Trading short strangles | Pat Mullaly, CMT | 10-28-19 | Trading with thinkorswim®
Good afternoon this is trading, with thinkorswim I'm, Pat Mullaly sitting in for Connie, Hill today are standing, in sore as it may be today's. Discussion. Or this webcast, is about. Demonstrating, the. Thinkorswim. Platform how. To use it how to place trades on the platform. This. Would be followed by about a five to ten minute, question-and-answer. Period so please write, your questions down have those ready for when we're done with the, discussion. Today, today's. Topic, is going to be trading. Short strangles, so we're gonna look at a demonstration on, that, so, with that let's, get rolling. And. Remember. That. Options, are not suitable, for all investors as, special. Risks are inherent to the options, to, options trading, remember. That spread. Straddles other multi leg options strategies, can entail substantial, transaction, fees, those, transaction. Fees can impair trades, with small benefit, potential. Benefit any, probabilities. We talked about today are theoretical. And nature, stop, market orders are not, guaranteed. That your execution, will be near, the. At, of the activation, price and once, activated they compete, with other incoming orders stop, limit orders risk missing missing, the market all together so, remember. That stop orders are not any kind of a guarantee past, performance, of any security strategy, is not a guarantee as well future. Success, not guaranteed. No. Soliciting photography, recording, transaction. Cost let's talk about that for a second they're important factors, as always. And this should be considered now remember we do have zero commissions, and those Commission's apply only to online us, exchange listed. Stocks. ETFs and, option, trades now options, have, a 65, cent options, contract, fee that applies as well Delta, Gamma Vega theta option, sensitivity, to changes in price time, and, volatility. Very, important, all right so. Today. What. We're going to be doing is we're going to be talking about Netflix, for our example, so let's, get out there and discuss. Netflix. We're going to go to the chart. Netflix. Here and. When. We do one. Of the reasons we're going to pick Netflix, is talk about short strangles. Last. Week Connie did a long, strangle, strategy, which meant that you wanted movement, you wanted to see price move large one way or large the other way with.
This Type of a strategy, however we're, going to be looking for price to stay. Somewhat. Neutral. Look. For price to say stay, neutral and in. That vein, how, do we how do we determine that well some people might use technical, analysis, we're, going to use a combination today, on the thinkorswim platform of, technical. Analysis, and probabilities. When, we get to the trading page so here's what we have so we look at Netflix here, Netflix, had their earnings announcement, and we. Can see with their earnings. Announcement, they had the big gap, to the upside which, reversed, immediately, ran, back down rounded. Back up right now it's, just trying to figure out which way it wants to go we do know that, it had lows back over here on the 23rd of. September. And. So the expectation somebody, might have and this is not saying that's what, expectation. Is but you're what, my expectation, or anybody's, expectation. Is but, if your forecasts your assumption, is that price will stay range. Bound. Within. This, within. This. Resistance. Area up at the top here. This. Red dotted line up, resistance. Up in there or support. Down in this area in here if you think that your. Assumption is is they're gonna stay that way for a certain period, of time then. You might want to put, on some, kind of a trade that, benefits, from stock. Really, not, going anywhere because in reality, if this stays, in between these. Highs and these lows in here over. The period of a week. 18 days 2 weeks you, know a month whatever. Then. That, might be the, type of trade that you might want to do so let's go back over and let's, talk about that. All. Right so. Let's. Get to the trade, tab here and what we're gonna do is we will type, in Netflix up, in the symbol box. So. We have Netflix, in the symbol box that, is going to populate. The. The. Options. String, what I mean about by option string is this, lower. Area. Down. Here okay. So if you're new to options, this, is an option string, and there are various. Various. Expirations. That, is what these dates are over here on the left so if we're looking at this. Date right here that's the 15th, of November, and it, has 18, days until it expires that's, what these.
