There are those who say fate is something beyond our command.
That destiny is not our own – but I know better.
Our fate lives within us, you only have to be brave enough to see it.

– Merida (Movie: Brave)

Prologue

Option Spread trading for consistent income is not probable – especially if my Spread tactics are monolithic and market-agnostic.

I can pick a Vertical Bull Put Credit Spread that appears to have an excellent probability of success. But with a linear approach to Options trading, the significant imbalance of the return on risk to the likelihood of a profit makes the Vertical Spread Option strategy a sizable loser in the longer run.

Using my Vertical Bull Put Credit Spreads as a reference, if I pick a strike price that has an 80% probability of remaining OTM with a return on risk of 10%, then over a large number of trades, I can expect 80% of my trades to win up to 10% of what I am risking. Conversely, I can expect 20% of my trades will lose up to 100% of what I am risking.

Consider the following trade examples:

IWM: $151p/$148p – 1 Contract – Open 8/1 – Expires 8/23 – Net Premium = $23.05
(Vertical Bull Put Credit Spread)
When Opened: Probability of OTM = 80.4%, ROC = 8.5%, Max Risk = $271

In a gross hypothetical calculation, if I made one of these trades per month over the next ten months, then I should expect to win eight of the ten positions for an approximate income of $184 ($23.05 * 8 = $184.40) but lose two trades for an estimated loss of $542 ($271 * 2 = $542.00), or a net loss of $542 – $184 = -$358 for my effort.

QQQ: $183.5c/185.5c – 1 Contract – Open 8/6 – Expires 8/30 – Net Debit = -$115.95
(Vertical Bull Call Debit Spread)
Open: Prob. ITM = 40.1%, ROC = 72.5%, Max Risk = $115.95, Max Gain=$84.05

In a similar calculation, a Debit Spread seems to have the same disadvantage. If this QQQ spread has a 40% probability of being ITM and I traded one Spread per month over the next ten months, I should expect to win four trades for an approximated income of $336 but lose six positions for an approximate loss of $696. Again, this would be an expected net loss of approximately -$360.

As a general observation, for income from Option Spreads to be a statistical winner, the return on risk ratio needs to be higher than the probability of success. The four simple Vertical Options Spreads strategies (Bull/Put/Credit, Bull/Call/Debit, Bear/Put/Debit, and Bear/Call/Credit) there is not a spread configuration where this is true.

Therefore, I must consider other ways to offset this intrinsic disadvantage. I need to find different ways to “change my fate.”

Ways To Change My Fate

In addition to the Options charts’ stated probabilities, I need to bias my trade constructions to be more in my favor.

I’m still a newb at Options Trading, so I don’t have much experience to preach. But as a lesson to myself, I need to document ideas to try in my blog-journal.

Consider these ways to bias profit probability…

• Trade the Trend.
• Construct “loss resistant” Spread trades.
• Actively mitigate losing trades.
• Expand my Spread knowledge.

Trade the Trend

As mentioned in earlier posts, I need always to be aware of the current market trends. Trading with the trend is one way of setting bias in my trade.

If the 50–day Simple Moving Average is above the 200-day SMA, then I would consider the intermediate market-trend is moving upward. If the 9-day is also above the 50-day SMA, then the immediate market-trend is also upward. Together, suggesting a bullish trend to the market and a Vertical Bull Spread may be best. If both are reverse, then a Vertical Bear Spread is a good option.

As in the above graph, if the current market direction is not readily determinable, this could be the best time for Iron Condors or other direction-neutral strategies. And always remember that not trading at all this week could also be the best choice.

Construct “Loss Resistant” Spread Trades.

These simple configurations guidelines make the market work harder to get to max loss:

• When constructing a Credit Spread, maximize the return on risk percentage by widening the strike-width accordingly and not increasing the number of contracts.
• With a Debit Spread, set the strike-width to 1 and then increase the contracts until the desired return on risk.

