In search of the 3rd chord... I mean leg

Discussion in 'Options' started by Pekelo, Jun 5, 2017.

  1. Pekelo


    Just like any aspiring musician can tell you, finding a fitting 3rd chord can be rather elusive. You come up with 2 killer chords, but the song is just not done yet, it needs a 3rd chord to make it a complete, Grammy Award winning, multi platinum selling, everyone singing it in the shower song. Once you find that 3rd chord, life is just more beautiful and it might even get you laid.

    But I digress... Today I was diddling with option strategies, because I got this idea that there has to be a 3rd cho.. I mean leg for option traders, making a strategy a no-loser, sure fire winner. Maybe not a huge winner, but a "I don't have to lose sleep over this because the money is in the bank" winner. Well, almost. You see if you sell 2 sides because you don't want to pick a direction and prefer the fence and time decay, those 2 sides usually don't cover the spread. Thus your strategy is going to have a max. loss, even if that is rather small compared to the premium or ROI.

    But! If you throw in the 3rd leg maybe later on, you suddenly are over the spread, and the strategy literally can not lose. Or so I thought, thus the Search for the Elusive 3rd Leg was born...

    After a few hours of tinkering, here is what I came up with:

    1. Sell a near ATM Iron Condor 2-3 months out on a highly volatile stock.
    2. If the price doesn't move much, do nothing.
    3. When the price moves more than 10% in one direction, sell a vertical spread opposite to that direction, strike is around the original price. (calls if it dropped, puts if it rallies) The spread is the same as the IC's was.

    This should be it, the 3 leg making the sum of the premiums more than the spread. But because we want to cover every possibilities:

    4. In case the price turns back, once it reaches the other part of the vertical, sell another vertical, the opposite of the first, making it another IC.

    I was testing it on TSLA's unrepentant rally, and it seems to work. The reason I use a vertical instead of just plane old naked selling is because it is defined risk and better ROI.

    As always, drop me a line if I made a mistake in the above master piece...

    Disclaimer: I am aware that technically I am talking about 6 legs and not 3, because IC has 4 and Verticals 2, but just play along, will you? Thanks...
  2. pekelo! I love stuff like this.. just to confirm.. step 1 is selling the condor which means u r short the wings? IOW, long call and long put verticals ?
  3. first off, I don't like step 3... you are selling a vertical that is now worth pennies that can blow up to multiple dollars. I would do the opposite.. i would wait for a 15% up move (for the calls) then fade the move by selling the expensive call vertical so if it was a $5 vertical you are selling it for $4.25 max loss at $5 vs. selling a put vertical for 50 cents that blows up to $5 if it reverses.. just my humble opinion.
  4. Pekelo


    I am shorting the legs closer to the current price and buying the wings.

    I forgot 2 things in the first post, an example and a clarification. The vertical sold later on doesn't have to be the same number of contracts like the original IC. Let me give you an example using TSLA:

    On Dec 19th close to the close TSLA was $202.6.... I sold the March 17th IC 195/200/205/210
    (selling the inside and buying the wings) for $4.6 Since the spread is 5 dollars, there is a missing 40 cents to make it a break even strategy. Max. loss for this IC is 38 cents, and the breakeven price range 195.4-209.5

    Now of course TSLA rallied a lot so on Jan 20th when price was $244 (I know it is actually more than 20%), I sold a put vertical same expiry 210/215 for 68 cents, thus I got my missing 40 cents. At expiration on March 17th although the price was even higher $262, the strategy showed a mini-tiny profit of $150. Way better than a loss or a slap in the face....
  5. Pekelo


    That is true, so I added step 4 to make sure that vertical doesn't blow up into my face. The problem with what you suggested is that even in that case I am not guaranteed the stock doesn't keep rallying and your vertical still can blow up. In TSLA's case it would have happened...

    I guess it comes down to, what is more likely for the stock, keep the movement or reverting to the mean. But if I count on a reversion, then there is no need for the 3rd leg at all...
  6. i just hate selling teenies and lose dollars. I bet you if you have a way to model out this layered entry and play it out across years, you'd come out ahead by (using your example)selling the 250/255 call vertical.. I know you would've lost in this trade but across years you'd prob come out ahead.
  7. i also would kick it up a notch by replacing the wings with further out wings in case TSLA is quiet after let's say 2 weeks. .. this way you have "charm" working for you. ie wings don't "wake up" as they age so by replacing them with further out wings, they participate when TSLA rips.
  8. Did you see the minimum legs thread (I know you did edge)?...similar thing there...
  9. Pekelo


    When you sell the vertical close to the original price, if the price turns back, the increase in value of the IC acts against the new vertical's decrease, so that is a very good reason to bet on continuation of the move. But your idea is noted, will keep testing it...
  10. Pekelo


    Here is an example when it is hard to decide if adding Step 4 is needed or not:

    On Apr 3rd TSLA was almost 300, at 297. I sell the June 16th IC 285/290/310/315 for 4 dollars, 1 more dollar needed for perfection. The Risk profile is 285.6-314 this will later determine which vertical to use.

    On May 1st TSLA reached $324, time to add a vertical, puts 310/315 for 2 dollars. The position's value is still slightly positive.

    On May 4th price fell back to the original $296. Pos. value: -$1000 (I actually use 10 contracts for easy testing)

    This is where selling a vertical call spread higher up like 320/325 could be considered. But let's do without it for now.

    On May 23rd after much zig-zagging the price is down again to $304. Pos. value: -$300

    And then price took off, on May 31st TSLA is at $340, Pos value is nicely in the green +$1000

    Now have I added the extra 4th leg the eventual rally continuation would have killed the position. But of course there is no way to tell for sure, maybe price has to pass the lower limit of the risk profile, what was 285 in this case...
    #10     Jun 5, 2017