Stepping into Options Trading
I will be placing my first options trade Monday. Well, not my first, but my first with my new options only account where I will be regularly trading options.
I started out wanting to do naked puts, where you get paid to buy a stock if the stock price drops below a certain point. Originally, I wanted to sell Google puts at $250, which would make about $5/month, and if it gets executed, you would end up with Google at $250. Google at $250 is a P/E of about 15, which I would be happy with, no matter what crazy nose dive the market took for Google to hit that price, since I wouldn’t be selling Google any time soon, and I would be paid to wait for it to hit my target price. The problem is, I need $25k sitting around so that I can buy the stock when the target gets hit.
So then I started thinking about put spreads. You sell one put, saying you will buy a stock if it drops too much and collect a fee, and buy one put, saying someone will buy your stock if it drops even more. The first put is more expensive then the second put, thus you are credited the difference between the two put prices. The second put provides you with insurance, so the most you are at risk is the difference between the two put strike prices. This is called a bull put spread, and it is a strategy you use when you think the market is going to be flat or go up in the next 30 days.
But I don’t really know what the market is going to do.
If you don’t have an opinion on the market, maybe a market neutral strategy is a good idea. I am reasonably confident that the S&P 500 will stay below 950 for the next month, and above 800.
Since I hold that believe, then an iron condor makes sense, which is a highly profitable strategy when the market is flat. The market isn’t currently flat, and that is why my high guess and low guess are so far apart.
So what is an iron condor. An iron condor is a call spread for a credit paired with a put spread for a credit, both side providing a credit. The benefit of the pairing is that only one side can be a loss. The downside is, the loss on that one side is usually enough to make the entire iron condor a loser for the month. The goal is to pick high and a low that the market will not reach, but still generate enough credit so the trade is worth doing.
This is where risk management comes into play. Iron condors lower your financial exposure, but if the market rockets in either direction, iron condors are losers.