My new trading rules are straight out of research conducted by Tom Sosnoff‘s Tastytrade financial network. It is intended for smaller accounts, and has the goal of many base hits rather than the occasional home run amid a lot of strikeouts.
Positions: Short vertical or iron condor spread.
Short leg entry goal: delta 16
Implied Volatility Rank (IVR) 25% or greater. (This is similar to the IV Percentile)
Entry timing: As close as possible to 45 days prior to expiration, giving preference to monthly options.
Exit timing: No later than 21 days prior to expiration
Due diligence before entry:
- Avoid earnings announcements
- Avoid ex-dividend days
- Short Iron Condor: At 50% loss of maximum potential profit, move untested short leg to delta 30, moving long leg to conform.
- Short Vertical: Exit at 50% loss of maximum potential profit, or…
- Add a short leg on the untested side at delta 30, adding a long leg in the usual manner.
- (Tentative: If more than half of the 1SD range is beyond the profit zone in the tested direction, then exit the position. If the price moves below the profit range and the number of days required for the price to return to the profit zone, as measured by the 14-day Rate of Change, is greater than two, then exit the position. See “Disaster Exits: A DIS Post-mortem” for a discussion.)
Maximum potential profit is calculated as this way:
(credit_received – current_debit) / credit_received
where credit received is maximum potential profit and current debit is the cost of exiting the position. If it’s negative, the position is a losing one at present.
The upside of this rule set is that there is consistently an 85% or so chance of the position being profitable, with clear rules for management in those 15% of cases where the positions moves outside of the zone of profit.
The downside of the rule set is that the credit upon entry is relatively low compared to other strategies, and therefore the risk/reward ratio tends to be higher. The brokerage sequesters more of your funds to support each trade. It’s a common decision traders must make.
In earlier strategies, I would insist on a risk/reward ratio no higher than 3:1. That guideline has been tossed out. I’ll accept the higher risk, limiting it by the percentage of trading funds that I want to commit to a single position.
The positions are actively managed, so in practice, it would take a catastrophic move for a position to reach the maximum potential loss.
Up next, a few test trades that I’ve made using the new strategy.
By Tim Bovee, Portland, Oregon, March 30, 2019
Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.
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