How To Adjust Short Strangles When Stocks Are Falling?

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Short strangle: In tonight's video, we're going to go over all the trades that we made for Monday, August 24th. So, active day, even after the big, big decline on Friday, we had a continuation of that here on Monday. And really, no surprise right? We knew it was going to be a volatile day, and the markets were all over the place.

They opened up kind of limit order and circuit breaker down, and most of the futures exchanges kind of shut down for a little bit. The markets were falling so fast, and then they rallied, and then they fell into the close. So, I ... They were just all over the place, and honestly, that's probably what we're going to get the rest of the week, so be prepared for that.

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So, today, really two themes prevail, and we talked about this a lot in the strategy call with the lead members on Sunday night, last night, and that's that we have to maintain some bearish positions ... So that's number one, right? We have to recognize and kind of respect the market move.

Have to maintain some bearish positions. And number two is that we have to get back to neutral as much as possible with some of our trades. Now, in this case, I didn't want to make adjustments to a lot of trades, but again you got to respect the market. If the market makes a five percent opening move to the down side, you've got to respect that type of move and start to adjust some of your positions.

Now we didn't adjust everything all the way, still have more room to do that, and we still have more room to add positions in our portfolio, so that's also key. We want to make adjustments ... Try to get back to neutral as much as possible, but we don't want to be overly aggressive, because this thing can snap back very, very fast. Okay?

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So, all we did today new opening trades and adjustments. I want to go over the adjustments in particular because all the adjustments that we did today were of the same vein. Meaning, we did the same type of adjustment across the board in every single security that we had, and that was EWW ... Early release in every one that we traded.

That's Apple, and EEM, and EWW, FXI, the Qs, and SPDR. And the name of the game here is rolling down the call side to collect a higher credit. So it all the cases we had either the strangle or the straddle, and we rolled down that call side to collect a higher credit because those now out of the money calls after a five percent drop in the market is practically worthless.

So, I want to go through one example in detail so you guys can understand kind of the concept. And we'll use the Qs in this example because it's easy to show kind of the maneuver and the strategy. But again, it's all the same for all of these. We just roll down the side in every single one. So in the Qs, we roll down the 112 calls down to the 100th strike.

So in all these examples, the first strike that you see here, that's the new strike that we have short options at, and we roll down from the second strike. So, an example here with Apple, we roll down from the 125s down to the 100s. With the Qs, we went from the 112s down to the 100s, and the net difference between buying and selling each of those was an additional $324 credit overall.

Now, the goal in doing this is taking our 112s, which were all the way up here, and now again, respecting the market move and moving them just a little bit closer. But notice that the 100th strike is not as we moved it all the way to 90. So we're still giving ourselves a little bit of room, some room for the market to move.

We're going to try to give ourselves as much of a cushion as humanly possible, because this thing's going to be all over the place, and all we're hoping for is that trade's a little bit sideways and sees a drop in implied volatility between now and expiration. So in the case of the Qs, we went ahead like I said, bought back the 112s, which were all the way out here, moved in closer to the 100s.

Now we have the 100, and the 95 strangle around the market. So now you can see this gives us a little bit more neutrality because our new position is right over top of where the stock is trading right now. So now we are again completely neutral in ... At least in this case with the Qs and most of the other ones, we are completely neutral in future direction, and we have an opportunity to bank a profit on these 112 calls that we sold and now bought back.

We bought these back today for about 33 cents, we sold them for a couple of hundred dollars, so kind of all in all on that side of the trade, we banked a nice little small profit rolling those down. And that's why we wanted to get rid of them, right? 30 cents is not going to be enough premium to hold them all the way through October.

There's just no point in letting this thing sit out there, carry a bunch of risks when they're practically worthless. So we want to move those in, roll those closer to where the stock is trading right now, not all the way, but roll it closer to where the stock is trading right now, and still give ourselves nice wide opportunity to make some money.

So, again that's the strategy that we deployed with all of our positions today. With all of the strangles and straddles, again, respecting the market move but also recognizing that we have to take in a credit and move things a little bit closer. As far as new opening trades, and again if you guys have any questions on any of these particular trades, please let me know.

Just add a comment, please don't send me an email, that way everyone can see it. It just helps everyone and myself in answering these questions. So as far as new trades go, the first one that we did quickly early in the morning was a big position in VIX. We sold the 28/29 call spread for 25s in credit.

That's when the market right opened, our first open in VIX. You can see the VIX closed much higher than that, but actually, that position is profitable right now, which is crazy because VIX pricing is not like normal pricing. But all we're trying to do here in selling these options around 30, kind of our strikes are around 30, is that we're assuming between now and expiration that volatility drops.

It's all it is, is a big play on volatility. And I've got no problems adding to this position even at these levels. If tomorrow the VIX goes up to 50, you better believe that we're going to be adding to this position and doubling up on it. At some point, volatility will drop, and we can roll these things forever in perpetuity until it happens.

So, I always love plays on volatility. They tend to be our most profitable plays, but we don't get them that often. That's why we have to scale into them when we get an opportunity to play a little VIX. So that was our position in VIX. We also added an iron butterfly in TLT and FXE.

And again, all we're trying to do here is take advantage of what the market gives us. So in both of these, we did the iron butterfly the same as we have for all of them. We sold options right at the money, so in TLT the 128 call, 128 put. Bought options $10 out on either end. That gives us a nice wide wing, and it gives us the most credit we can get.

Same thing here with the FXE. We sold options right at the money at about 115, bought options $10 out on either end, even beyond that. Gave us some nice big credit about 401 on FXE. And we wanted to get into TLT yesterday, but just didn't have an opportunity to do so. And you can see that position in TLT is now right centered around where the stock is trading at this moment.

