
If you do a Google search about any topic concerning options, you’ll be bombarded with ads for paid services, but then below them will be lots of YouTube.com videos, and other sites, maybe even this one. There are lots of quality YouTube videos on options, but many that are dubious at best. I first discovered TastyTrade.com through watching some of their YouTube videos. Tastytrade has their own channel on YouTube, and I’d encourage subscribing. One TastyTrader that I enjoy watching is “Sweet Bobby” Gaines. He has a “Sweet Bobby” channel on YouTube. Look around and search YouTube for option trading, and find your own favorites to follow.
But even watching others still doesn’t give you community. There’s nothing like interacting with others. This is where social media actually can be a help. A feature on Facebook.com that you may not be aware of is “Groups.” Just click on the Groups icon and either use the “Discover” icon or the search magnifying glass to look for groups that specialize in option trading. Some are more active than others. Most are private and require you to apply for membership- this is generally to keep out spammers and robots who will ruin the experience. I’ve joined a number of groups- some I’m active in and others not so much. For groups that don’t have members doing strategies I have in interest in, I simply drop my membership. I now have a number of virtual friends from these groups. Some of them message with me on an almost daily basis. I’ve discovered numerous trading strategies to try from posts in these groups, and the banter from members gives the members a wide variety of opinions about different trading scenarios, positive, negative, pointing out risk, ways to manage, and success stories.
Another social site that gained a lot of traction in early 2021 was Reddit.com. Reddit became an overnight sensation for traders when a little-known group on the site called “Wall Street Bets” essentially cornered the market on the stock of GameStop, an almost bankrupt video game store chain. By realizing that there was a huge amount of short interest in the stock and a small float of tradable shares, the group started buying up cheap shares of stock, and bigger buyers followed, driving up the price. Many short sellers, including some large hedge funds were caught flat-footed and had to buy back their short positions at huge losses, further driving up stock prices, a classic short squeeze. Call option buyers joined in as well and market makers hedged by buying increasing numbers of shares also driving up prices. By the time the craziness ended the stock was up over 100 times the price when the buying started. This crazy action drew attention to Reddit and the “Wall Street Bets” group. Like many, I joined both for the first time to see what the fuss was all about. The group membership ballooned to an enormous number and the content turned to mush- just a lot of nonsense posts slamming each other and promoting hundreds of other crazy schemes. I dropped my Wall Street Bets membership after less than a week.
However, Reddit has a feature that suggests posts from other groups that it thinks a reader might like. I found some other groups that I started commenting on that were more serious and in line with my view of trading. Again, I met a number of new virtual friends and engaged in both public and private dialogs about trading strategies. Groups on Reddit are public to read and join, so there can be a lot of spamming behavior and many users delight in being very foul-mouthed in their responses. Rudeness is tolerated a bit much, in my opinion. However, I’ve found that if I stay on the high road in my posts and stay factual and data focused, people generally engage back with me in a respectful way. It’s kind of a what goes around, comes around. In fact, the site has a measure called karma that is based on how well your posts are received by others. People who are mean and overly negative end up with negative karma and many of their comments get deleted by moderators.
Another social site that I’ve found helpful is Discord.com. Discord was started as a way for gamers to chat with each other in private rooms, and have discussions in groups on a private “server.” Once you join Discord, you can set up your own server, or join public servers set up by others. As it applies to traders, individuals will set up and organize a server and invite others to join. Many people have private servers by invitation only. Some of my local friends set up a server like this and invited me- I like the familiarity of the small group and we get along well with each other. I’m also a member of a number of other groups. A nice feature is that anytime someone posts a response to a server, I can have a notification pop up on my phone, or I can choose not to- the choice can vary from server to server. So, I have notifications on for some servers and off for others. The idea is that like-minded people can have an ongoing private dialog about their trading. Some conversations are based on users posting each of their trades for comparison and comment. So, a group of 0 DTE traders might each post their opening and closing trades, and then discuss what went right and what went wrong, critiquing themselves and other members on strategy. A Discord server can be very busy, or not busy at all- it depends on the number of users and how active they all want to be.
Twitter.com can be another source for information on trading. There are lots of famous and not so famous traders and information sources that tweet out information on a regular basis. I personally don’t have the bandwidth for it at the moment and don’t use it much. However, I know lots of traders love it. TastyTrade has a daily show, the Liz and Jenny show, where much of their discussion is based whatever Twitter posts use the hashtag #LizJny, which has fostered a community feel. Other shows on trading networks and CNBC have similar features and hashtags. Many high profile traders will respond to personal tweets or tweets that use an @ reference for them. However, the format really doesn’t lend itself to in-depth discussions. Often, it just allows tweeters to refer followers to content that the tweeter thinks is interesting.
I used to be a big fan of LinkedIn.com and its groups. Now, I think other social media resources have taken the lead in being sources of interaction with like-minded traders. I joined a few trading groups, and I have to say that I’ve been disappointed so far. Maybe new groups will emerge that will be better for the trading community, but I’m still waiting.