Parentheses. Are is 25, days till this one expires pop down here, 144. Days that until this, one expires on the 20th, of March next, year 2020. So, that's the beginning of the option string now if depending. Again on your assumption how. Long you think it would take for, any. How well you get paid and the probabilities, different things you. Might. Vary. On which expiration. That you choose today, we're just going to choose something that goes 18, days out, and when. We come in here let's talk about this real quick we. Have the call side of the. Option. String in. The middle we, have the. Expiration. And we. Have the, strike prices the strike prices is the contract, price where. You in. The, case of short strangles, when we get into that you are obliged, to, perform. On, those contracts, meaning you will be either selling, somebody. Shares. Or you will by being buying somebody, shares or. Someone, shares from somebody else on the other side of the string, it are puts and, so, we have puts on the, right, side calls on the left side we. Have the expiration down the middle and the strike price is down the middle I also, have. Up. Here Delta, probability. Of out of the money and. You. Applied volatility. Real focus, really just on, Delta, today, just. For this sake, of the the space. That we have in this time frame and what I'm going to do here is we also have strikes, up here so, I'm going to open up the strikes because what we're gonna do here is a short strangle and I'll explain what that is here in just a second but we're gonna open up the strikes and we're going to either choose all or. You can put in the amount of strikes that you want in there I'm just going to choose all for now for. Ease of movement so what. Is a short, strangle. So. Connie talked about long, strangles, that meant she was buying something out, of the money on call side and buying something out of the money on the. Put side expecting. Big, moves one way or the other on some kind of news event now, this can be the same thing you can be expecting, news events but you're expecting, price to stay within a range in the case of Netflix, we were looking at, price. Possibly, staying, within this. Range of. Support. And resistance. So. Well. What somebody might do is they may choose something, out of the money we're going to use a couple different things here, so when we say out of the money that means where price is not, yet, at okay. So with the fit-in in, the case of calls on Netflix. Calls is trading at 281, I mean, some stock is trading at 281 so, if we want to go out of the money we're gonna go into this lighter-colored, space. Here, and we're, gonna pick a strike price but, there's going to be a method, to how we pick the strike price we're going to use probabilities. So we looked at technical, probabilities. Of support and resistance where, people have a tendency to sell where people have a tendency to buy and. Then. We're going to use probabilities. We're going to use Delta, now. Delta, says that. There is a, right. Here, on Netflix. Going. Out 18, days the Delta of 15, basically. Says there's a 15%. Chance that, the 302, strike, will. Be in the money by a penny, okay. And. So. What we're gonna do what we're gonna look at to do is sell this, 15 Delta. Okay. So why am i choosing the 15 Delta hang, on we're gonna get to that. But, that, 15 dealt that we're gonna sell that in theory. For a dollar 38. So we're gonna sell the short, call we're, going to short a call sell it at the three hundred and two point five, strike. Price for a dollar thirty eight. We're. Also going, to use a fifteen, delta now you can use other deltas on the puts and that puts us at the two sixty, strike and the. Very same type of information. We have a delta of fifteen a fifteen. Percent chance that price will be below, two, sixty. Honor. Before, expiration. Okay. And for. That. We. May get a credit of a, dollar. Seventy, six so, we have these two blue areas, the two sixty short put, and the, two are assuming the 302 and a half short, call the, reason, we're choosing these, deltas, at. Fifteen, and fifteen is, there's, two sides of this trade there's, a there's, the put side and the call side anything. Below the puts puts, you. Put you at parable, about peril, these are undefined, risk, meaning really, strong moves to the downside really, far, could. Put you at a loss really, far moves to the upside above 302 and a half would, put you at a loss on the call side so. We use the fifteen Delta to give us a little, more leeway plus, since there's two sides you. Can only be wrong on one side but that changes, the probabilities, if we, only if we only chose. The call side and only sold this call with. A fifteen, Delta, that, tells.