So, that's our profit window. We just want this stock to trade sideways. We want implied volatility to go down in TLT.  With FXE we were around the 115 strike. Now FXE moved up a little bit, because of implied volatility ... because of all of this stuff out of China. So FXE was one of the bright spots in the fact that it was moving higher today with implied volatility.

So we skewed this just a little bit higher, and it was trading around 115 when we entered the position. That gives, again, kind of a baseline. We want the stock to stay right near 115, but with our credit of almost $4, that moves our break even points out to about 119 on the top side and down to about 111 on the bottom side.

So our profit range is wide in FXE. Again, given that implied volatility. So if the stock continues to move higher, great, as long as it doesn't move higher than about 119. If the stock drops, fine, it can drop as long as it doesn't drop further that about 111. And that's the name of the game here, is that this high implied volatility market gives us the opportunity to collect a little bit more money that widens these break even points on some of these trades.

All right, so beyond the butterflies, we did a ton of vertical credit spreads. Again, the vertical credit spreads in this case, and what I'm using them for is just purely market directional play. So I knew earlier in the afternoon when the afternoon when the market was popping up that it was most likely kind of a short covering rally, so the market opens low and people who were short end up covering their positions by buying stock, and so that naturally just drives the market up.

It's that dead cat bounce, right? So the market popped up earlier in the day, and I assumed, "Hey look. Let's respect the move in the morning that the market might sell off in the afternoon," which it did. So what we tried to do was enter a lot of this credit call spreads, again bolstering our credit call spread positions in a lot of things.

Namely in ... Amazon, and Baidu, and XLF, and XRT. So we added all of this credit called spreads and did them fairly wide in some cases because they're five dollars wide. If they weren't five dollars wide, like XLF was only one dollar wide, we did five contracts. In XRT we did even a bigger position, two dollars wide and six contracts because we're taking in a really big credit.

So the whole idea that we're trying to do here is that we're just trying to get something on besides our neutral trades that profit if the market drops. Right now we'd love to see the market rally just a little bit. That would help out all of our straddles and strangles and iron condors. But if the market continues to drop, then we need to have traded on like these that will be kind of moneymakers for us and kind of help soften the blow of a market continuing to move down until it rebounds.

So that's what we want to do with some of these positions. It's what we did last week with XRT, and we had a nice click trade with XRT, so we're going right back to the same well. Doing it again, and again, and again. With USO, which is our last position here, what we wanted to do in USO is trade things a little but bullish.

Look, USO is a huge ETF. And it's getting low. I mean, it's in the $10 and $12 range. So what we wanted to do is trade it a little bit bullish. Implied volatility is crazy high in USO. So for me, this is a further out position compared to a lot of the other stuff we've been trying to do, because I truly think that at some point implied volatility is going to drop and the markets are going to see some normalization, reversion to the mean, whatever you want to call it.

And I think oil is going to be one of the first ones to move higher. Now in this case if it doesn't, it's range bound at 12, it can't necessarily go to zero ... It's an ETF fund, so it's not going to go to zero. So we could continue to roll this contract month, after month, after a month if needed to maintain the position and maintain a bullish bias.

So that's why I did the position USO. It wasn't necessarily that I think it's going to turn around right away ... Although it very well could. If the markets rebound, oil could be the very first one to go higher. It's definitely at a low state. But I did so because it's range bound in price.

So that ability to have kind of a barrier at zero gives us the opportunity to continue to roll these contracts even if they go a little bit lower, adjust them even if they go a little bit lower, and still maintain a position. And eventually, we'll have an opportunity to close out this position, or a roll of this position, with a profit later on in the future.

So that's the addition that we had in USO. So overall I can tell you it's been a busy, crazy, hectic last couple of days. I've been trying to get to as many emails as I possibly could. One quick suggestion and request that I have is that I've gotten a lot of emails from people saying that they've already maxed out their portfolio with positions.

What I can tell you honestly is that one, you should never max out your portfolio. You should always try to have between 40 and 50 percent in cash, and that includes any margin positions. So if you have one person emailing saying, "Well I have $80,000 in cash, but I have $40,000 in the margin." Okay well great.

You have 50% of your account margined, that's enough. You can have 50% margined, and that's probably a good radar to be around. So if you have more than that, that means that your initial position sizes are too big. If you have five positions and you've maxed out your account, that means you're doing 20 percent position sizes, and that is way, way too large.

I had to tell somebody that very gently today, which they needed to scale down their position sizes dramatically. Okay? So you have to look at your position sizes. Make sure that you're doing these appropriately. That also means that sometimes you might not be able to take all the trades. So take the trades that fit your portfolio.

If you don't need anymore exposure to oil, don't take the USO trade. If you want to get some more exposure to currencies because you have a bunch of oil and bonds and ETF, then get some FXE with us. Okay? So make sure you're taking some of these trades if you can't take them all, that fit your overall portfolio, because that's what you want to do ...

Have a balanced portfolio, diversified of option selling strategies. You don't want to have everything in one sector, everything in one market, so try to be a little bit picky-choosy here. And again, make sure your position sizes are correct. Take a look at our video tutorials that we have on position sizing inside the risk management section of the video tutorials.

There's perfect step by step video tutorials that we have and guides about how you should be properly position sizing your trades, and how you calculate your proper position size. So please take a look at those guides and PDFs. They're there for a reason, and this is exactly the type of market that you've got to be real, really diligent about keeping your position size small and putting out a lot of trades so that you have an opportunity to take a bunch of these off with profits. Okay?

So as always, I hope you guys enjoy these videos. If you have any comments or questions, please let me know. And until happy next time, happy trading.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.