Watch HowardCohodas Trade Index Options Credit Spreads

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HowardCohodas

HowardCohodas

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Introduction
I trade index options credit spreads and form Iron Condors when market conditions permit. The primary difference between my methods and the methods popularized by others in the use of new tools recently available and a more aggressive management strategy to turn trending markets into additional profit rather than a loss. More specifically, I use probability of touching rather than probability of expiring as my proxy for the chances that the spread will fail to produce maximum return. And I roll spreads as they near maximum profit if new spreads are available that meet my credit goals and are within my risk parameters.

The Journal
This journal is identical in content to the one I keep for my own trading. It is slightly different in format due to the limitations of the forum presentation. This journal is more than a record of trade entries, adjustments and exits. It is also a record of the good, the bad and the ugly for these transactions. Did I follow my rules. If not, why not? Did I mess up execution. If so, what am I going to do to prevent it from happening again. Did things work out as expected. If not, are rule changes in order or is it just one of the chance occurrences we are prepared to endure.

Given that it is identical, some background to my practices is needed to interpret the information.

There are two key parts to a trading system; the strategy and the trader. Each must be a good performer to achieve trading success. And each must be continuously assessed to assure top performance. The journal is used for both of these tasks. The journal is all about quality assurance. Evaluating the strategy and the trader for any degradation in performance so that action can be taken before serious damage is done.

Journal Analysis
The journal is meant to provide analysis in three time frames; tactical, intermediate and strategic. The same daily information is used but summarized and formatted differently for each time frame. I keep the entire spectrum of time frames in mind when I create the journal entry commentary.

Once a trade is established, actions can roughly be divided into two categories; taking advantages of opportunities and avoiding jeopardy. The commentary will keep this perspective in mind as well.

Tactical
At the tactical level, the commentary records every action and sometimes attempted actions that take place from the event that established the position to the event that terminated it. For this time frame I note reason for entry and any rule non-compliance, accidental or on purpose. I may note that a roll was attempted, but no spread that met my requirements was available.

Intermediate
The intermediate time frame consists in reviewing the life of a particular trade or group of trades part of the same iron condor. Here I am trying to identify the performance of myself, the trader. Did I follow my strategy? Did I deviate? Why? What happened?

Strategic
The strategic time frame consists of reviewing several different trades over several expiration times with the goal of identifying any degradation in performance of the strategy. Here I want to identify any changes in the trading environment that may render the strategy ineffective. The strategic review is intended to help me spot systemic changes that may require changes in the rules, changes in the parameters or abandonment of this strategy because the market conditions no longer exist for keep it profitable.

Dashboard
The key monitoring tool for my trading is my Dashboard. I will keep the current output available here as an image as long as there is interest in following my trading so you can see what informs my actions.

Activity Summary
Each time I complete a transaction, I will update the summary so that my current position can be monitored. The summary will be in a new post at the end of the day that the activity took place. As spreads are initiated, they will appear in the summary as long as any spread in the iron condor is still in play.

Others Posting to This Thread
I see no reason not to let anyone who wants to, to post a comment or question. I will however moderate offensive (to me) posts even if they contain useful information, comments or questions. I plan to continue this effort as long as there is interest from others. Comments and questions are one way to keep me interested in keeping this thread timely.
 
The Dashboard

T2W_Journal.png



Decision Support
Opportunity
IC
Iron Condor sequence number along with an indicator if this spread was a put spread or a call spread. The cell is highlighted if the iron condor is incomplete indicating an unrealized opportunity if the completing spread had good return for the risk level.​

Spread P/L
The profit/loss represented by the current mark price. If the profit is greater than 80% then a roll opportunity may exist.​

Jeopardy
Probability of Touching
The probability of the underlying financial instrument reaching the strike of the option that was sold short. Generally only used when the spread is near expiration to make a decision on whether to close the spread or let it expire.​

Days Until Expiration
Generally only of concern when the spread is five days or less from expiration.​

At Risk P/L
This is the key indicator of whether a spread should continue to exist or to be abandoned.
​
Commentary
 