Us That there's about an eighty, five percent chance of this, options, these this options going out worthless but since we're using two. Options. You can be wrong on the upside you can be wrong in the downside, now, you can be wrong in two places so we're going to add those two things together, of fifteen, Delta plus fifteen, Delta gives you 30, Delta, total. That. You've sold sold, to put sold a call you subtract, that from one hundred and that changes, that eighty five percent chance to. A 70. Percent chance and, that's. Why, we move a little bit further away plus. We get credit on both sides okay, so that's. Why that's, why we do that if you want more information on that we have lots of we. Have different, options. Classes, you can take if, you're brand new to options you can join barb Armstrong, on Fridays, 11. O'clock, Eastern. Time for. Getting it started with options, Ken rose on Thursdays, at 3 o'clock Eastern, has a. Advanced. Options. Strategies. Class so you can join those okay. To put this trade on how do we do this we're going to make this real simple first. We're gonna choose the bid we're, gonna sell on the bid because, that's because we're retail. Traders. When to sell on the bid on the calls we're gonna sell, on the bid on the. Put so we're gonna sell a call we're gonna sell a put we're, gonna sell them out of the money that makes it a strangle, if they're at the money it's a straddle, if you remember, some economies other classes, and the previous, weeks if they're, out of the money it's a strangle, so, we're gonna sell them when they're just going to come over here to the bid and I'm gonna left click on that. Bid. Price and that populates. This, and. Says that we can sell this for $1 38, at the, three hundred and two and a half dollar strike price and it says sell over in here and we have a quantity, of one, it's. On a limit order and. It's, a day order for spreads oftentimes, you may want to leave it as a day order so to make this pretty simple, what. We're going to do is I'm going to reduce. That. Window. There and then I'm going to come up here to the bid and I'm. Going to just I'm. Gonna I'm using a Mac so I'm going to use the command key on a PC. You'll use the control key but, I'm just going to hold the command key down or if you're on a PC hold the control key down and I'm gonna left click on the bid. There. It is I was wrong it's a control key on the Mac as well, so I've left key I left, clicked on the, bid holding, the control key down and, what.
Happened, Is it, put those two, trades. Together, so you can see how we've done that we've. Sold the, call and we've, sold the. Put and they, were put together the. Two credits, are combined, for, a total credit, of. $3.22. So. In the, case of Netflix, over, the next 18. Days because, that's how far there is till expiration. Over, the next 18 days. If. Price, lands, somewhere, between the. These. The, strike prices which, are 302 on the, top and. 260. On the bottom, down. Here price. Lands, somewhere in the middle, then. In theory, the. The. Credit. Is. Yours, is, yours to keep if you if they go out worthless, right now, there's, no guarantee on that things, happen probabilities. Remember there's two sides to probabilities, if there's, 85%. Chance of something happening there's a 15%. Chance of, something, else happening, okay, so, just remember that and then what we'll do is we'll just leave this at 1 I'm going to come over here and left-click. And. That brings up our confirm, and sinned this is our last place to double-check everything, and. Make sure we've got what we want in here or strangle, we've got one the 302 and. The, 260, the call and the put and a in a, limit. Order for, a $3. And 22 cent credit I'll send that that'll, stay overnight the market is closed now so that won't fill it'll, hold overnight and. We'll see what happens in the morning so. That. Is a short strangle simply, selling, a call, out of the money and selling. A put out of the money the opposite, of a long strangle, to, do that it's a neutral or stagnant, style trade and that's what we're expecting out of it neutrality. All right let's see if we've got some questions over here. And. We'll, get to that. And we widen. This out so I can see here. So. The question comes from Coco, says can we use the probability, of in the money versus, purses. The Delta. Or versus. Of some other method, absolutely. Probability. Of out of the money is, the. The. Inverse, of Delta, so, if we look at these two here probability, of out-of-the-money 76%. Chance that, this particular. Option. At the, 95. Strike will go out worthless but we can come up here to probability. And, probably. Move out of the money the tab right there and go, down to options. Theoretical, z' and greeks and come into probability. Even the money and that's, that, matches, very closely to. What the Delta is so so, you can see Delta's not perfect, proc it's a proxy it's not perfect, mathematically. For, probabilities. So if you want to get more perfect. You can come in and use probability, even the money as perfect as that can be with that kind of with whatever. Underlying. Math, that they're using. With. Respect to short strangles. In. Some cases one. Leg may be further. Out of the money let's say it has, a delta of five with less than thirty days left.
