Below is a list of the transactions that I’ve made in the SPX options with an Apr14 expiry. There was a total of 8 trades with 9 fills (1 order required 2 fills to complete). The first 3 trades resulted in a net loss of $5,580. Oops. 😕 This is an expected outcome in trading! I’m going to have losses but the important thing is to not let the losses get too big. If you look at most of my ‘price action‘ posts in this blog you’ll see that my trades utilize stop losses where, if a setup based on a chart fails, I exit a trade with a relatively small loss. That’s exactly what happened here.
Below is the current risk profile showing the net result of all of the trades that I’ve made. The risk profile includes the initial $5,580 losing trade. The current profit is $38,137 and the biggest loss to my initial capital that I can now suffer is limited to $3,660. The simplest analysis of this trade progression is to buy a Call(s) when the chart shows a bullish setup and then, when either the chart shows price approaching significant resistance or I just decide that I’d like to reduce my directional risk in the position, sell a further OTM (out of the money) Call(s) to create a Vertical Debit Spread. I could’ve easily picked a strike where the credit received would’ve exceeded my original purchase price but I wanted a wider spread to give me greater upside profit potential. As you’ll see later in this post I can bring in additional credits later on if I decide to reduce cost/risk even more.
This position is still long over 100 Deltas. Let’s say that price is approaching significant resistance and I decide now is the time to reduce my directional (Delta) risk. What can I do? I’ll demonstrate 2 potential adjustments but there are many more ways to change risk profiles by using different width spreads and and/or by selling more or less spreads. The risk profile below shows what it would look like if I sold an equal number (8) of same width ($100) Vertical Credit Spreads to create a standard Butterfly spread. I could sell an 8-lot of the Apr14 SPX 4500/4600 Vertical Credit Spreads for a $37.30 ($29,840) Credit. That would result in a position that can do no worse than make a $26,180 profit and could potentially make a $106,180 profit. The Delta risk would drop from over +100 to -2. In other words, the open profit of $38,000 wouldn’t change much even if SPX moves up or down in price over the next several weeks.
Below is the risk profile of another adjustment I could make. Everything I mentioned describing the above Butterfly spread applies to this risk profile except that instead of selling the Apr14 SPX 4500/4600 Vertical Credit Spreads I’d push them further OTM and sell Apr14 SPX 4600/4700 Vertical Credit Spreads. That would create a Condor spread with less credit received but a wider area of maximum profit. I generally prefer Condor’s to Butterfly’s but to each his own! The Delta on this position would be +15 so a little more directional risk than with the Butterfly.
Bottom line: Changing my current Vertical Debit Spread into a Condor or especially a Butterfly can put the Delta risk ‘on hold’ while price experiences a potential pullback. I can at any time take that adjusting trade off and turn the position back into a Vertical spread to add Delta risk back on again. The adjustment can be put on and taken off as many times as I would like.
If this simple strategy seems to be too good or too simple to really be true I can assure you it is an extremely simple and effective strategy and I have no idea why it is that nobody else seems to teach or utilize this strategy. Regardless, you are now aware of the strategy so you can decide whether or not it makes sense for you in your trading. Remember, I don’t offer trading advice, I’m simply educating traders on all their options! Feel free to leave a comment or question below or tweet at me @VegaOptions.