Lesson Overview

Risk-Free DIA Iron Condor

Today we'll show you with live trades how we turned our original custom DIA naked put trade into a risk-free iron condor with NO possibility of losing money. Since we sold a call spread above the market and a naked put we were able to take in a credit of $1.33 overall and then used just $0.30 of that credit to buy protection as the market traded sideways.

The key here is that during all this the market did not move directionally that would have helped this position. Rather selling options and time decay proved to be the most beneficial strategy here.

More Discussion

Was This Helpful? Add Comments/Questions

  • Nope – you would need a margin account though.

  • It’s mostly used when you first have high IV on a stock and can afford to sell one of the sides naked to start. I do not use it often but it’s a great concept for adjustments.

  • You can just click the individual options one by one and at the same time hold down the “CTL” or “ALT” key depending on your computer. It will add the custom order.

    • Jhun

      OK Thank you.

  • The specific trade would have been in the archives for PRO members under the nightly video updates – the “Bullish Trades” section is just what you said, helps you generically learning about different trading strategies.

  • It’s a simple initial order you can do anytime really but I’m looking for really high IV ranking before I get into a trade like this because the initial trade is undefined risk before we covert it over.

    • Alex

      I understand – thank you for responding!

Show Video Transcript +

In this video tutorial, I want to talk about a cool adjustment we made to one of our custom naked put trades in DIA. And we created a new Iron Condor in DIA that has absolutely no possibility of losing money, and it costs us nothing as far as margin is concerned.

So we were able to hedge this original position, turn it into an Iron Condor that cost us no money with a lot of upside potential as far as profit.

So we're going to go through the trade here in detail. So, this is the trade we're looking at; it's the DIA. And you can see this is a live trade that we're making so ...

And that we're currently in. So, here's the original position that we had made. We did a custom naked sell of a put. And so what a custom naked sell is for our purposes and the way we teach it here ...

And again you can see a video tutorial of this inside the membership area under the Bullish strategy section. We go over this exact order and how to place it. But what we're doing is selling a call spread above the market.

So we sold the 179, 178 credit call spread above the market. That takes in a premium and also means that we're short implied volatility, so this strategy works well when implied volatility is high.

Now at the same time what we decided to do was to sell a naked put. And so basically what we do here is we sell that naked put and add the credit from the naked put to the credit from the credit call spread.

If that difference in all of the credits we received ... In this case, it was $133 ... If that is more than the width of the credit spread that we sold above the market, then we have no risk to the upside of this trade.

So again, if the credit from selling all of these different things with the call spread above the market and the naked put option below the market is more than the width of the call spread above the market, which is only a dollar, you can see we have no upside risk in this trade.

So when we originally put this position on we took in $1.33 in credit. So that means that if DIA continues to move all the way higher to whatever price in the future, we only have ...

Or we can still make about 33 cents because of that dollar that's subtracted out of there. Now here's the actual trade that we make. Again you can view the trades right here. So, with these trades, you can see that we placed this trade on 116.

So I'm just going to show you guys the chart here because what's so cool about this is that the stock hasn't moved anywhere since the trade. So on 116, we place this trade, and you can see we then made our adjustment trade on 128.

So those are the two different time frames that we had, and again I'll show you the adjustment that we make. So let's first go to the chart here. You can see DIA on 116 was right here. So this ... this exact day was ...

This green day right here was where we placed the opening order. And you can see implied volatility at that time was high. Well since then, implied volatility has dropped a little bit, but it's come back up.

But the stock had gone nowhere because yesterday is when we made the adjustment to that trade. So, and yesterday the stock closed down which is bad for this position because we should be bullish, right? This is a bullish trade.

We're selling a naked put below the market; we're selling a call spread above the market. We want the stocks to move higher, that's our profit window.

But you can see the stock moved sideways from the time we entered the trade to the time that we made the hedge. So, there's no directional advantage that we had in making this trade.

It was all just time decay and volatility premium that's getting out of this security. So this is a look at what the original position looks like in Think or Swim. So again we have this long side here for the call...

For the short naked put. Then we have a nice big profit window, and it dips right here at 179 180 because that's our call spread that we sold. So you can see, that's where the profit/loss diagram dips.

But everything stays above zero every beyond that. This is where we make our $33 credit even if DIA continues to move higher. So at this point, now that we're in this trade, we want DIA to trade basically between 179 180 and about 159 which is our break even point.

A very wide window of opportunity to make about $100 on this trade, so good profit window as far as we're concerned. But now what we saw is we saw that as the market has evolved and gone through the process here of the last couple days, it's traded sideways, we've gotten a little bit closer to expiration ...

Implied volatility has gotten down just a little bit; it's back up today, though. But implied volatility has gotten a little bit closer to expiration, so the decay in these options is pretty substantial.

So what we decided to do is to go back and create an Iron Condor out of this position. So remember, we have a call spread above the market and just a naked put at 160. So to create an Iron Condor, we want to just mimic that call spread above the market by creating a very similar put spread below the market.

This means that we had to buy the 129 puts that were just below the 160 puts. And you'll notice, all we did was buy one because we were just short one of the 60s.

But here's where the key comes in. We took in an original credit of $1.33 on this trade. So the key here is that we have to spend less than $1.33. So if we spend less than $1.33, we're still taking in an overall credit.

But even more so than spending less than $1.33, remember we originally said that we want to have that credit be equal or greater than the width of the call strikes. And that width of the call strikes is one dollar.

So really, we want to maintain the fact that we have no risk in this position ... Or if we want to maintain no risk in this position, we're got to use $1.33 and buy a put option for less than 33 cents to maintain that one dollar overall profit.

And that one dollar overall profit means that we have no risk on either side of this trade. So again, if we have $1.33 in credit, we want to spend a dollar but keep a dollar at the end of the day.

So we went out, and we bought the 159 puts which were trading for 30 cents. So we took 133 minuses 30, and we're still left with $1.03 in credit. Now that $1.03 means that the width of our strikes is completely covered by the dollar.

We have absolutely no risk on this trade whatsoever, and we still keep the difference between the width of the strikes and our credit received which is three dollars if the stock moves outside of our strike ranges.

So again, here is what the new position looks like. So I just activated it here on the platform here on the analyze tab. And you can see on either end of this new Iron Condor here we have absolutely no risk.

This is the zero line, all of our red line, which is the profit loss and expiration. Absolutely, emphatically no risk on this trade at all. So that means that all the margin that we were carrying originally is completely gone.

We still have a huge profit window between 160 and 179 where we can make about $100. So we've already made the vast majority of that, we're sitting at an $84, $85 profit now.

But at this point, the trade's not costing us anything, and it's still got a very large profit window, again 160 to 179 that we can make money. So here's what DIA is, and you can see here ... I'll zoom out so you can see it ...

Here's our profit window, all the way up to about 179, 180, all the way down to 160. So as long as DIA stays inside of this range, we get to make all the premium on this trade. And at this point, it does not cost us anything.

So hopefully this was a cool example of how we're using options. And again, being a little bit strategic, very smart about how we're doing it. The key here and the takeaway here is that you just have to take your time with understanding these positions.

It's all about the credits and debits that you receive. Again, if you understand how much money you're taking in and how much it costs to protect the position or hedge it, then it makes it very, very easy to look for the appropriate hedge.

And in this case, it was a hedge that was able to completely reduce the risk of the trade 100% and keep all the upside potential. So, again I hope you guys enjoyed this video.

If you found it helpful, please share it online on Facebook, on Twitter, on Youtube. Help spread the word about what we're trying to do here at Option Alpha. And until next time, happy trading.

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