Thursday, February 18, 2010

Parnos, Option Profits

In Options Profits: “The Naked Truth” (Traders Press, 2009) Mike Parnos spices up his options teaching with lots, and lots, and lots of humor. Not my kind of humor (I prefer the clever and subtle), but I will defer to others for comedic criticism. In between what might be comic relief if it weren’t so pervasive Parnos takes the novice from options chains to puts and calls and finally to “little known conservative non-directional strategies used by option pros.”

These “little known” strategies include the “meat and potatoes” iron condor as well as a range of other non-directional trades in the standard repertoire. So what does Parnos have to offer the reader who is familiar with non-directional strategies? He devotes the most space to the iron condor and its distant relative that the author dubs the “Siamese condor,” so let me confine my remarks to these two strategies.

Parnos’s approach is not always mainstream, and I am not experienced enough with condors to pass judgment on it. I will simply describe his entry and adjustment techniques. He deals first with entry criteria. Let’s say a person is trading the SPX with strikes at 10-point intervals. Since the iron condor is profitable if all strikes expire worthless, the trader should place the credit spreads as far away from the underlying as possible while still collecting enough premium ($0.50 to $0.70 on a 10-point spread) to make the trade worthwhile. Parnos’s math gets a little fuzzy when describing the probability of the trade’s success using delta as a proxy (I suspect a typo), but the upshot is that the trader wants a delta of between 7 and 12 for the calls and between -7 and -12 for the puts. I modeled out a short-duration iron condor (February expiry) with this profile on the Think or Swim platform using January 29 as the trade date and 1073.87 as the closing price. I would have received a $1,200 credit for a 10-lot iron condor with a 1140/1150 call spread and a 970/960 put spread and a total delta of -13.90. The risk on the trade would be $8,800 and my maximum profit at expiration would be $1,200. (I obviously did a good job simulating Parnos’s trade because my profit and risk are the same as that in his example.) At expiration my break-evens are 969.46 and 1141.41.

Unlike many, Parnos believes in adjusting iron condors. When one of the short strikes is threatened (when the delta of the short strike to the downside, assuming a downward movement in the underlying, reaches -25), it’s time to adjust. Close out the 970/960 vertical, at a cost of somewhere around $2,200, and sell another bull put spread 40 points beneath the original to take in an additional $600. The trader’s balance sheet now shows a debit of $400 ($600 + $600 - $2,200 + $600). If the market doesn’t turn around but continues to threaten the new lower short strike, the trader can adjust again, rolling down and racking up an additional $1,600 loss, now down a total of $2,200. “The whole idea,” Parnos writes, “is to manage your risk. If you take a loss . . . that can be made back in a month, the four or five profitable months will provide you a very impressive percentage return.” (p. 160)

So what is the Siamese condor? It’s a near-term iron condor with the two spreads joined at the short strike. This is not a trade to adjust; the trader should bail when the underlying reaches the common short strike plus the net credit or the common short strike minus the net credit. Why a Siamese condor instead of an iron condor? It has the potential, Parnos claims, to make more money with lower risk. I’ll have to think that through (unless some kind experienced options trader does it for me). My brain is rebelling against a long work day and is rejecting any new mental challenges.

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