Custom DIA Option Spread With Huge Profit Window

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Option spread: In tonight's video, I want to go over all the trades that we made for Friday, January 16th to close at expiration here. The first thing that we're going to do is go over the closing trades and then we’ll talk about the new trades that we entered, both the custom order in DIA which is the diamonds for the Dow and in XLF which is financials. The first one that we’re going to go over here is we did end up having to a buyback, unfortunately, this stock. It rallied just a little bit too far on the last day of expiration week.

We thought that it was going to all expire worthless out of the money, but GILD just rallied right above our 100 call strike on our original iron condor, so this did mean that we had to go back in and buy this back for a loss of $60 which is an addition to that smaller loss that we had in GILD. And you can it’s just rallied just barely above our strikes today. And who's to say that it couldn’t have gone the other way? But I guess it’s just luck or nor luck of having an expiration on Friday and just being right at the end.

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As far as other trades that we closed out, we were magnificent this week in trading three profitable earnings trades on Friday. All three of the trades that we had made on Thursday at the close all closed those out early in the day on Friday for profits. That is Intel, the iron condor. We bought that back for a $.7 debit, so we took a $36 profit.

The strangle in SLV was great. It was an $85 profit, buying that strangle back for $.24. And the same thing with Goldman Sachs, bought the iron condor that we were short back for $.27 and ended up taking a $48 profit. A superb week of trading earnings, we’ve had no trades that have gone against us.

I’m sure that it will be turnaround eventually because the odds and probabilities just favor the fact that at some point, we’re going to end up with a couple of losing trades, but I’ll take it right now. I’ll take a nice little streak of winning trades.

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The one that I wanted to highlight here real quick just pointing out to the fact that with these earnings trades, you got to try to close them as close to the beginning of the day as possible. And you don’t have to do it right in the open, you don’t have to send a market order, you can play around with the numbers a little bit and try to get a better fill. But at the same time, you don’t want the stock making a huge move up or down against your position.

And SLV is a great example of this because into the close on Friday; it rallied way above where our breakeven price would’ve been. When we initially made this trade, we sold the 80 call, and we took in total about 109 in credit. That would’ve put our breakeven price at about 81.09 on the topside of the trade. And when we look at the chart here of SLV, you can see that the stock rallied all the way to 81.33, so it rallied much higher than our original breakeven point.

And it would’ve been a loss had you held it all the way through the end of the day, but because we got out early in the open, as soon as the market opened and we got that drop in implied volatility that we were looking for, you just to get out of the trade and take whatever is left on the table. And in this case, we got out and paid a debit of $24, so we theoretically left another $24 on the table, but at the end of the day, it would’ve been a losing trade, so I’m glad we got out early.

And the same thing with Goldman Sachs, Goldman Sachs moved back into the range at the end of the day, but towards the middle part of the day, it was trading well below the 75 short strike on the put side. And I know a lot of people were having trouble getting fills, but at the end of the day, it came back into the range that we were expecting.

Alright, as far as new trades that we got into, the first one that we’re going to go over is this custom order in DIA. And we’ve done this a bunch of times before in Yahoo and some other securities out there. We did it before in DIA and IWM and SPY, so I really, really like this trade. But even still, liking this trade as much as I do, we’re only doing one contract here, keeping the position size very minuscule. Now, here's the thing with this custom order.

It's not a regular trade that you’re going to see inside of the broker platform, so you’re not going to be able to create this in a couple of clicks. You’re going to have to do this in a batching formation. And what you want to do is think of it as two separate orders. You want to think of it as the 179/180 call spread, so you’re selling the 179/180 credit call spread above the market, and at the same time, you’re selling a short 160 put.

We’re selling a call spread above the market and selling the short 160 put. That gave us a total credit of 133 with absolutely no upside risk. And that's what I love about this position, is that if you can get a credit, if your credit that you receive is more than the width of the call spread, in this case, the width of the call spread is $1, and our credit is $.33, then that means we have no risk to the upside.