Positions 2010/11/24

Code: 
Spread           In           Out           Series				                        Credit
31		11/18/10		          NOV4 10	NDX	CALL	    2200 	2225 	1.600
32		11/19/10		          NOV4 10	NDX	PUT	    2025 	2050 	1.200
38		11/24/10		          DEC1 11	NDX	CALL	    2225 	2250 	1.110
39		11/24/10		          DEC1 11	NDX	PUT	    2050 	2075 	1.100
20		10/26/10		          DEC 10	NDX	CALL	    2325 	2350 	1.030
14		10/18/10	11/08/10	  DEC 10	NDX	PUT      1825 	1850 	2.100
26		11/08/10		          DEC 10	NDX	PUT	    2000 	2025 	2.300
21		10/27/10		          DEC 10	RUT	CALL	     800 	 810          0.500
16		10/18/10	11/23/10	  DEC 10	RUT	PUT	     590 	 600 	        0.950
37		11/23/10		          DEC 10	RUT	PUT	     650 	 660 	        0.920
29		11/09/10		          DEC 10	SPX	PUT	    1125 	1130 	0.500
30		11/12/10		          DEC5 10	SPX	PUT	    1075 	1100 	1.800
35		11/22/10		          JAN 11	NDX	CALL	    2375 	2400 	1.000
33		11/19/10		          JAN 11	NDX	PUT	    1875 	1900 	2.160
34		11/22/10		          JAN 11	RUT	PUT	     610 	 620 	        0.900
36		11/22/10		          JAN 11	SPX	PUT	    1070 	1075 	0.450

Warning:
////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////
Although the process I describe is deceptively simple, there is a lot of study and testing that went into developing the strategy. Although I have only taught this to a few friends and family, It took a 20 hour class to cover the details of the risks and management of these trades. These details cannot effectively be communicated by just watching me trade.
////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////
 
Last edited:
timsk said:
Hi Howard,
Your journal promises to be comprehensive, instructive and rather different to most others. (y)
For those of us that struggle with options, let alone credit spreads and iron condors, it would be helpful if you could provide some kindergarten links which outline in basic terms what these are and how they work etc. That will help to make your journal a useful educational resource for members and make it more appealing to a wider audience. Just a suggestion!
Cheers,
Tim.
(This post will self destruct in a day or two.)
Click to expand...

I think anyone without the gumption to find these out for themselves shouldn't have their hands held that much as they'll end up legging into naked shorts and crying to Howard and t2w.... just my opinion...
 
A Brief Overview of Credit Spreads & Iron Condors

At the suggestion of an earlier poster, I am including some information on credit spreads and iron condors. I am limiting that discussion to what is necessary to follow my trading. If you want to use this strategy yourself, you should study options, spreads and iron condors in considerably more depth than presented here.

My journey (short form)
--Studied credit spreads and iron condors for 3 to 4 months.
--Backtested my ideas for 1 month using 5 years of historic data.
--Paper traded for 5 months to understand the trading mechanics and hone my rules accordingly.
--In the middle of the paper trading time, I took my wife to a seminar on trading credit spreads so she could learn it from someone else besides her spouse. I was surprised that I learned some additional technique from the instructor which I now incorporate.
--Traded for small money to understand the differences in paper trading and real trading.
--Began serious money trading Aug 2, 2010.​

Today my account has increased 42.5%. That includes credits received for open spreads so I may be forced to give some back should I have to buy back the spread rather than let the options expire. This results in a monthly average of 11.3% to date. It must be noted that a much longer time frame and at least one complete market cycle should be traded before one can see if these results are typical or atypical.

Trading Credit Spreads - Some Basics
Options, in general, and credit spreads, in particular, are very flexible instruments used for accomplishing a variety of financial goals from income to hedging. I will limit my discussions to what I believe is pertinent my strategy.

This is not an in-depth discussion of options or credit spreads, so further study is recommended. The following discussion is meant to provide the focus for additional study to better understand the rewards and risks of this strategy.​

What is a credit spread:
For purposes of understanding my strategy, a credit spread involves the simultaneous sale of an option and the purchase of another such that​

Both options are on the same underlying financial instrument​
Both are in the same series​
Both options are OTM (out of the money)​
The option sold is nearer the current trading price of the underlying instrument and thus has a higher premium​

I execute this trade with my broker as if it were one transaction. I do not care about the prices of each option (leg) of the of the spread individually. I only care about the credit I receive. Most brokers can accommodate this type of trade.

I may trade options naked, but I never trade naked options.

The result of the transaction is an immediate credit to my account of the difference between the premium of the sold (short) option and the purchased (long) option. The broker will quarantine sufficient funds (margin) such that you have the ability to pay to unwind the spread for the worst case scenario.

