Defining Risk

Good evening!

I hope everybody has enjoyed there Saturday. I was stuck inside working the whole time and well this is still working so nothing changed haha. I hope you guys have been following me the last few weeks. I am shock at the progress I have made thus far. I have generated roughly 15%  returns in 3 weeks. I know this isn’t and shouldn’t be sustainable but I will keep on trying.

Now remember last time we talked about selling premium and how we have more chances to win and make money because we don’t know where the market or a stock will go. We then discussed what happens when we sell an option and how there is unlimited risk for that trade. This article will discuss how we can define our risks.

How can we cap our unlimited downside and if we can, what do we give up in order to do it. Here is the scenario we will reference. Stock ABC is trading for $100. We are bearish on the company so we are going to sell the $105 call for $300.. There is also a $106 call trading at $280 and we have a $110 call trading for $130.

If we just sold the $105 call for $300, our max profit is $300 but our max loss is infinite if the stock shoots all the way up. We do not want to be out thousands of dollars. The way we can define our risks here is to buy a option to cap our risk. How does this work? Let’s say that in addition to selling the $105 call for $300, we also bought the $106 call for $280. So by selling and buying both of these options, we only received a $20 credit. By selling the call naked, we were able to collect $300. Why are we giving up $280?

The reason we do this is to cap our max loss. In return, we make less money. So how does the scenario work out to cap our max loss? Remember that our short $105 call goes against us as the stock goes up and pasts our $105 strike price. For each $1 the stock goes above $105, we must pay out $100.
So at $110, we must pay (110 – 105) * 100 = $500. We did collect in a credit of $300 so we are down $200.
In the scenario above, what happens with our $106 call. Since we are long the option, we make money as the stock goes up and past $106. For each $1 above $106, we make $100. So if the stock is at $110, we make ($110 – $106) * 100 = $400. We did have to buy this option for $280 so we made a total profit of $120. The end result of both of these trades is a loss of $80 or to better put it, the difference in our short and long strike less the credit received. When we buy an option that is further out of our short option, we cap our max loss and define our risk.

The max profit we make by shorting an option and buying an option is the credit received. We only collected $20 above. The max loss we have is the difference in strike price less the credit. ($106 – $105) *100 – $20 for a total of $80. At the end of the day, if the stock is less than $105.20, we will be a winner, but if the stock ends up at $110, $125 or even $1,000, we will lose no more than $80 because we bought the $106 call option.

This seems like a good idea and is one way to set a max loss in your head. In theory you could sell that $105 call and put in a stop loss but one thing you will realize with options is that for the most part, they will always test you and so you must be mechanical and adjust accordingly. Most trades will lose a little before they become a winner. A stock can go up $10 one day and just as easily drop down $15.

What if the scenario above, instead of buying the $106 call, we bought the $110 call for $130. We would be short the $105 and long the $110. From our example, the most we can lose here is $500. We received a credit of ($300-$130) = $170. Our max loss on this trade is $500 – $170 = $330. If you are going to define your risk, one thing that I always try to do and the people at tastytrade try to do is to sell these spreads for 1/3 the width of the strike. This gives us a high probability of success and limits our max loss to 2X the credit received. So in the scenario where we received $20 but our max loss was $80, our probability of success is about 80% of making at least $1 and max of $20. In the scenario where we buy the $110 call, our probability of success is around 67% but we could make $170. By defining your risks as well as determining how much credit you receive is up to your own risk tolerance. I try to increase make trades with 60-75% probability of success but there are times I am more or less aggressive depending on my perception of the market/stock.

This same scenario works for Puts as well. Now that you know what a vertical spread is, you now have all the tools needed to create all sorts of strategies such as iron condors, butterfly, jade lizards and put ratio spreads.

I don’t think I did a good job explaining everything here and might further touch on it at times but I hope we have answered some questions and concerns about selling options and the unlimited risks we originally had.


Trading Day 15

Good evening!

The market has been up and down today. Started down many points and eventually went back up. It is good we were able to get out of some of the positions we did this week. If we didn’t manange them early, we would be looking at a loss. PCLN was one of those examples.

Not much went on today. I got out of my BIDU earnings for about $100 profit. I also got out of my weekly RUT for a $200 profit. This one was close because the day started with RUT testing the strikes. The only other thing I did today was put on a straddle for X expiring in 56 days. This was the trade I got out of before because of low IV. X is trading at $37 and the straddle is almost a 20% credit of the stock price. I bought very far out wings so this is technically an iron fly but only on paper. I am looking to manage for about $150 winner here x 2 contract. Besides that, I just set a lot of GTC orders because my availability next week will be hindered with work related items. Hopefully I don’t miss out on anything too big. I should be able to close out some of my very first positions I put on back when I started.

I will try to squeeze in an article tomorrow following the last article.


Trading Day 14

Good evening!

I might switch it up a bit here. I don’t know if all the trades I list out is really worth it. I might just collectively discussed what I did and the strategy in a different format.

The market rallied in the beginning to start the day off. While that happened, I was able to get out of my PCLN position and now the full total of all positions netted $500. We also had a play in TSLA which I closed out for a profit. I had to leg out of my iron condor because I couldn’t get to it until the market started and TSLA just kept falling. I also took that to my advantage and bought a debit put spread hoping for a slightly further movement down. I then sold another call spread because I don’t see TSLA coming back up. After I bought the debit spread, TSLA went back up and so to reduce my basis, I sold a put spread to finance my debit spread so I am still only out my initial debit. Let’s hope TSLA ends up around @$250 for max profits.

