Entry Guideline updated

To expand on my previous post Two Out of Three, I have updated my Entry Guideline with more details.

Entry Guidelines
A. Position

B. Price

C. Time

Conditions for Entry

1. Implied Volatility (IV) is higher than Historical Volatility (HV)

2. When the volatility is spiking up (that is, a down day)

3. Sell put on a down market; Sell call on a up market

A. Position

1. Strike outside Straddle range

2. Strike outside One Standard Deviation

3. Strike outside previous highs and lows

4. Delta 10 or lower (not more than 12)

B. Price

- minimum of 0.20 credit or greater

- minimum 12% return on margin

C. Time

- Days To Expiration (DTE) 6-8 weeks (42-56 days)

- DTE not lesser than 49 (consider if volatility takes a huge jump before day 42)

This is also updated in the Trading Plan.

Exit Guidelines updated

Taking profit should be the easiest thing in Option Selling, especially in Credit Spread.  You either take the 100% credit through the expiration or you take part of the credit before expiration.  As described in this post "Exit Strategy", I no longer wait till expiration.  I only take part of the credit, mostly at 70% of the credit.

Stopping loss is more difficult, in most trading.  However, it is the most important decision to make, especially in Credit Spread Option Selling when the Risk/Reward ratio of the position is almost 10:1.

The below are some updates/refinement made to my Exit Guidelines, to make it more defined.  Hopefully, taking profit and stopping loss is easier with these guidelines.

Exit Guidelines
1. Take profit
- Delta <= 5 (usually about 70% of credit)
- target profit >= 70% of credit
- target profit >= 50% of credit when Days In Trade is <=5

2. Days To Expiration (DTE)
- 7 < DTE < 14
- exit the position before DTE is less than 1 week (start staring at it when DTE is less than 2 weeks)
- exit with whatever profit or break even if possible, else exit with a small loss

3. Stop Loss
- 25 < Delta < 30 and DTE < 30
- Loss >= 200% of credit and DTE < 30

This is also updated in the Trading Plan.

Exit Strategy

When I first started selling options, I only hold till expiration.  I was lucky that most of the trades expired worthless.  I was also 'fortunate' to receive the assignment notice in my early trading days, which I described in this post.

After more reading and more experience selling options, my exit strategy has changed.  The book that influences me most is "Profiting with Iron Condor Options", by Michael Benlifa.

Assuming that the Iron Condor was sold for 17% credit base on margin require, ie 17% Return On Margin (ROM).  Say, it is $170 credit on $1000 margin.

Chart from "Profiting with Iron Condor Options", by Michael Benlifa.

The option expire in 72 days.  Base on the theoretical yield curve (assuming everything remains the same), you can forecast your P&L from the day of your trade till expiration.

After 18 days, you will be able to keep 5% (ie $50) out of the 17%.  This represent 29% of the total credit.  You have still 54 days to expiration.  Those 18 days represent only 25% of the total length of the contract (72 days).

If you wait 36 days, you could keep 12% (ie $120) out of the 17%.  This represent 71% of the total credit and 50% of the total length of the contract (72 days).

You could decide to wait the entire 72 days with the idea of keeping the entire credit (i.e. $170).

Chart from "Profiting with Iron Condor Options", by Michael Benlifa.

As you can see from the above Time risk versus reward chart, the best risk/reward ratio is 50% of the total length of the contract (72 days).

Michael explains that it may not worth to chase for the remain 29% (i.e. $50) by staying in the market for another 36 days.  Things may go wrong.  The wining trade can start to lose money. 

He also explains that if you are content with 5% ROM (which is good by anybody's standard), don't take the risk for another 54 days.

Thanks for his insight, my exit strategy has changed.  I usually take profit when I have >70% credit.  I don't hold the option till expiration anymore.

I may not explain his concept very well.  Go read the book.  It has many good ideas, concept.  Although it is a small book (can finish in 1 day), but I keep going back for reference, for ideas.

Two Out of Three

The following are ideas from the book "Profiting with Iron Condor Options", by Michael Benlifa.  I am summarizing the idea and trying to put in into practice in my Trading Plan.  Most of the time you cannot get the perfect trade three out of three considerations below.  You got to choose just two out of three.  Which two?

The three considerations when selling Iron Condors are :

1. Position : Delta 10s, outside previous highs and lows
2. Price: Credit of 20% of margin
3. Time : Expiration is in 4 to 5 weeks

Michael suggest the first two : Position and Price, leaving Time negotiable.