Download The One Sigma Method

IRON CONDORS
ONE SIGMA METHOD
Version 5.0
Iron Condor Strategy -
Version 5.0 – 3-28-10
[email protected]
1
Disclaimer
• This is not an investment or trading recommendation.
•
The losses in trading can be very real, and depending on the investment vehicle, can exceed your
initial investment.
•
I am not a licensed trading or investment adviser, or financial planner.
•
You should make your own trading plan decisions based your own research and tolerance for risk.
•
I am not a trading authority.
•
Most of this presentation is just information I have compiled from other sources and other
authorities over the past year
•
Links , Footnotes, and Appendices have been added after the end of the show to help with your
deeper research.
•
I am not an Iron Condor expert. All that follows here is just my current trading strategy. If you
want to read in more depth on this type of trading strategy and see where I got some of my ideas,
please see APPENDIX C which is roughly around slide 47 in this presentation
2
What is heck is Sigma ?
Sigma is a symbol used as a reference in over 20 different science and mathematical applications
The historical background is Sigma - it is the eighteenth letter of the Greek alphabet, which was a writing system
developed in Greece 1000 BC and is the direct or indirect ancestor of all modern European alphabets.
Sigma upper case is Σ
and
Sigma lower case is σ
In Statistics and for our purposes ,
1 sigma
is a reference to 1 standard deviation.
More on sigma later in these slides and in APPENDIX A
3
ROCKET SCIENCE
First off, none of the following is Rocket Science.
But on the other hand, it can get a tad complicated
as it involves trading options using probability and statistical analysis
I am not the expert on the subject
So if you want to dive deeper into this trading style,
you can get a better overview explanation from the experts at TOS
Try to catch one of the ThinkorSwim / Option Planet seminars
COMPLEX STRATEGIES FOR TRADER
when they come around to a city near you.
The seminars will not tell give you a “click by click” demonstration like you will see in this Power Point
But the seminars will explain better the overall theory and concepts from people who are experts on the subject
Here is a link if you want more detail on those Free seminars
http://www.optionplanet.com/assembled/list.html
Also, I have found the good group at CONDOR OPTIONS.COM
do a pretty good job of explaining the general strategy.
To me , it seems like they are trading similar to the TOS / Option Planet plan
http://www.condoroptions.com/
4
SPY
Right now, I only trade these Condors in the SPY.
SPDR S&P 500 International Consumer Discretionary Sector ETF - NYSE symbol SPY
Reason being,
the SPY is the #1 ETF for volume and thus it has nice liquidity.
And Condors need a certain amount of liquidity for entry and exit
I will be just trading the SPY for time being , mainly for simplicity and then
expanding into other underlying products maybe later
5
WARNING – HAZARD
NOTE : BEFORE GETTING STARTED,
UNDERSTAND CONDORS HAVE A “HAZARD”
CONDORS DO NOT DO SO WELL
IN STRONG TRENDING MARKETS
UP OR DOWN
If the underlying goes “out of range” and stays there through expiration,
you can lose your “max loss” amount.
These trades have a known up front max lose figure - You can’t lose more than that.
That is why they call the trades “defined risk” … and is one good feature about Condors
Statistically, this “max loss” event should occur only 32% of the time
if you enter 1 Sigma Trades
But this lose can wipe out a number of past winners
That is the Condor “Hazard” and it is still an area I am working on to improve
There are ways to manage Condors to reduce this risk and they will be discussed in this presentation
Of course, There is no single strategy which is good for all market conditions
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WHEN IS A GOOD TIME TO
ENTER CONDORS ?
VOLATILITY - Try to enter (sell) SPY Condors when the VIX is
relatively high compared to the last 1 to 3 months
Watch the VIX chart daily your trading platform along with the SPY chart
STOCHASTICS - Try to enter when the market is not extremely overbought or
oversold which might indicate the market is getting ready to make a
dramatic reversal. The long sustained directional moves can be rough
on Condors
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The Volatility Reference Chart
Watching the VIX when trading SPY Condors
When you enter
Condors
When you exit
Condors
High volatility
(An easy way to track volatility is
to watch the VIX)
Low volatility
Comment
Best scenario is to enter
Condors when the VIX is
high and then exit later
when the VIX is low !!
