Lessons from the Pros
Subscribe to the Weekly Newsletter published by Online Trading Academy. Receive the full newsletter with charts!When a trade goes wrong, a trader is presented with two choices: The trader could take responsibility for the trade going against their initial plan, or the trader could attempt to pass the responsibility onto someone else. The usual complaints can go to any of the following: The platform did not work properly, the stock market is unstable or the individual stock had unexpected news come out without any warning. A professional trader must be fully accountable for every single trade that is placed. Achieving that level of accountability is connected with pre-planning all the possible outcomes beforehand.
Now, having said that, let us look at a trade in which I initially did not think I would need to do anything after the entry. The trade did not have any directional bias because price action was channeling in between two levels. I used the option strategy known as an Iron Condor, expecting the price to remain bound within its confines.
The Iron Condor involves placing two short vertical spreads on a sideways moving stock and basically waiting for option expiry. The profitability of the trade rests in the fact that it is basically Delta neutral, and money is made through the time decay of the option premium.
The Iron Condor is a directionless strategy in which the expectation is made that the underlying is going to stay traveling sideways for the time being. As with any trade, there are two dimensions involved: Time and price. Without getting too deep into the intricacies of the Iron Condor, I will just focus on the bottomline: Price and time. Any stock market chart is composed of two components, the vertical axis displaying the price and the horizontal axis with the time on it.
This trade was on the IWM.
Vertical component = Price
The IWM is a ticker for the Exchange Traded Fund that tracks the Russell 2000. At the time of my entry, it was trading around 70, with the immediate level of resistance around 73 and support at 66. I placed the Iron Condor involving those exact levels. The 66 put was sold and the 73 call was also sold. Hence, as long as the IWM stayed in between 66 to 73, the option premium would decay and the trade would be profitable. The 65 put and the 74 call were bought to limit potential loss.
Horizontal component = Time
How long could the IWM continue going sideways is the question that needs to be answered prior to trade entry. Of course, there is no certainty and that is why many traders turn toward technical analysis for help. The daily chart below shows the IWM at the time of the entry.
Clear zones of support and resistance were there at the time of entry and my line of thinking, in hindsight, was that after a volatile week, the stock market would calm down for at least a few days and stay flat. With that frame of mind, I placed 10 contracts on this small Iron Condor trade. The goal was to exit when about 80% of the maximum profit was achieved. In this particular trade, the max profit was 32, so 80% of that would be around 26. By the way, the risk for the entire Iron Condor was only 68. The specifics below show the Iron Condor as two verticals, each with a max profit of 16 which are to be added together for the total possible profit.
| Bought 74 call | ($0.20) | 74 call |
| Sold 73 call | $0.36 | 73 call |
| Max Profit for both calls | $0.16 | Max Loss = 0.84 (1.00 - 0.16) |
| Sold 66 put | $0.69 | 66 put |
| Bought 65 put | ($0.53) | 65 put |
| Max Profit for both puts | $0.16 | Max Loss = 0.84 (1.00 - 0.16) |
After the entry, the trade stayed price-bound for the first several days, but then my mindset changed due to unforeseen news coming out from all over the world. I chose to exit my directionless trade, at the least painful way, by buying back my obligations. Namely, the sold 73 call and the 66 put were closed while the long (65 put & 74 call) legs were left (untouched) at the table to expire worthless. The main reason I exited was due to the possibility that the market might move significantly out of the 66-73 range. At the time of the exit, each side of my trade had made me some profit, but the total was not 80% of the max profit as was my aim. On the Bear Call side, there was 11 made out of a possible 16, and on the Bull Put side, only 9 out of a possible 16. Together, 20 (11 + 9) was made out of the possible aggregate of 32 for the entire Iron Condor.
The very next day after the exit was made, the market dropped rapidly, and one of the legs that was left to expire worthless had gained in value due to the significant market drop. On the chart above (Figure 4), a blue arrow is placed below the spot that the price went the lowest. The long 65 put, which was initially out-of-the money protecting the sold 66 put, became valuable due to the price drop. The IWM fell through the 66 support and was nearing the 65 zone; hence, the 65 put had increased in value to 49. None of that 65 put value was intrinsic, so I knew that it would go away within a matter of hours. The logical thing to do was to close the 65 put by selling to close. Due to the additional income of 49, the entire profit loss calculation had changed.
CONCLUSION
Be totally accountable for your actions; if the trade does not do what was initially expected for whatever reason, be flexible to adapt to the current situation. It does take courage to be accountable because full accountability is not always the most popular choice; but when trading, that is the only road a trader must take.
Source: http://www.fxstreet.com/education/related-markets/lessons-from-the-pros-options/2011-08-30.html
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