Income Strategies

This is the third installment of Fujisan’s series on option spread strategies.

BWT – in case you missed it – evil.rat has been released – detailed announcement can be accessed by clicking on the image:

Cheers,

Mole

Opex Earnings Recap

I hope you had a wonderful OPX.  That was a lot of fun, wasn’t it? Here is a recap of ATM Calendar and OTM Butterfly that I discussed last week:

Not bad at all.  Average performance of ATM calendar is 35%, which is much higher than my original estimate of 25%.

(Please note that I did not take ISRG and BBT trades.  I borrowed the trading results from you guys).

Also, please take a look at OTM GOOG Butterfly.  This is a beauty!  It does not cost much to put it in, and when you hit it right, you make it big.  Remember GOOG expiring in 50 point increments?  Well, she never fails to meet our expectations.

Going Forward

Now that we are done with OPX week, what’s next?

These ATM calendars and OTM butterfly do not work well going into May options.  It was IV rush and time decay combo that gave us beautiful results.  If you like to play with earnings going forward, you need to play it in a traditional way; i.e., bull/bear spreads, or ATM straddle that I discussed a couple of weeks ago.  I have to warn you though that if you hold on to your position through earnings, probabilities are against you.  If the trading is going your way, take a profit and move on!

After Earnings Play

Once the earnings are out of the way, and IV goes back to normal, the underlying stocks go through the range-bound price movements.  Depending upon your bias, you could use the exact same strategies (i.e., calendar & butterflies) for income strategies — sorry, Mole, I don’t have that many rabbits coming out of my hat, but we can use the same strategy for different purposes.

Unfortunately, this time, it does not work as quickly as OPX week.  Yes, we need to hold on to the positions for the whole month, not just a couple of days, in order to make the same return.  Sorry, OPX and earnings do not come every week, but we can still make 30~40% on this if you play it right.

SPY April/May Calendar Results

Do you remember SPY calendar that I discussed three weeks ago?  Here is what it looked like back then:

Here is what it looked like before I closed my positions:

I made an adjustment to add 85 calendar.  I closed 80 calendar on Wed and 85 on Thurs, both with nice profits.

Now, 35% may not sound that much to some of you, but this is an income strategy.  You put it on and manage the position.  I only had to adjust it once.  No ins and outs, no whipsaws, no, nothing.  This is the type of position that I would comfortably put in more than 5 digits capital without losing sleep.

Income Strategies

Income strategies are delta-neutral positions with positive theta, and mainly come in three different positions:

1. ATM Iron Condors (high probability, low return)
2. ATM Calendar (high probability, high return)
3. ATM Butterfly (low probability, high return)

For a beginner, ATM Iron Condor would be a good strategy but  I’m not going into details here as Iron Condor typically generates only 5% a month.

For an intermediate spread trader, here is SPY ATM calendar example for May/June:

Assumption: SPY will retrace to 82, then go back up to 88 to retest Friday’s high.  Possible upside range of 90~95 range (mole, please feel free to correct my assumptions) [ Mole: We could easily go as low as 800 ]

Trading Plan: Hold on to the position as long as the underlying is within the range of 80~90.  Once it breaks above Friday’s high of 87.65, add 90 calendar.  If it breaks below 80, add 80 calendar.

For more advanced traders, here is SPY BWB (Broken Wing Butterfly) example:

In order to create this particular position, we need to leg out at a different time:

1. Put on 90/85 bear call spread on Monday once Mole gives us a “GO” sign to short.

2. The target price for a pullback is 82 (is this correct, Mole?) [ Mole: We could easily go as low as 800 ]. Once we hit 82, close half of 90/85 position, and put on 80/85 bull call spread.

Please note that, by putting 80/85 spread on, you are technically locking in the profit that you already made on 90/85 without taking it off.

3. Once SPY starts to crawl above 85, start buying back 85 short one by one.

If it’s too much trouble of going through these steps separately, simply wait for the pullback and put the whole thing on at the same time.

This particular strategy works very well when the underlying is going through consolidation and you know which way it will break out.  I used this strategy for GLD for April and worked quite well.

If you want me to put together these strategies for your favoriate stocks, let me know.

I hope you all have a wonderful weekend.

Fujisan