Low volatility
Low volatility
OK
High volatility
High volatility
OK
Low volatility
High volatility
Danger
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INVESTOOLS CHART SHOWING
STOCHASTICS
Stochastics
Be aware of these
peaks and troughs
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HOW TO ENTER THE TRADE
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WHICH WAY IS THE MARKET GOING ?
Selection of strikes could be based on
"feelings" or "hunches"
but obviously that won't get us very far.
Some traders use technical analysis to help with strike selection.
But that can bring directional bias into our trades
Many experienced traders have given up trying to guess which direction the market will
take in the future.
So they place trades which are “market neutral” or have even odds of the market going
up or down. Also you will hear this being referenced in “Delta Neutral” trading
conversations.
I am not going to get into the Greeks very much in this Power Point.
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The One Sigma Method
Perhaps the simplest way to construct an iron condor
with a reasonable chance of success
(while still generating sufficient premium)
is to select short strikes which are one standard deviation
(or one sigma) from the current price of the underlying.
This means about 68% of the time,
the underlying index or equity will close
on expiration day within one standard deviation
(or "one sigma") of the current price.
If we structure trades so they can tolerate a one sigma move
and still expire worthless,
then we can expect success over two thirds of the time.
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WHICH MONTH TO ENTER ?
Just enter trades MIN 30 day and MAX 70 days before Expiration –
Example – I will start looking for Feb Condors
the week after Dec expiration (about Mon Dec 21)
And I will start looking at June Condors
the week after April Expiration, etc
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FINDING THE DAYS TO EXPIRATION
Click the TRADE tab and enter your
underlying, these are the CALENDAR
DAYS left in these option months
before their expiration
Enter trades MIN 30 day and MAX
70 days before Expiration – best
seems around 50 days
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WHICH STRIKE ?
One of the key factors determining whether
an iron condor will be successful or not
is the selection of strike prices.
But how do we decide which strike price ?
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For this strategy , pick strikes which are :
1. DELTA NEUTRAL
SHORT STRIKES will be equal distance from underlying on
the day you enter (Sell) the Condor
LONG STRIKES are just 2 points farther out from the shorts
We are not trying to pick direction.
We want to be DELTA neutral entering this trade.
2. ONE SIGMA
The strikes will yield a 68% probability of success
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CLICK BY CLICK
The next slides will show how to enter the
Condor trades “click by click” in the TOS
platform
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To start, Right click on the Blue
dot next to your underlying,
Then click TRADE
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Open the Option Chain on the
Month you want to trade
RIGHT CLICK on the BID PRICE
of the
“AT THE MONEY” Call,
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1. Left click
SELL
2. Left click
IRON CONDOR
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This “default” IRON CONDOR will load up and look
like this on the TOS platform.
This is just a starting point.
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First, make your verticals 2 points wide
In other words,
The long call should always be 2 points above the short call
The long put should always be 2 points below the short put
See below for example
The basic logic behind the 2 point spread is it is a happy medium
1 is too close and 3 is too far
For more detail on why 2 points, see the Option Planet Workbook in Appendix C
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The Underlying SPY is at 110 today
To be market neutral and have your Delta as close to zero as possible, your
short strikes to be an equal distance from 110
Adjust your short strikes farther and farther out from 110 until you get about a .68
to .79 credit price
Remember, Keep your long strikes 2 points away from your short strikes
.68 credit would be close to a 1 sigma trade
But you will rarely be able to get an exactly .68 credit
I always try to get the next Credit higher than .68.
In the example below, my starting Credit would be .77
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You could enter this trade at .77
But it will normally not fill quick
You could enter a Limit day trade and it might fill later today or you could enter a
Limit GTC trade and it might fill sometime in the future
If you want this Condor quick , you will need to cancel and adjust your credit down to
.76 . Wait 5 or 10 minutes.
If that does not fill, cancel order and retry order at .75
Generally speaking, in the SPY, 1 or 2 ticks below mid price should yield a fairly
quick fill
MID PRICE
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You might not need it but
the next Slide shows a snapshot of an Excel file I
use for each of my Condor trades.
