It’s all well and good to trade a Bullish or Bearish view of the market and if the market is volatile (taking strong movements) there are vast opportunities to profit. But when the market starts to whip sideways in a tight range, opportunities start to dry up. We have seen this in recent years; the Australian market can go into these sideways phases for long periods, from a month to six months.
In these periods the strategy I lean on is called a Short Iron Condor and it can only be built using Exchange Traded Options. This strategy involves setting up a Bull Put below a level you expect the market to stay above and a Bear Call above a level of resistance. A Short Iron Condor is referred to as a short volatility trade, in that it is best entered when you have a view volatility will fall. When talking volatility – this is both share price movement and Implied Volatility.
The two above strategies are known as a credit spread which gives you a net credit to enter. The strikes are all out of the money and if they remain that way you get to keep the credit you received on entry.
To explain this, I have set up a Short Iron Condor on the XJO.
Bear Call setup:
Buy Call 6150 November 15th expiry
Sell Call 6100 November 15th expiry
Goal: keep market below 6,100 for 15 trading days.
Max Risk: market above 6,150 on expiry
Bull Put setup:
Sell Call 5700 November 15th expiry
Buy Call 5650 November 15th expiry
Goal: keep market above 5,700 for 15 trading days.
Max Risk: market below 5,700 on expiry
Max Profit: is $1,800 pre-costs. (I have rounded this down to a 12CR on 15 Contracts) This is realised if the market stays between 5,700 and 6,150.
Max Risk: is capped at $5,700 pre-costs which is realised if the market is above 6,150 or below 5,650 on expiry.
As you can see I have set the support level below the 10% correction level, and the market will need to move to it’s lowest since October last year to breach this level. As the market has fallen a lot in the past few months, I feel confident on the downside risk. On the upside 6,150 is the risk as the market could take a quick sharp jump around the bank reporting next week.
Below is a matrix based on theoretical option value. It shows you the profit and loss on the trade between now and expiry. The Calculator that provides the below values is available to TradersCircle members.
The trade can be closed early for a profit or loss. You may take profit early as you think that there is an event that may make the market move. Also, you can’t go broke taking regular profits. You may want to close out for a loss early if you think there is the risk of the market breaking out of the current range, to avoid losing the maximum on the trade. There are other strategies that can be adopted rather than just closing the trade like rolling to another strike and/or month.
So, this is the go-to strategy if we believe the market will go sideways. As the ASX now has weekly expiry options, this trade can be done for a much shorter period but will offer a lower credit on entry. This strategy has become one of the more popular trades for our clients as our market spends a lot of time drifting sideways.
I’m running a free webcast on Advanced Strategies for the Australian Market on Tuesday 30th of October 2018 at 7pm. In this webcast, I will cover the above strategy and more.