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Options Trading: RUT Index, Low Cost Spreads, and Iron Condors


A stock trader new to the options game has questions. Here, Mark Wolfinger provides some answers.


Andy writes:

I'm a longtime stock trader, but over the past couple months, I've taken a real liking to the options game and was wondering about a couple things:

1. I notice you trade the Russell 2000 Index. What it is about RUT that draws you to it? And a more general question is, what do you look for in a stock or index for IC/credit spread trades?

2. What are your thoughts on a strangle comprised of an out-of-the-money call spread and an out-of-the-money put spread, both bought in large lots at low cost, say .20 -.25 per spread, both puts and calls?

As long as I'm confident of movement in the life of the options, one of the spreads will pay for the other, especially if one moves ITM, if the stock tends to swing, both sides can be closed for a nice profit.

A recent hammering of the financial sector and the market in general has made this very tempting, especially ahead of earnings.

I haven't seen much advice online about using debit spreads to put on a strangle position, so I get the impression it's not used by many traders.

My thought process is that buying a spread at $0.25 delta and selling for $0.40 or $0.50 is like buying a $25 stock (albeit one that expires) and having it rally to $40 or $50, even though the underlying stock is only moving a dollar or two.

Any advice or critiques would be most welcome. At this stage, my comfort zone is being long either naked options (giving me the option to leg into an instantly profitable debit spread, or sell to close) or debit spreads.

1. Regarding RUT: I prefer to trade European style options because they settle in cash and have a favorable tax treatment. I'd prefer SPX options, but I've had terrible fills.

I don't trade stocks. However, if I did, my requirement would be "plenty of strikes," and that eliminates all mid-priced stocks.

2. You're writing about low-cost spreads.

Correct: If you get a big enough move and if you get it quickly enough, you can earn a nice profit. To get a profit from both sides, you need a pretty good-sized swing. Plus, you must have a good knack for exiting one side at an opportune time. Double profit is a rare bonus. Don't think about it. The game is to win on one side.

I have nothing against that strategy in principle. However, I take exactly the opposite position in my own trading.

I sell those credit spreads (that's an iron condor position, not a strangle) and hope to profit from lack of movement, time passage, or shrinkage in implied volatility. The difference is that I don't trade those $.25 spreads. I collect roughly $3.00 for 10-point iron condors. In reality we can both win when taking opposite sides of the same trade -- depending on how adjustments are handled and on our timing of trades. However, I obviously prefer my side to yours -- but I am not suggesting that you change. You're okay preferring your side. Our results depend on how well we handle position risk.

You haven't seen much advice online about "using debit spreads to put on a strangle" because you have the terminology wrong (no big deal).

A strangle consists of naked options (long or short), not spreads. The position you're describing is the iron condor, and not a strangle. The iron condor is very popular.

Buying a spread at $0.25 and selling at $0.40 is similar to trading penny stocks and paying $0.25 and selling at $0.40. It's not like a $25 stock and a $40 stock.

3. I suggest you consider an alternative when you own a profitable trade.

First, do you still want to remain long this option at the current price level for the stock? If no, sell the option, take your larger profit, and move on. If yes, then it's okay to do as you suggest and find a hedge. But know this: You're not locking in an instant profit. This is a common misconception.

You're taking your own personal money, the profit you already earned, and reinvesting it into the call spread when you could sell your position and keep the entire profit. When you exit, the cash belongs to no one but you (and the IRS).

When you hedge the trade -- even at a wonderful price -- it's your money at risk. Decide:

  • sell and take the money;
  • reinvest part of it into a a new, hedged trade.

In other words, do as you suggest -- only when you believe the new position (in this case a calendar spread) is the place to invest your cash. If it's a borderline decision, it's intelligent to take your money off the table and wait until you find a satisfactory new trade.

Enjoy your options.

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No positions in stocks mentioned.

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