It is just a simple “assistant” I used when picking
my Condor Strikes and tracking the trade
Email me if you want a copy of the Excel file
[email protected]
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For me, it is easier to use an Excel spread sheet like this to pick
the strikes prices
Just change the numbers in the Yellow boxes
and it will show the strike prices you enter TOS.
Price locations are same format as TOS trade
File - CONDOR CALCULATOR - 12-5-09.xls
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PRICE
See APPENDIX G
if you want more detail on why we picked price .77 in the
above trade example
APPENDIX G is approximately on slide 67 in this Power
Point but it moves around plus or minus a few slides
from time to time
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ANALYZE TAB
and the Probability of Success
See APPENDIX F
if you want more info on how to use the TOS Analyze tab on your Iron
Condors
APPENDIX F is on approximately slide 56 of this Power Point but it
moves around plus or minus a few slides from time to time
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EXIT STRATEGIES
And CONDOR TRADE
MANAGEMENT
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CONDOR ENTRY IS EASY
THE TRICK IS THE EXIT
I AM STILL WORKING ON THE EXIT and
MANAGEMENT SECTION
One Condor loss can wipe out a lot of earlier Condor winners
This is the CONDOR HAZARD
This is an area where I am still doing research. Not done with this yet
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MANAGEMENT and Exit Strategy
This is my current Condor Trade Management and Exit Strategy - as of 3-28-10 – See other ideas in Appendix E
1. INSTALL PROFIT STOPS
The idea is to Buy back either the Call or Put Vertical portion of the Iron Condor if you can ever
get them back for .15 or less.
( Why .15 ? Some of the reason is just taking some profit when you can.
The idea and price setting of .15 was also noted in the TOS Options workbook)
So , a few minutes after the Iron Condor trade fills,
I will put in two separate “GTC Limit” orders (or Profit stops)
One order will buy back the CALL VERTICAL for .15
One order will buy back the CALL VERTICAL for .15
Then during the day when I am not in front of the computer,
the TOS platform will automatically buy back VERTICALS if the price ever gets cheap enough
The CALL VERTICALS get bought back as the market drops
The PUT VERTICALS get bought back as the market rises.
See the next slide for a recent trade sequence which seems to be a pretty representative
example of how the trades have been transpiring over the last 12 months
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4. The market turned upward so the profit stops
filled for 4 March VERTICAL PUTS. In other words,
I bought each VERTICAL PUT back for .15 each in
this time range. The first 3 Condors are all completely
closed now with 20%+ profit each
1. After expiration in Jan 2010, I
entered three different March
Condors in this general time range
The Condors profit range is
generally the 2 horizontal red lines
5. Expiration. The 4th March Condor
had to be closed at a loss. The one
VERTICAL CALL did not fill and I
closed it expiration day at a loss
3. Entered a new March Condor here which is
the 4th March Condor. The premium collected is
financing the loses which were starting to occur on
my 1st three trade VERTICAL PUTS
2. The 1st three VERTICAL CALLS profit stops filled
in this time range. In other words, I bought each back
for .15 each
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MANAGEMENT and Exit Strategy
(continued)
2. SELL MORE CONDORS
You start to incur loses when the underlying crosses your short strikes.
So when this starts to occur,
sell new market / delta neutral condors to help finance those loses.
Adding positions (inventory) is similar to the basic TOS / Option Planet idea.
They have most sophisticated strategies of using Calendars and other underlying
instruments
But , In a sense, you are using the new trades to finance the loses which are occurring
on the older trades
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MANAGEMENT and Exit Strategy
(continued)
3. EXIT – Start the Exit process 10 trading days or 14 calendar days before
Expiration
Scenario #1 – Underlying is still between your short strikes
This is kind of a rare event
More than likely, you are already out of this position with +20% profits
if you had .15 profits stops in place
If you are not already out,
Exit now at 10 days before expiration. Take your profits now.
Scenario #2 – Underlying is at a short strike or already past a short strike
into losing trade zone
CIRCLE THE WAGONS – see Next page
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CTW – Circle the Wagons
Scenario #2 continued –
The Underlying is at or past the short strike
and there is only a week or two until expire
CIRCLE THE WAGONS
Adjust your Profit stop so your overall trade just makes $1.00 after commissions
Statistically, it should return to profit zone by expiration day
But stats are based on historic data.