The goal of entering a credit spread is to keep all the credit you received when the options expire. This will happen if the underlying instrument price remains away from the option you have shorted. The maximum reward in this type of transaction is limited to the credit you receive. The maxim risk is the difference between strike prices.

An Iron Condor is formed by selling a credit spread on the other side of the underlying instrument price. One half of an Iron Condor will be a PUT spread and the other side will be a CALL spread, both OTM (out of the money). The attraction of forming an Iron Condor is that no additional margin is required by most brokers because you can't be at risk for both spreads simultaneously. The underlying instrument price can only be in one place at a time. This means that an additional credit can be collected without any increase in quarantined funds. This "effectively" doubles your return. "Effectively" because the credit received may not be the same for both sides of the Iron Condor.

When I return home, I will add links to the two reference books that I found that were the easiest to read and the most informative relative to trading credit spreads and iron condors.

Warning:
////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////
Although the process I describe is deceptively simple, there is a lot of study and testing that went into developing the strategy. Although I have only taught this to a few friends and family, It took a 20 hour class to cover the details of the risks and management of these trades. These details cannot effectively be communicated by just watching me trade.
////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////
 
Last edited:
Whoah, wait a moment, you've been trading this since AUGUST?

Just be aware that there are lots of lemming morons* on this site that may try to emulate you, just make that clear

*Hence my sig...

Anyway, question... are you mostly trading greeks here or just expressing an outright view?
 
arabianights said:
Anyway, question... are you mostly trading greeks here or just expressing an outright view?
Click to expand...

The simple answer is no and no, but for those who understand the Greeks and directional bias, it is an incomplete answer.

Other than choosing what index's options I will use, the only two criteria I use are the Probability of Touching and the amount of credit I require. These choices are not driven by the Greeks or a directional bias, but the Greeks clearly show that the Iron Condor will have a delta of near zero. The market, when determining the prices of the options and the credit available, has a market bias built into it. If I am only able to form one of the spreads of an Iron Condor, then there is a built in bias.

Warning:
////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////
Although the process I describe is deceptively simple, there is a lot of study and testing that went into developing the strategy. Although I have only taught this to a few friends and family, It took a 20 hour class to cover the details of the risks and management of these trades. These details cannot effectively be communicated by just watching me trade.
////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////
 
FAQs

I'll try to keep this post updated as needed.

  1. Why do I trade so many different indexes?
    I trade three different indices as a teaching device. Were I not planning to teach this material commercially, I would stick to just one.

    The indices I chose have three different strike price increments. The SPX at $5, the RUT at $10 and the NDX at $25. In that fashion, each student can see actual trades that will work for the size of the account that they have. I stop at $5 increments for two reasons. First, the minimum account size that my broker requires to trade options will accommodate $5 difference in strike price spreads. And second, with $1 difference in strike prices, commissions take a significant part of your income.

  2. Why do I trade credit spreads?
    I have been only moderately successful at trading that requires a directional bias. I trade the Forex that way with some success, but I feel somewhat out of control. I'm a retired software engineer and engineers never like to feel they are not in control.

    There are always two sides to any trade; opportunity and jeopardy. See Dashboard.

    Opportunity
    Credit spreads using my strategy attracted me for two primary reasons.​

    Selling Time
    Time marches on and the time value of the options involved in a spread must decay to zero at expiration. I enter trades around 60 days before expiration of a series as funds become available from expiration of the current series. This is also about the time that the non-linear decay curve begins it's increasingly steep descent to zero.
    ​

    No purposeful directional bias
    Since I am selling time, I don't need to have a directional bias when entering a trade. Certainly, the credits available have a built in bias, but my only requirement is that it meet or exceed my return goals. To protect myself I use the probability of the underlying price touching the short strike. Some risk is assumed to get a reasonable credit. The risk level to use depends on the individuals risk tolerance. Mine and yours will be different.
    ​

    Good return for the time funds are committed
    Options are used for many purposes in the financial market that are not related to spread trading. These market forces permit a nice income to be generated for the time the funds are committed for the credit spread trader.
    ​

    Additional Return When Forming an Iron Condor
    Forming an Iron Condor when the market makes it attractive is a nice bonus. An additional return is obtained without additional margin requirements.
    ​

    High Probability Trades
    The choice of probability of touching limit helps estimate the probability the trade will be successful. A simple calculation of mathematical expectation will inform the trader of the limits to put on this choice when the desired return is factored in. My opinion is if a trader doesn't know how to make this estimate, he/she should consider some other activity than trading.
    ​

