August 20, 2017

Selling Junk to Speculators

I, along with many of you, am in the business of selling out-of-the-money credit spreads with a high-probability of success.

Essentially, I sell junk to speculators. Take the following iron condor in Apple.

An iron condor strategy is a non-directional options strategy that profits when the option on the underlying stock or ETF of your choice expires within your chosen range at expiration.

The basic premise of the strategy is easier to understand in the chart below. But the key part, and the real advantage of this trade…

You choose the price range of the trade. Increasing the range will decrease your potential profits, but will increase your likelihood of success.

10-3-13 AAPL

Recently, due to the increase in implied volatility in Apple, I have been able to sell credit spreads like verticals and iron condors for higher prices. But the increase not only allows you, the seller of options, to bring in more premium/income, it also allows you the ability to widen your range, thereby increasing your probability of success.

Just look at the range in the iron condor above….135 points. That’s right as long as Apple stays within our 135 point range we will make 17.6% in less than 40 days. I challenge anyone to find a trade/investment that consistently makes that much over such a short period of time. More importantly, I challenge someone to find a trade like this with such a high-probability of success…86% to be exact. When you compare that with the probability of your typical stock trade (50%) you begin to see the power of credit spreads.

Back to Selling Junk

As I said in the beginning, I sell junk to speculators. What do I mean when I say “sell junk”?

Let’s go back to the Apple trade.

If you look at the probability or (Prob. OTM) of the Nov 13 550 Calls and the Nov13 415 Puts you will see that the probability of success is 86.64% and 92.41%.

What that means is that there is a speculator taking the other side of the trade buying the Nov13 550 calls and Nov13 415 puts with a 13.36% and 7.59% probability of success otherwise known by professional options traders as “JUNK”.

10-3-13 calls aapl

10-3-13 puts aapl

Now you should have a good idea why professional options traders prefer selling options with a high-probability of success. Don’t believe the hype you hear from the financial media. Believe the numbers, the statistics, the probabilities…let common sense lead the way.

The house always wins…just ask the casino owners in Vegas.

10-3-2013 8-35-59 PM

If you are a believer in a statistical approach towards investing please do not hesitate to try my options strategies. I use simple mean-reversion coupled with probabilities for each and every trade. Give it a try, it’s free for 30 days.

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  • MaxL

    your article sounds like a sure thing … too much so … oh, these
    stupid “speculators” on the other side (in reality, extremely
    sophisticated firms which make money consistently both selling to and
    buying options from the retail) … if this article is not hype then I
    am a skip-strike-calendarized butterfly – look, you would attract more
    customers IMHO if you were more honest about the risk and less arrogant about “speculators”, and make a point that while IC strategy is OK, it’s in fact should not be a major part in any strategic option
    portfolio as “speculators” win quite a bit – in fact these
    “speculators” has made sure it’s extremely hard to make money on defined
    risk strategies in the last years lowering IV levels significantly – the real opportunities are with “undefined” risk strategies, but those are much harder to manage, of course

  • acrowder

    Max…Thanks for the comment…you, like others take the “speculators view and that’s fine…I, on the other hand, prefer to use statistics/probabilities as my basis for trading…I’ve worked closely with an old (and might I add very successful) bond trader from GS. When he left the desk he went to “risk defined” strategies with high-probabilities of success. His stated reason…”options traders continue to trade after their professional careers, stock/bond/future traders don’t, they make their career on one trade if they are lucky and hope to break-even after all is said and done.” I’m not attempting to be arrogant in my view, it’s those touting the latest and greatest stock pick on a daily basis within the financial media that take care of that for me. I just want to educate investors about how they can successfully use options to their advantage. How they can view each trade with a mechanical approach, using probabilities as their guide. It’s purely common sense. Respectfully, you are wrong, very wrong…which is why 99.6% of all professional mutual funds, hedge fund managers can’t outperform the market over the long-term.

  • MaxL

    sure, I was not comparing against non-option based strategies – a retail investor cannot consistently win buying stocks, period, no question about it, and sure all the stock “picks” are in some shape or form revenue generators for the “picker”. I used to be a retail option trader, I then had a chance to look inside a high-tech “other side” business and learned how hard it is to beat this
    “other side”, and how much more their models are sophisticated than school-level probabilities math of risk defined strategies pitched by folks like you and the likes of Thinkorswim “educators” and to large extent Tastytrade (although to be honest they make a point of using undefined risk strategies).You should be honest that this is a zero-sum game and on it is the trading kinds of Kasparov and Phelps and Deep Blue supercomuters that are on the other side of your trades and they consistently earn money. The most ridiculous part in the whole “high probability of winning” for risk defined argument is that it still is a ZERO SUM game –
    on enough occurrences they are NO BETTER than 50/50 – yes, your IC wins 85% of the time – but when it loses 15% of the time it takes all the gains and you lost commissions at the very least and are prone to psychological and other human mistakes. All I’m saying that using defined risk strategies is in fact equivalent of 50/50. The real advantage and consistent return selling options is only possible with undefined risk strategies, that require significant capital and AUTOMATED management to be consistently profitable. The is no free lunch and easy money in this business. Respectfully.

  • Johansmith

    Thanks for such an interesting article. I had read many article on options but i liked it more.
    I had also tried for options strategies.