Not all Condors will be winning trades
Note: Friday expiration is normally the last day you can Exit SPY. But Quarterly, watch
out for triple witching. You will need to exit Thurs before expiration during those
periods. TOS will send you a warning email to exit Thurs when it comes around.
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Overall Trading Strategy Idea
Try to keep Delta as neutral as possible
Try to keep Theta as high as possible
Layer in inventory over time
to keep delta neutral.
If you can, enter Condors when the volatility jumps up
This will give you a little extra premium
and then hopefully volatility drops throughout the life of the trade
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Thanks !!! And for other questions, you can contact me at
[email protected]
37
APPENDIX A
Sigma
Sigma is the eighteenth letter of the Greek alphabet, which was a
writing system developed in Greece 1000 BC and is the direct or
indirect ancestor of all modern European alphabets.
Sigma upper case Σ
Sigma lower case σ
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Sigma is a symbol used in a wide variety of applications
Here are some applications just in science and mathematics
Upper case Σ is used as a symbol for:
–
–
–
–
–
–
the summation operator - See Excel
a class of baryons in particle physics
macroscopic cross sections in nuclear and particle physics
self-energy in condensed matter physics
the balance of the invoice classes and the overall amount of the debts and demands in economics
the set of symbols that form an alphabet in linguistics and computer science
• Lower case
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
σ
is used for:
sigma bonds in chemistry
the sigma receptor
the standard deviation of a population or probability distribution in statistics
a quality model for business, Six Sigma, based on the standard deviation, often referred to as "6σ"
sigma-algebras, sigma-fields and sigma-finiteness in measure theory; more generally, the symbol σ serves as a shorthand for "countable", e.g. a σ-compact topological space is one that
can be written as a countable union of compact subsets.
the generated sigma-algebra of a set A is denoted σ(A)
the sum-of-divisors function in number theory
the Stefan-Boltzmann constant
the "sigma factor" of RNA polymerase
a measure of electrical conductivity
the Surface charge density in electrostatics
Normal stress in continuum mechanics
volatility of a stock generally needed for options pricing
a syllable in phonology
the spectrum of a matrix A, denoted as σ(A), in applied mathematics
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For our purposes , We are using the sigma symbol for
statistics and probabilities
Lower case σ is used for:
the standard deviation of a population
or
probability distribution in statistics
More on Sigma later,
but first the disclaimer and some current events
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APPENDIX B
ROR
One way to calculate RATE OF RETURN
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Condor trades April 2009 to March 2010
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The method I used to calculate ROR – Rate of Return
How to calculate returns:
Return percentages for each trade can be calculated as the ratio of real risk to final net credit (debit) received.
For example, say we have an iron condor with strikes at 50/52/60/62 and we open the trade for a credit of $0.90.
The trade goes well, and a few days before expiration we close it out for a small debit of $0.10.
To figure out our ultimate return on the trade, we need to calculate two elements: real risk, and final net credit.
Real risk = distance between the short and long strikes on either side, minus the credit received to
open the trade.
In our example, the strike distance is $2.00, and the opening credit is $0.90, so our real risk is $1.10.
$1.10 is the most that we can lose on the trade, i.e. that’s exactly what we’re risking.
Final net credit = opening credit minus any debits incurred in adjusting or closing the trade. In our example,
that’s $0.90 – $0.10 = $0.80.
Now we divide our final net credit by our real risk: .80/1.10 = 0.72, or 72%
For more in depth details, Check out the good summary on ROR at Condor Options.com
Performance page
Here is the link http://www.condoroptions.com/index.php/performance/
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APPENDIX C
OTHER INFORMATION RESOURCES
THE NEXT SLIDES NOTE WHERE YOU
CAN DO MORE IN DEPTH READING ON
IRON CONDORS
44
THE TOS OPTION PLANET IRON CONDOR SEMINAR WORKBOOK
Here is a source for more information about the Condor Strategy
discussed here.
