Hey everyone.
This is Kirk, here again at optionalpha.com.
And in this video tutorial, I want to talk about a really cool trade adjustment that
we made to one of our custom naked put trades in DIA.
And we basically created a new iron condor in DIA that has absolutely no possibility
of losing money, and it's causing us nothing as far as margin is concerned.
So, we were able to hedge this original position, turn it into an iron condor that costs us
absolutely no money with a lot of upside potential as far as profit.
So, we're going to go through the trade here in detail.
So, this is the trade that we're actually looking at.
It's the DIA.
And you can see, this is a live trade that we're making and that we're currently in.
So, here's the original position that we had made.
We did a custom naked sell of a put.
And so, what a custom naked sell is - For our purposes in the way that we teach it here.
And again, you can see a video tutorial of this inside the membership area under the
bullish strategy section.
We go over this exact order and how to place these.
But what we're basically doing is selling a call spread above the market.
So, we sold the 179/178 credit call spread above the market that takes in a premium.
That also means that we're short implied volatility, so this strategy really works well when implied
volatility is high.
Now, at the same time, what we decided to do was to sell a naked put.
And so, basically what we do here is we sell that naked put and add the credit from the
naked put to the credit from the credit call spread.
If that difference in all of the credits that we received - In this case, it was $133.
If that is more than the width of the credit spread that we sold above the market, then
we have no risk to the upside of this trade.
So again, if the credit from selling all of these different things, the call spread above
the market and the naked put option below the market is more than the width of the call
spread above the market which is only $1, you can see we have no upside risk on this
trade.
So, when we originally put this position on, we took in $1.33 in credit, so that means
that if DIA continue to move all the way higher to whatever price in the future, we can still
make about $.33 because of that $1 that's subtracted out of there.
Now, here's the actual trade that we make.
Again, you can view the trades right here.
So, with these trades, you can see that we placed this trade on 1/16.
So, I'm just going to show you guys the chart here.
What's so cool about this is that the stock hasn't moved anywhere since the trade.
So on 1/16, we placed this trade.
And you can see we then made our adjustment trade on 1/28.
So, those are the two different timeframes that we have.
And again, I'll show you the adjustment that we made.
So, let's first go to the chart here.
You can see DIA on 1/16 was right here.
So, this exact day (this green day right here) is where we actually placed the opening order.
And you can see implied volatility at that time was really, really high.
Well, since then, implied volatility dropped a little bit, but it's actually come back
up.
But the stock is basically going nowhere because yesterday is when we actually made that adjustment
to that trade.
And actually, yesterday the stock closed down which is actually bad for this position because
we should be bullish, right?
This is a bullish trade.
We're selling a naked put below the market.
We're selling a call spread above the market.
We want the stocks to move higher.
That's kind of our profit window.
But you can see, the stock basically moved sideways from the time we entered the trade,
to the time that we made the hedge.
So, there's no directional advantage that we had in making this trade.
It was all just time decay and volatility premium that's getting out of this security.
So, this is a look at what the original position looks like in thinkorswim.
So again, we have this long side here for the short naked put.
And then we have a nice big profit window and it dips right here at 179/180 because
that's our call spread that we sold.
So, you can see that's where the profit loss diagram dips.
But everything stays above zero even beyond that.
This is where we make our $33 credit even if DIA continues to move higher.
So at this point, now that we're in this trade, we basically want DIA to trade basically between
179/180 and about 159 which is our breakeven price, a very wide window of opportunity to
make about $100 on this trade, so a good profit window as far as we're concerned.
But now, what we saw is we saw that as the market has kind of evolved and gone through
the process here.
The last couple of days, it's traded sideways, we've gotten a little bit closer to expiration,
implied volatility has gotten down just a little bit, it's back up today though.
But implied volatility has gotten a little bit closer to expiration, so the decay in
these options is pretty substantial.
So, what we decided to do was to go back and create an iron condor out of this position.
So remember, we have the call spread above the market and just a naked put at 160.
So to create an iron condor, we want to just mimic of that call spread above the market
by creating a very similar put spread below the market.
This means that we had to buy the 129 puts which are just below the 160 puts.
And you'll notice all we did was buy one because we were just short one of 60's.
But here's where the key comes in.
We took in an original credit of $1.33 on this trade.
So, the key here is that we have to spend less than $1.33.
So, if we spend less than $1.33, we're still taking in an overall credit.
But even more so than spending less than $1.33, remember we originally said that we want to
have that credit be equal or greater than the width of the call strikes.
And that width of the call strikes is $1.
So really, we want to maintain the fact that we have no risk in this position, or if we
want to maintain no risk in this position, we've got to use $1.33 and buy a put option
for less than $.33 to maintain that $1 overall profit.
And that $1 overall profit means we have no risk on either side of this trade.
So again, if we have $1.33 in credit, we want to spend the money, but keep $1 at the end
of the day.
So, we went out and we bought the 159 puts which we're trading for $.30.
So, we take 133 minus 30 and were still left with $1.03 in credit.
Now, that $1.03 means that the width of our strikes is completely covered by the $1.
We have absolutely no risk on this trade whatsoever, and we still keep the difference between the
width of the strikes and our credit received which is $3 if the stock moves outside of
our strike ranges.
So again, here is what the new position looks like.
So, I've just activated it here on the platform here on the analyze tab.
And you can see on either end of this new iron condor here, we have absolutely no risk.
This is the zero line.
All of our red line which is the profit loss at expiration, absolutely, emphatically no
risk on this trade at all.
So, that means that all the margin that we were carrying originally is completely gone.
We still have a huge profit window between 160 and basically 179 where we could make
about $100.
So, we've already made the vast majority of that.
We're sitting at about an $84, $85 profit now.
But at this point, the trade is not costing us anything, and it still got a very large
profit window (again, 160 to 179) that we could make money.
So, here's what DIA is, and you can see here - I'm going to actually zoom out, so you can
see it.
Here's our profit window, all the way up to about 179/180, and all the way down to 160.
So, as long as DIA stays inside of this range, we get to make all the premium on this trade,
and at this point, it's not costing us anything.
So hopefully, this was a really cool example of how we're using options.
And again, being a little bit strategic, very smart about how we're doing it.
The key here and takeaway here is that you just have to take your time with understanding
these positions.
It's all about the credits and debits that you receive.
Again, if you understand how much money you're taking in and how much it costs to protect
the position or hedge it, then it makes it very, very easy for you to look for the appropriate
hedge.
And in this case, it was a hedge that was able to completely reduce the risk of the
trade 100% and keep all of the upside potential.
So again, I hope you guys really enjoyed this video.
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Help spread the word about what we're trying to do here at Option Alpha.
And until next time, happy trading!