I know TikTok.com is gaining ground in this space as well. Similar to YouTube, TikTok offers videos, generally short in duration, and based on your reaction, the site steers you to similar content that might be appealing. As I write this, it seems a bit of an immature community currently, but by the time you read this in the future, TikTok could be the greatest resource available. We’ll see.
This is just a start. Feel free to leave your favorite way to get involved in the trading community in the comments below. New forums and sites are emerging all the time and providing new opportunities to connect with other traders. I’ll refrain from naming any specific groups on any particular site, because if you are reading this years from now because I haven’t updated it, there will likely be many new groups and sites to join and find community.
From my website Analytics, I can see that over half the hits to my site come from people clicking on a link to this site from a post someone referenced on a social media site. It used to be just me that did that on occasion, but lately others are finding this site and sharing it with their groups and trading friends. I really appreciate it when readers of this site find it helpful enough to copy a link from this site and share it with others. People seem to like the pages I have on my favorite trading strategies. I hope that you find some community here as well and find content worth sharing. Your comments are always appreciated, even it is a pain to leave them. It’s a challenge to have a site like this that doesn’t get nailed by spammers and hackers, so I have to put up some hurdles to allow comments.
Remember, the whole point of this post is to give you ideas about connecting with other people who understand the kinds of struggles you face as a trader, and give you a chance to give back to newer traders. Discussing trades on social media is the only place where I can discuss the merits of 20 delta short strike on a wide put spread, and know that most of the people reading will not only understand, but have an opinion to share back with me. That won’t happen at the next neighborhood block party. You aren’t crazy. There are people out there that get what you are trying to do and will be happy to have a discussion about it. You just have to know where to look. That’s the power of community, even when your community is spread around the world.
I recently responded to a social media post which asked why there is so much hate out in the social media world regarding rolling losing option positions. If you frequent any discussions about managing option trades, and someone discusses rolling a losing position, there will be some critic who comments to say that rolling options is horrible and locks in losses, and is a low probability trade, and basically is un-American. I sometimes get these kinds of responses myself, and if you read much of what I write, you know that I disagree with that. Rolling is a key part of many of my strategies including the rolling 7 DTE trade that I frequently trade. So, the following is my thoughts on rolling losing option positions.
As someone who rolls almost all my positions, win or lose, and often writes about it, my thought is that a lot of people that write negatively about rolling don’t really understand the benefits. It isn’t an issue that everybody should roll, or that nobody should, but more that it is a method that works well for a certain mindset. Some traders approach managing trades very differently and that’s great for them.
I think the issue is when the discussion comes to managing a losing position. There’s really three choices: hold, stop, or roll. A legitimate argument can be made for each approach, but I think the right answer comes down to the type of position that is in trouble, the trader’s view of the market probabilities looking forward, and personal preferences around risk and reward.
I roll my credit put spreads on SPX in virtually every situation. I want to avoid expiration drama, so I never hold to expiration. When I used stops in the past, it seemed like I got stopped out just as the market bottomed out and I found that frustrating. I now specifically seek out trades that accommodate rolling options and develop mechanical triggers on when and how I’ll roll a position.
For me the benefit of rolling a losing position is giving myself time and space to be right. I almost always collect a credit for a roll, so I’m paid to wait for a turnaround. Each roll improves the cost basis of my trade. When my position is being tested I try to roll both down and out for a credit, so that I don’t need a full recovery to come out with a profit. Since most of my positions are credit spreads, I do have an issue that if my position gets in the money, it is no longer able to roll for a credit, and I’m forced to pay a debit to stay in. Because my positions start at least an expected move away from the initial price, I rarely end up in the money paying a debit. I’ve found that with the trades I do, I collect credit 97-98% of the time, and the debits I pay have generally been about the same as the credit I get when I’m rolling a winning trade which happens much more often.
The big benefits I see from rolling credit spreads is that I keep time decay working for me 24/7. I don’t have to decide when to jump back in after being stopped out because I’m never out.
For those that say that rolling locks in a loss and puts you in a worse position, I understand that the act of rolling options, closing a losing trade and opening one is truly closing a losing trade. However, my new position is poised to earn all the loss back plus a profit beyond. Usually, when rolling a loser, the market is approaching an oversold situation and is increasingly likely to start back up. Since almost all my rolled positions are still out of the money, I usually still have positive expectancy and better than 50/50 odds of a profit. Market downturns are the best time to buy, so in many ways I’m forcing myself to buy the dip.
Rolling losing option positions does introduce a lot of volatility into a portfolio value. I get great returns through rolling, but my positions’ marked values go up and down more than many people can tolerate, and I understand. Every strategy for management has pros and cons, and some are no-goes for some traders. Each person has to find mechanics that match their tolerance for risk, and expectations for return.