It is called the (COMPLEX STRATEGIES) WORKBOOK
Link is xsprofits.com
There are currently six User Groups in the Southern
California area (link). This web site is common repository
of information and presentations the groups share
45
SOURCE INFORMATION
TOS IRON CONDOR
(COMPLEX STRATEGIES)
WORKBOOK
46
BELOW ARE MORE SOURCES
WHERE YOU CAN READ IN MORE DEPTH
ABOUT THE CONDOR TRADING STRATEGY
This presentation is essentially my interpretation
of a Condor trading strategy taught at the
TOS - Option Planet - Advanced or Complex Strategies for Traders seminars
Here is a link if you want more detail on the free TOS seminars
http://www.optionplanet.com/assembled/list.html
Here is a link to the TOS seminar workbook for the Complex seminar
http://xsprofits.com/Documents/OP%20Complex%20Strategies.pdf
A very similar Condor strategy is discussed at length at CONDOR OPTIONS.COM
Here is a link to the Condor Options web site
http://www.condoroptions.com/
Of course, the strategy in this presentation is not exactly the same strategy as the above 2 sources
It is just my version and my interpretation
So , Please - Study the above sources
and develop your own interpretation and application of this strategy
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APPENDIX D
PROBABILITY CONES
These can be used on charts
on the TOS trading platform
48
Here is a good place to find an explanation of
using Probability Cones on the TOS platform
Link - http://xsprofits.com/tues_nites.aspx
49
PROBABILITY CONES
And
STANDARD DEVIATION
A standard deviation is a measure of the distribution
of a given set of values.
In trading, we usually assume prices
will be normally distributed,
and therefore any given possible value will fall within
one standard deviation of the mean about 68% of the time.
Two standard deviations from the mean
would account for for almost 95% of all possible values,
and three standard deviations would account for nearly 99%.
You can also see the standard deviations (sigma)
by using the Probability Cones on the TOS trading platform
50
PROBABILITY CONES
And
The One Sigma Method
Perhaps the simplest way to construct an iron condor
with a reasonable chance of success
(while still generating sufficient premium)
is to select short strikes that are one standard deviation
(or one sigma) from the current price of the underlying.
This metric means about 68% of the time,
the underlying index or equity we're using will close
on expiration day within one standard deviation
(or "one sigma") of the current price.
So if we structure our trades
so they can tolerate a one sigma move
and still expire worthless,
then we can expect success over two thirds of the time.
51
APPENDIX
E
OTHER EXIT
and
CONDOR MANAGEMENT
IDEAS EXPLORED
52
MANAGEMENT and EXIT STRATEGY # 1
Reference TOS seminars – Don Kaufman - Option Planet Exit method
Always exit 4 to 10 days from expire
Do not exit sooner
(unless you can buy back for 80% of the profit)
Be consistent
Just add Inventory (Sell more Condors, etc)
Keep Delta as neutral as possible
Sell more Condors or other positions (to reduce delta)
when market trends up or down
and is threatening your short calls or short puts
The idea is to sell future Condors and collect that money
as a way to pay for the loses (if any) of near term Condors.
Selling future Condors will tend to keep your Delta closer to zero
That is why Don uses the Greeks to manage his positions.
He is always adding inventory to keep Delta more neutral
TOS says this adding of inventory process is a way to “ finance the loses”
53
MANAGEMENT AND EXIT STRATEGY #2
JUST BUY CALLS OR PUTS
(Peter idea being explored)
when the underlying starts to threaten your short strikes
Just Buy calls (Next month out) when the market trends up and
crosses your short call strike.
Or Just Buy puts (Next month out) if market downtrends and crosses
your short put strike
Example: If your current Condor is a November contract, then you
would be buying December Calls or Puts for protection.