    Jeopardy
    No management of a credit spread or an iron condor is necessary if the market does not trend. This happens around 80% of the time. When the market does trend, management is required to take advantage of opportunities that develop and to avoid large losses if the trend is strong enough to overtake one of the spread positions. Sometimes the spread that goes into jeopardy must be abandoned for a significant loss. Your risk tolerance will help set this limit along with your mathematical expectation calculation.
    ​
  3. Why do I use Probability of Touching for a proxy of an estimate the spread expiring worthless?
    Before I became a customer of ThinkOrSwim, I came up with the idea that I was more concerned about the probability of the underlying instrument touching the short option strike price as opposed to the probability of expiring away from it. I reasoned that I was likely to abandon the spread if the price neared the short strike rather than anticipating a return to profitable territory.

    I started out by using a Markov Chain approach of looking back over a market cycle to estimate the probability that given the time available how often did the market move sufficiently to close the gap. This, of course, blends the volatility over the look-back period and takes no account of the current IV.

    I then began using Monte Carlo methods of estimating the probability of touching and took into account the time remaining and the current volatility.

    Then I learned about TOS and became interested because of their deep experience in options and their feature-rich platform. As I was learning the platform, I discovered they had a probability of touching estimate as one of their built-in functions that could be added as a column in the option chain presentation. Their answer was close enough to mine that I abandoned mine and use theirs. In talks with TOS, I'm informed that the calculation is proprietary. And I have found no similar calculation in other platforms I have looked at.

    The downside is that TOS has suspended granting new FIX (financial exchange) accounts to retail customers. And I am advised that after more fully integrating with TD Ameritrade, they are unlikely to restore the program. I was further advised not to waste any time in development in anticipation of these accounts being granted in the future.

    When I am in my office, I use the live connection between Excel and the TOS desktop platform to populate the Excel Dashboard with current information. When I'm away from my office I use an online application I wrote to populate an HTML Dashboard with 15-20 minute old data "screen scraped" from online access for some of the spreads I have in play. And the probability of touching is simply not available. At the end of the day I update my data base that supports the online application from data I export manually from the TOS desktop platform.
 
Last edited:
arabianights said:
What's this about students?
Click to expand...

I covered this in other posts, but the only one I can count on to read all of my posts is me. ;) This is a good place to repeat my situation and plans.

In the process of teaching friends and family (no charge, no income), I decided to prepare to teach this material commercially. In correspondence with the forum management about needing a vendor's badge, they decided that until I started my commercial adventure in this area, a badge was not required.

Furthermore, I am exploring advertising on this forum. If the cost fits into my advertising budget, it gives me a chance to provide funds to help support this free forum we all enjoy in return for attracting students.
 
Phil's still at uni...

Good luck Howard, nice to have something a bit different.
 
Question, maybe for the FAQ bit ?

Why or what are the benefits of trading credit spreads, condors or greeks and what not, as opposed being taught how to trade directional out rights ?
 
spinola said:
Question, maybe for the FAQ bit ?

Why or what are the benefits of trading credit spreads, condors or greeks and what not, as opposed being taught how to trade directional out rights ?
Click to expand...

Risk. Howard mentioned in his previous post that as an ex-Software Engineer, he's used to always being in control. Directional trading is far from that...you're simply betting the market will go in your direction - not exactly being in complete control.

As I understand it, credit spread trading as Howard is doing, is not like directional trading. He is simply hoping to pocket the spread.

He has effectively covered the downside risk but at the expense of a limited upside potential.

Howard, out of curiousity, what models did you use compute the probabilities on your dashboard? Sorry if you already covered this, I may have missed it!

Great thread by the way! (y)
 
Good luck with this Howard..

I have a few questions:

1 - You mentioned probability above. Can I confirm that you are using the option data to give you the probability of price hitting that point and not any additional analysis?

2 - What is the logic behind applying your strategy to 3 highly correlated markets?

I also have 1 request
1 - Could you add a few columns to the sheet - can you put in the fees - so we can see the total credit to the account after fees ? Could you also add in max risk ? I am guessing this comes from a spreadsheet & so the column should be easy to add. Whilst I don't think you need to be teaching people about spreads on here as per the A'rab - it would be nice if we didn't have to calculate risk & reward ourselves.

Cheers

DT
 
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