Actively Mitigate Losing Trades

When a golfer takes to the links, he knows that not every shot will be okay. He knows that a certain percentage of his hits will be duffers. But when he does have that skulled shot, he does not pick up his ball except max-strokes for the hole. Instead, he mitigates the miss-hit by taking more strokes so to minimize the loss. – Not all losses have to be max-loss.

In a previous post, I looked at how to Manage a Losing Trade. If a trade has gone wrong, then either close early for a smaller loss or roll the position a couple of weeks out. Never immediately accept the max-loss. Never let a spread become assigned.

Expand my Spread Knowledge

There are other Spread strategies beyond the Verticals. Calendars, Condors, Strangles… names just a few. Additionally, volatility has a significant impact on trade decisions. So my learning curve is far from peaking.

P&L and Performance Status

YTD (2019)

Realized Net Profit from Spreads: $-1,555.70
Spreads started: 54
Realized ROC (target = 72% for the year): -39%

Last Month (July)

Realized Profit: $-652.4
Spreads Started: 8 (all closed)
Realized ROC (target = 6.0%):-13.53%

Spread Trades Won: 4
Spread Trades Lost: 4
Win Ratio: 50%

MTD (August)

Realized Profit: $-350.75
Spreads Started: 10 (7 still open)
Current at risk $$$ for Spreads (Max: $3,960): 1,235.90 (31% of max risk)
Realized ROC (target = 6.0%): -29%

Spread Trades Won: 1
Spread Trades Lost: 2
Win/Loss Ratio: -50%

Schedule for this Week

Monday:

• Review and tweak Trend-Channels for all stocks in watch list.
• Confirm that the target expiration date for all options trades is set to Sept 20 (25 days).
• By 10 AM, stage possible trades for all watch list stocks (but don’t trade anything).
• Watch 1 Webcast or take one online mini-course to be completed by Friday.  

Tuesday:

• Review how yesterday’s staged trades moved. Adjust premiums to take advantage of movement (these are “long-shots”). 
• Submit a couple of Vertical Bull Put Spreads, but keep a close watch. If one takes, cancel the others (we just want one new active trade). 

Wednesday:

• If no “long-shot” spreads were accepted yesterday, then readjust premium to ATM prices and resubmit. We want only 1 vertical spread accepted so keep watch.
• Recheck/tweak trend-channels. 

Thursday:

• Reset target expiration date to Sept 27 (29 days out to the following Friday). 
• By 10 AM, stage possible trades for all watch list stocks. 
• Submit a couple of Vertical Bull Put Spreads, but keep a close watch. If one takes, cancel all others. (Do not submit a trade with for the same ETF as Tuesday.)

Friday:

• Same as Wednesday.
• Update trading journal (this blog) and update it to the Internet by end of the day.
• Make sure you watched a webcast.

Trades Ended 8/23/19

IWM: $151p/$148p – 1 Contract – Open 8/1 – Expires 8/23 – Net loss = -$286.90
This trade ended 8/23 deep ITM but was “rolled” for another 2 weeks. The new installment for this roll came with a net premium collected of $202.00 for the same deep ITM configuration but with an expiration date of 9/6. This $202.00 credit offset the $286.90 loss, so my ‘current’ loss on this trade is only $84.90. But that may change if the market does not rebound enough by 9/6 to allow that new leg to expire worthless.

IWM: $147p/$145p – 2 Contract – Open 8/15 – Closed 8/23 – Net loss = -$135.95
This trade was closed 8/23 at a debit of $1.48. In retrospect, I should have rolled this trade out one more week where it would have expired worthless instead of accepting the -$136 loss. This trade was a miss-managed.

Trades Still Cooking

QQQ: $183.5c/185.5c – 1 Contract – Open 8/6 – Expires 8/30 – Net Debit = -$115.95
(Vertical Bull Call Debit Spread)
Open: Prob. ITM = 40.1%, ROC = 72.5%, Max Risk = $115.95, Max Gain=$84.05
Now: Probability ITM = 65.0%

This Debit Spread has a strike-width of 2, which I have learned this week is not the wisest construction. For Debit Spreads, if I want to increase the risk amount, I need to buy more contracts (unlike Credit Spreads).