What if you buy the call and the market immediately turns south and
goes against you ? This exit strategy needs some testing. You
don’t want to lose more on the call than you can make in the
Condor. Sizing will need to be tested more
54
APPENDIX F
THE ANALYZE TAB
55
ANALYZE TAB
I don’t use the Analyze tab much for the way I trade Condors, but the next
few slides show you how to use features of the Analyze tab when trading
Condors
USING THE ANALYZE TAB TO
CHECK YOUR CONDORS
56
A more in depth Power Point presentation
on the Analyze tabs is in my file ANALYZE TAB - ALL - 2-18-10.ppt
The next slides are a cut and paste from that
larger file and just a quick summary on
Condors
57
1. First load up any trade like below
or pull up any trade from the past
2. Left click BLUE dot
3. Click ANALYZE DUPLICATE TRADE
58
The page will default and
show all your open and other
trades
Click ALL to clear checks
from all boxes and then put a
check mark only by the trade
you want to analyze
59
1. Click RISK PROFILE to
show this graph
2. Click +1@Expiration into this box
4. Click SET SLICES – Click
BREAKEVEN – Click March 20th
3. Change this date to Expiration date
of Front Month. In this case , it is
March 19th
60
These VERTICAL RED DOTTED lines
are what they refer to as the “SLICES”
61
This light shaded area is the 1 sigma or range of one
standard deviation. This range is dynamic and
changes as volatility changes. 97.5 and 120.1
match the numbers on the chart Probability cones
62
If you set your red dotted line “slices” just to the edges of the LIGHT BLUE areas,
your probability of success number will always be around 68%
because the LIGHT BLUE areas is the 1 standard deviation area or 1 Sigma
Probability of success number
You can change the
LIGHT BLUE area
by adjusting this
field
63
If volatility increases after you enter
your trade, then this probability of
success number will decrease
because the vol will be recalculated
and your short strikes are too close
and thus prob of success decreases
If you set your slices to BREAK EVEN
POINTS, then you can get a number like
55.62% which is more precise calculation of
probability of success of your particular
trade. This number is the probability of your
trade being in a positive range between the
break even prices between now and
expiration data. This figure will change as
the market volatility and prices change. In
this case, mathematically, the .76 Credit
here yields a 62% probability of success.
But that 62% is just rough mathematic
calculation. The 55.62% Calculation shown
on this analyze page is a more accurate
“live” figure
64
If you want, you can click this date
day be day into the future to see
how your position changes with time
65
APPENDIX G
PRICE
66
PRICE
Trade entry is based on Price
Price can be used to calculate probability
Below is more info on how Option Prices are developed
…if you want to read more
The price of your option includes:
Intrinsic portion – Underlying current price – strike price
PLUS
Extrinsic portion - determined by 4 main factors :
Time to expiration,
Interest Rates,
Volatility and
Dividends payable.
Calculated by using a pricing formula such as the Black-Scholes Model
Price includes all of the above
So price can be used to calculate probability
67
PRICE
MORE DETAILED NOTES if you want more info
The goal of every Condor manager is to Collect as much money up front as possible
Shoot for a 60 to 70% chance of success
68.27% is one standard deviation in a normal distribution
i.e. One Sigma
Let time and volatility cause the options to decay in value
Then, Try to buy back the position as cheap as possible later.
When you enter a trade, TOS will summarize what your Max possible $ loss or Risk
You can review and print the summary page
before you click the final button to send the trade
Condors are “defined risk” trades
When you sell a Condor, you collect some money up front. This is the premium.
Max $ Loss Possible – The premium = Your actual $ possible loss or $ risk
So as your premium decreases, your max possible $ financial loss increases.
The less you collect up front, the higher your probability of success.
So what is strange here is your probability of success can increase
but your Max Possible financial loss will also increase.
The Long call and Long put in a Condor are just thrown in there as insurance.
You don’t want to sell a Naked Put or Call without some insurance.
68
PRICE
USING PRICE TO ESTIMATE PROBABILITIES
Below is a Rough calculation for figuring trade Probability of Success
(The Analyze Tab in TOS gives a more precise calculation of probability of success but this is pretty quick)
•
First figure your max loss
•
Max Loss = The Width of your vertical (this is always 2) – your trade credit (say we are getting .77 credit in this case)
•
So the math for your Max loss is
•
Probability of Success = Max Loss / Width of your vertical
•
So that is 1.23 / 2 = 61.5% is your probability of success
•
If you would have picked a .65 credit, the probability of success would be 2 - .65 = 1.35
standard deviation or a 1 sigma trade
•
Above is just a rough calculation. The Analyze tab in TOS will yield a more precise figure for probability of success. See next slide on
more about the Analyze tab.
2 - .77 = 1.23
and 1.35 / 2 = 67.5% which is closer to one
69