I rolled my YELP spread another 2 weeks for a small credit hoping for a bounce back. I then closed out of my SPX spread, thank god as the market just went down. I also got out of my HTZ iron fly for a small profit. Too risky to stay in after earnings. I then sold an iron condor in RUT for $252 a contract. Sold a put in SHLD for $140. I sold an iron condor in K because of high IV. I then had a few earnings trade such as FIT, DKS, JWN and BIDU. Let’s hope they all stay within their expected move or I will have to be rolling in and out in time.

The on regret today was getting out of my X short call because of low IV yesterday. The stock managed to drop $4 today and I would have made about 40% in one day if I kept it on. In hindsight it was bad but I could have been on the other side of that so I am counting my blessings.


Trading Day 13

Good evening!

Today was a first for me but before we get to that, let’s realize some profit. I closed out of my Best buy trade for a $250 profit 🙂 Now down to something I didn’t think I would do until way later. I sold a naked put and a strangle…gasp…. I just for some reason wanted to try it and the underlyings I selected aren’t relatively risky so I think it will be a solid play. I also only did one contract each. I finished the day with some Tesla earning plays

Here are my trades for today

  • YELP – sold the 35.5 call to match my short put. Trying to receive some credit as YELP stays in the $34 range. Received $90
  • BBY – sold my iron condor for 50% profit
  • X – sold a 45 call with 59 DTE for $156. Steel has been on the way up and trying to play the contrarian view. This stock shouldn’t fluctuate too much. I might get out of this trade faster than intended as I just see that the IV Rank is 1.2%…
  • XOP – sold 37/42 strangle for $139 with 59 DTE
  • EWW – sold 44/49 strangle for $150 with 59 DTE
  • TSLA – made two earnings play here. First is an iron condor expiring this week 250/255/292.5/297.5 hoping it stays within the expected move. Sold for $158
    Second trade was a call butterfly with the 295/300/305. Oops, just looked at it and instead of buying the butterfly, I sold it for a $17 credit. I do not want TSLA to go up to 295 unless it goes all the way pass 305. This trade did not go in as intended…Will close out as soon as I can barring how the earnings went


I hope to have put an informational post this weekend but I have work items I might have to get done. After next week though, I should have a bit more free time to indulge my readers.


Trading Days 11-12


Good evening!

I definitely did not have time to post this weekend due to all the fun I had. Free game, free party and free fun all in NOLA. Can’t wait to go back next year with the boys. With that said, I had some small hiccups on Friday. I was driving so I almost missed my window to close out my PCLN position because it was right near my short strike price. I was able to log in with roughly have an hour left and rolled the position to this week. My RUT and SPX position both expired worthless so full profit on those.

Here are my trades for the last two days

  • HTZ – closed out my iron fly here for a small profit. This stock just yo-yo us before coming back to reality
  • LUL – closed this one for a winner as well at 50% max profit
  • COST – this has been rallying up and moved between my short call strike. Rolled it out in time an additional 17 days for a $51 credit
  • AMZN – this has also rallied so sold a short put vertical for $149 with same expiration as my short call that is now in the money
  • PCLN – closed out the call leg of the iron condor and rolled the put to this week’s expiration
  • IWM – this is the start of all my Monday trades. I rolled up my short put vertical from the $130 to $135. IWM is hovering around $140 and in case it blows past it, I hope to collect enough credit to have only a small loss. Rolled for a $172
  • BCRX – stock had high IVR so sold a short put vertical at the 3/4 for $120 with 24 DTE
  • FRED – also had high IVR so sold an iron fly here at the 15/17.5/20 for $684 with 24 DTE
  • TMUS – just finished with earnings so sold an iron condor with neutral assumptions. Wrapped around the 56.5/59/66/69 for $568
  • COST – rolled up my short put vertical again to simulate an iron fly around the 172.5. Was able to do this for a $93 credit
  • WMT – earnings propelled the stock up so sold the position and realized a $56 profit. Then sold a short put vertical wrapped around the ATM strike expecting a continued move up. Sold for $404 with 38 DTE
  • AAPL – getting back on the AAPL band wagon with a wide iron condor for a total credit of $404. 129/132/142/145 with 38 DTE
  • XRT – index option with neutral assumption on the retail sector. Sold Iron Condor for $324 with 24 DTE
  • Yelp – closed out my long call vertical hoping for a move up so I can close out the short leg. Expecting Yelp in total to be a scalp or small gain
  • SPX – I love trading short term so sold iron condor expiring this week for $340 if SPX can stay between 2350 and 2380. Will roll if tested
  • PCLN – closed out of my longer term short vertical for a small profit. Earnings are coming up and I don’t feel like staying in there too long
  • SPY – rolled out to April expiration to gain more time and went inverted with the put side for a small credit. I am locking in a $300 loss per contract but have received almost $400 per contract so hoping to gain $100.

Things are looking good after roughly 2 weeks. Account is in a positive territory even with all the losses we have had. Expecting to take a few more trades off the table this week and realizing some big profits.