DIA: $263p/261p – 2 Contracts – Open 8/15 – Expires 8/30 – Net Premium = $263.05
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 27.1%, ROC = 202.3%, Max Risk = $130, Max Gain=$270.00
Now: Probability OTM = 38.3%

This trade is a 2-week Vertical Roll from the original Vertical Bull Put Spread opened on 7/25. Before the market closed on 8/16, this spread was deep-ITM and most certainly doom to be assigned. I entered a Vertical Roll order that closed the original spread mid-day 8/16 for a trade loss of $355.90 and immediately opened this same deep-ITM configuration but to expire 8/20 for a collected premium of $270. At this point, my net loss on this trade is -$85.90.

Now two weeks later, DIA has made a substantial rebound and is currently trading for $264. If this could expire now worthless, then this Vertical Roll helped me dodge a near $400 loss (only losing $86). But at $264 with only one day left until expiration, a Trump Tweet Sneeze can send the market in a tizzy.

IWM: $151p/$148p – 1 Contract – Open 8/23 – Expires 9/6 – Net Premium = $202.00
(Vertical Bull Put Credit Spread)
When Opened: Probability of OTM = 80.4%, ROC = 8.5%, Max Risk = $271
Now: Probability OTM = 34.5%

SPY: $277p/$272p – Open 8/9 – Expires 9/06 – Net Debit = 40.05
(Vertical Bull Put Credit Spread)
Open: Prob. OTM = 82.2%, ROC = 8.8%, Max Risk = $454
Now: Probability OTM = 80.4%

IWM: $151c/150c – 1 Contract – Open 8/20 – Expires 9.13 – Net Debit = -$61.95
(Vertical Bull Call Debit Spread)
Open: Prob. ITM = 43.4%, ROC = 78.6%, Max Risk = $61.95, Max Gain=$44.00
Now: Probability ITM = 42.5%

DIA: $263c/262c – 1 Contract – Open 8/23 – Expires 9/20 – Net Debit = -$64.95
(Vertical Bull Call Debit Spread)
Open: Prob. ITM = 43.4%, ROC = 78.6%, Max Risk = $61.95, Max Gain=$44.00
Now: Probability ITM = 42.5%

IWM: $150c/149c – 1 Contract – Open 8/23 – Expires 9/20 – Net Debit = -$61.95
(Vertical Bull Call Debit Spread)
Open: Prob. ITM = 43.4%, ROC = 78.6%, Max Risk = $61.95, Max Gain=$44.00
Now: Probability ITM = 42.5%

New Trades for This Week

DIA: 273c/276c/238p/235p – 1 Contract – Open 8/28 – Expires 9/20 – Credit = $32.05
(Iron Condor)
Open: Prob. OTM = 82.3%, ROC = 12.3%, Max Risk = $261, Max Gain=$32.05

There have been wild swings for the DIA ETF over the past 3 months. The 50-Day Simple Moving Average is well above the 200-day SMA, but the 9-Day is below the 50-Day moving average. I’m reading this as indecision as to the direction. The Implied Volatility is relativity high, so I’m also reading that the plurality of current traders are anticipating a relatively significant drop reasonably soon.

From my lessons learned, the dual Vertical Spreads that make up this Iron Condor have maximized the ROC by constructing them as three-strikes wide and only one contract.

Epilogue

Simple Vertical Option Spreads are the inherent losers. However, if I can better read the direction of the underlining fund, then I should be able to bias the trade probability more to my favor.

The Option Spread then becomes just the mechanical vehicle used to profit on general market awareness. Trade management is to minimize or maximize the post-trade decision. However, and more important, market awareness that comes from both technical analysis and fundamental research is the way to change my trade-fate.

Cheers…