It isn’t easy emotionally to roll in tough markets, but I don’t think it is any easier to take a loss when you are stopped out. I lost a lot just today, Nov 30, 2021, and did a number of rolls as part of my mechanics. However, I’ve been through this numerous times before, recovering fully each time, and built up cash reserves in good times, so that I’m ready for whatever the market is going to do.
Some types of trades just aren’t made for rolling options. For example I won’t roll a credit call spread that loses because I find they just compound losses as the market drifts higher more often than it falls, and it isn’t a fight I can win consistently. I don’t use rolls as much in individual stocks because moves can be extreme and last a long time. I don’t try to roll trades on expiration day because the numbers don’t work out. So I do have limits and don’t blindly roll every kind of trade. I find that many people critiquing rolling as a strategy are talking about one of these losing situations that even I won’t roll in.
I’ve had many people reach out to try to understand rolling options and from their questions I can see that it is a hard concept to grasp. I love it when the lightbulb comes on for someone, and it is also troubling when someone misses the point and drops a position, closing at the worst possible time. I usually get a few messages of a bad loss on days like last Friday or today, but I also get nice thank you notes from many more when the market goes up after a downturn and the person came out of a down market with a profit overall and their account at new highs.
I know my rolling approach isn’t for everyone and that’s okay. But it works for me. If it doesn’t work for you, then do what does work for you, and maybe learn a little more about rolling before you bad mouth it out of hand.
I hit a milestone trading the broken wing butterfly strategy, passing 500% return in one year.
In June I hit a milestone trading the broken wing butterfly strategy, passing 500% return in one year. I learned the basic concept from Nick Batista and Mike Butler of TastyTrade.com. I was so pleased that I wrote the following note to Nick and Mike:
BWBF Success 500% in a year
Nick Batista/Mike Butler-
I’m writing to thank you for introducing me to trading broken wing butterflies.
A few years ago, you guys turned me on to the concept of Broken Wing Butterflies. I played around with the concept and settled into a trade that I was able to repeat over and over. Last June I set up an account with $9,000 trading only butterflies. Earlier this year I added Broken Heart Butterflies to the mix, because my strategy was a little susceptible to big drops. Not really sure why I have kept a single strategy in this account, but I’ve just kept going with it. After a year, I’m now at $54,000, which is 500% above where I started. I’m “only” up 119% this calendar year as I’m carrying around 50% cash most of the time to have for fighting downturns.
I played with this trade for over six months until I settled on this strategy in early 2020. I realized that butterflies hold value until expiration is close, so I adjusted this to a 21-day trade. I also wanted to make the trade worth my time, so I collect a lot up front. And I realized that hitting the high profit butterfly butterfly was close to impossible, so I just hold to get my premium collapse, which is much faster than a simple spread with the same risk.
typical setup of a broken wing butterfly trade (negative premium = credit to open)
My butterfly strategy is to sell two of the 25 delta puts and buy one a strike or two above, and buy the one twice as far below. I sell these 17 to 21 days before expiration and collect 12-18% of the width of the narrow spread or max risk. I close when this gets to 2%, by converting to a free butterfly. This works around 90% of the time. I was doing this in several accounts last year and had over 100 wins in a row at one point, making 10% in two weeks, over and over again. Eventually, I had some tests where I sell the debit side and roll the credit side, often for a debit. As long as I have cash to fight, I can hold out. I then wait them out for recovery.
Adding the Broken Wing Condor
I noticed that my tests were more likely when the market was going crazy up, hitting new highs every day and then a correction occurs. So, I was attracted to the broken heart butterfly in those situations for a little more probability, but less benefit. I think it is actually a broken wing condor, but whatever. For that trade I buy a 40 delta put and sell the one a strike or two below, then sell a spread three times as wide centered around 20 delta. I try to collect 6-8% of 2/3 the width of the wide spread (max risk). I open this up 14 days to expiration. Because of how this setup decays faster on the credit side, I target to collect 1-2% on the close. So I collect about 7% to open and collect another 1% to close. I can make a little more if I’m on the verge of being tested with 2-3 days left to expiration. Worst case, I sell the debit spread and roll the credit. I think I’ve only had one or two of these need to be rolled. I’m all about return on capital, so I look to make at least 10% a month on any short option strategy I do, while keeping probabilities very high.
All in all, I’m happy with how this is going and continue to watch Tasty for new tidbits every day. I especially like your show, because you are all about trade mechanics- what works and why. You also seem to venture out from standard Tasty style trades and look for creative ways to think about opportunities. Your discussions on leveraging skew and other unique situations are very insightful. Anyway, I just wanted to let you know that what you do is really helpful and that your approach to trading has given me tools to keep experimenting and try new things that have ended up being very successful for me financially.
Thanks so much-
(I received a nice note back from Nick)
If you want to see how I set up broken wing butterflies and how they work, go to the page I wrote on it here.