Till Expiration, not, sure, you know you can have you can skew these they. Can be further out of the money on one side they may naturally be further out of the money as far as strikes go because. There's a thing called sticky. Strike with volatility. Sticky. Delta lots of different things in in. The options world that can happen but. If you did want to use a delta of five you. That's a 95% chance of. One. Side working out you put them together and you have five, on one side five on another side let's say that's, a that adds up to ten so a 90% chance of it working out but typically you're gonna get a small credit which, means that the risk. Becomes. Larger, but you're a lot further away in in. That area, how. Do we determine if we. Should let the out of the money leg expire, worthless versus, covering. The out of the money leg and removing, that risk from the portfolio, that comes from Michael that. Is another great question Michael. Because, this is where people hurt themselves. Let's. Take a look at something here on the monitor tab I'm, going to go to the monitor tab here I'm going to pop down active, strategies, and here's, a Netflix, short. Put spread that. We have on here this is a defined, risk trade but, it has four days left, now we're, short, 302. And, a half-dollar call, I said put spread I meant call spread short call, spread or short the three and a three Oh two and a half it's, only worth 26, cents so you, know four days left hey you know maybe it'll go out worthless, if your if your, belief, is that, there's no way that in. Four days that price can get up above 302. Then. Yeah you might you, might take that chance but there's, always a chance right, as. They like to say you say I've got a chance and if it decides, it wants to blast off to, the upside we're not that far away right here from, where it was over here now this was an earnings announcement, but any kind of announcement. Could. Push this up over, the next three or four days and into the money so, the, question, again for, those out there listening, is how, do we determine if we should let that out of the money leg expire, worthless so when, you look at this say if this was just a short string. Or one side of a short strangle, and you. Sold it for, $6.65. And it's only worth 26, cents this. Credit of 665. How much of that do you want to give up less. The 26, cents to see if you can get another 26, cents so, common. Sense might say for some people that hey, you. Know I've just I just gained. Basically. 6, dollars and 40 cents, how. Much of that do I want to give up to see if I can get another 26, cents so a very small percentage.
That Might, be your determination, right there to say you know what let's close this out let's not get greedy over a little bit weak, you can always close it out and resell. Something else for a credit bring, in more credit and if. That one works out then you're all. The, better off. So. The catalyst is to let your profits run however I'm not sure if a trader should let, the profit run on waiting less than 30 days, and. That's again from Michael yes so you know let your profits run cut your losses short, when you're selling options a little bit different you have to learn what that means, oftentimes. That means to, go ahead and take that profit sell, something, else, let's um let, some premium in let. Some premium out let some premium in let some premium out so, it. When. You when, you start layering. In, that's. How you that's, how you're gonna let your profits run and, cut your losses short because, over time layering. And using probabilities. Well, actually. Mathematically. And in historically. Have, actually, increased, your, increase. That are made the probabilities, work out better and oftentimes. Made. The risk/reward a little bit better. How. Is this different from an iron condor it's, only it's only half an iron condor, so so an says how's it different from an iron condor. For. A range, bound stock when, when you use it same it's. The same reason you would use it for an iron condor, the, difference, here is that an, iron Condor is two verticals, that have defined risk so, an iron Condor. Trade. To make it different may, actually, come. In. Look. Something like this I'm going to draw a line across here, and a. Line across here so, with. An iron Condor, your, short strikes may. Very well be where these dotted lines are right. And so, those short strikes give. You a narrow, or an, error, or field of neutrality. Right so it has to stay in a tighter range but. You have less risk because, you've defined, your risk via, the via, the vertical, itself, all. Right. That. Brings us to the allotted, time here. I appreciate. Everybody Connie we'll be back again. A next week and, so, please join her I'm not sure what the topic, is going to be but remember we have plenty of webcast, to. Help you out, with. The with. Your strategy, decisions. With just your education, as, a whole remember. Everything we've done here is for educational, purposes only and not, for recommendations. And any investment, decision that you make in your self-directed account, solely, your responsibility take, care everyone and we will talk, to you soon.