If you can get a credit on a trade like this where your total credit is worth more than the width of the strikes on the call spread which is $1, then you have no risk to the upside, and we keep $.33 actually in case DIA just runs high. Just to drive home this point. If your spread above the market, your call spread is $5 wide, you’d be needing to take in a credit of at least $5, so that you’d have no risk to the upside. Does that make sense?

As we go here to the chart… Let’s first go to the trade tab of DIA. And you can see this position is already doing well. It’s profitable as the market rallied. Here's exactly what we did. We sold the 179/180 credit call spread above the market. We sold that above the market and at the same time, we also sold a naked 160 put. You'll notice that the 160 put is a lot further away from the market because we’re selling naked options and we want to get far away from the market.

It was about the 15% probability when we entered the trade. It’s now going down just a little bit. But when we look at we analyze tab and the risk profile, it’s a cool risk profile. Here's what it looks like. And I’ll just shrink this a little bit. It sounds like a credit spread for pretty much most of this. You can see it looks like a very generic credit spread like that, but then it has this naked put option down here.

Now what we have is we have this bigger window of opportunity in which we can make money if the market sits between 180 and about 159, 160. We have this larger window of opportunity where we could make a little over $100 on this trade or about $133 if everything expires worthless. And if the market does continue to rally up, we’ve got absolutely no risk to the topside. You can see our profit and loss line does not dip under zero at that point.

And most people would say this is a perilous trade because we’ve got this undefined risk future, but I don’t see it that was because at this point, it’s not taking up that much margin and our breakeven point is down around 159, so that’s much, much lower than where DIA is trading right now. Here's a chart of where DIA is. And you can see our breakeven price is all the way down here at 159, so stocks would have to have a very, very hard continued selloff all the way through February expiration for this thing to go in the money because our breakeven is at 159.

That means we have the potential of making money anywhere above this price point. And ideally, if it stays between about 180 and about 160, then we end up making the full credit that we have. You can see great, great trade, very high probability of success trade, and it all stems from the fact that implied volatility is extremely high right now in DIA. And that's why we like the trade. Just because we like the trade doesn't mean that we’re going to extend or over-allocate the trade and do more than one because it is a naked trade, so we want to be cautious of how we use our margin.

Alright, the other trade that we got into today is an iron condor in XLF. But what’s different about this one if some of you remember that have been members for a while is that we did this one, and it looks like a butterfly spread because our short strikes are the same on both the call side and the put side. You can see that in XLF, we sold the 23/25 call spread above the market and the 23/21 put spread.

Those same short strikes are at 23, so that looks like a butterfly spread when we look at the profit and loss diagram. But before we do that, let’s just take a look at the chart here. You can see that XLF has had a hard run-off, banking hasn't had a magnificent time here as interest rates start to drop and the markets start to drop. And implied volatility is still pretty high in XLF, it’s up at the 67th percentile, so we’re good selling options, iron condors, definitely something we can do.

Let’s look at the trade tab here first with XLF, and you can see where our positions are. On the call side, we sold the 23 and went out and bought the 25. You know that’s where these positions are. And on the put side, we sold the 23 and went out and bought the 21. You can see they’re just about two strikes apart on either end, so it’s a very even trade, very symmetrical trade, just trying to make it right over the market.

The market was trading at 23 and probably about $.10 when we entered this trade, now, it’s up about 23.49, so it’s okay, it moved a little bit. But we’re trying just to pin it right over the market. Now, here's what the profit and loss diagram looks like. It sounds like a butterfly spread here because it’s got this hump in this peak very much like a butterfly spread would, but it’s just a little bit wider. It’s just a little bit wider as far as the wings go.

And ideally, we want the stock to close somewhere between about 22 and 24, so it’s a little bit more of a narrow range, but we have good risk reward. We could make about $100, lose about $100 on this trade. It’s a pretty even risk reward trade and we’d like to see the stocks close somewhere between about 22 and 24. It’s got a pretty good window of opportunity here, a little bit more room to the downside now that the stocks rallied, but we like our chances especially with implied volatility as high as it is.

Alright, as always, I hope you guys enjoy these videos. If you have any comments or questions, please add them right below. I’ll get back to all of those tonight or tomorrow. And 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.