Preface to Profiting with Iron Condor Options: Strategies from the Frontline for Trading in Up or Down Markets
This chapter is from the book
This chapter is from the book
This chapter is from the book
Preface
I used to hate trading. The problem with stock trading is that you have to know too much in order to be correct, or you have to trade on blind faith. People buy and sell stock every day without having the slightest idea about the company or the stock they are trading.
A while back I used to work in Mergers and Acquisitions. My job was to determine the viability of businesses for acquisition by large corporations. Let's scale it down and say you have $100,000 and you want to buy a small business. What kinds of things do you want to know about that business? You need to look at the books and track revenues, profits, and expenses. But to buy a business solely on that information would be foolish.
You also want to know about the competition, market share, number of competitors, and competitive advantage. Without an understanding of the competitors and who they are, you don't really have a grasp of the future of the company.
There's more. Who are the suppliers? What contracts exist? Who else do they supply? The supply line is crucial for the bottom line.
There are even more questions about the employees. You need to know who is indispensable and who isn't and what kind of employment contracts are in place. You need to talk to the sales staff and marketing department to get their perspective.
There are many more questions you should ask about a business before investing. Yet almost everybody who invests in stocks cannot answer the most basic questions about a company. Pick your favorite company. Can you name its five biggest competitors? How about the main suppliers? Would you buy a business by just looking at charts? Usually just those few questions are enough to stop people cold. Still, people will put their life savings on a name about which they really know nothing.
Who actually knows the answers to those questions? Maybe there are things about the company that full-time experts know and that you never will know. Even those experts still will get it wrong some of the time.
So I hated trading because I didn't believe I had the confidence to make sound decisions that wouldn't just be guesses at the end of the day. I was a Financial Advisor and people were always asking me about what I thought about the market or whether I had a good stock tip. It wasn't too impressive to say, "I don't know," but it was an honest answer. I mostly recommended Structured Products, hybrids of stocks, options, and bonds designed for hedging risk. Some of those Structured Products were unfortunately issued and guaranteed by venerable institutions like Lehman Brothers. The more I learned about these products, the more I started to learn about the intricacies of options.
What appealed to me about options was that there were strategies that worked even if you didn't know anything about the company whatsoever. You didn't even need to know whether the price was going to go up or down. In fact, the trade had nothing to do with either the company or the price. It had to do with the fear built into the price and how much time was left until expiration. The actual ticker was irrelevant. So now I realized I could trade without having an opinion.
Over time, I worked on and studied various options strategies and adopted condors as my favorite. There are a number of ways to trade this strategy and I tried them all. The strategy presented in this book is the one that I find works best in a variety of market conditions. In the very difficult market conditions of the past few years, I've managed to generate pretty decent returns on a regular basis. Don't be surprised if your returns are in the 30% to 60% range in a year. No guarantees, but it can be done.
There are a few questions I'm always asked after I explain what I do. The first is always, "What's the risk?" The second is, "Why have I never heard about this before?" The third is, "Why doesn't everybody do this?"
As to the first question, I always describe the risky nature of the trade. There is a lot of risk in this trade. Everybody should consider the nature of the trade and how much they are willing to risk and who they are willing to risk it with. Results count. I'm generally far more risk averse than I am for the clients whose capital I trade.
"Why have I never heard about this before?" The answer to this question is not so simple. The ordinary investor either is trading his own stocks or has handed a portfolio over to an advisor to manage for him. Advisors by and large don't really want anything to do with options. What they do understand about options is generally very limited, and their approach is pretty simple. They trade them like stocks. Buy this or that option and see what happens at expiration. The other officially condoned strategy is covered calls. Additionally, my experience at large firms is that they actually dissuade advisors from trading options in any sophisticated manner. There are generally no tools on the system to do proper analysis of options even if they wanted to trade effectively. I was told by a chief options strategist at a major brokerage that they don't want their advisors trading options because they are worried about big mistakes. That is a smart decision on their part but truly limits what you as a trader and investor can do to earn money and protect your assets.
Additionally, sophisticated option trades require constant supervision. An easy trade needs no attention, but you can never tell which one is an easy trade until you are done. Markets can move on a dime and you have to be ready to respond. Unless you have the luxury to pay attention to the market and place orders when necessary, you could increase your risk in a trade substantially.
The last question is, "Why doesn't everybody do this?" This has a few different answers. First is the poor experience investors have had with options in the past. Most of those burned by options have lost money buying options, which is all too often a sucker's bet. Second is a genuine lack of education and understanding of options and particular strategies, which this book seeks to help remedy. The third answer is that no one will do this job for you. Your advisor will not manage options strategies for you because there is not enough money in this for him relative to the risk involved. He will not monitor it because he has 100 other clients for which he has to make financial plans. Mutual funds don't do this because it's not in their charter. Hedge funds are too big. They can't just step up and start spending a billion dollars in the options market.
Many people have asked me why I'm giving away my strategy. They wonder, wouldn't that ruin its effectiveness? First of all, I didn't invent condors nor am I reinventing the wheel. This is a merely a strategy and not a formula. Think of it as a method or an approach to trading condors. What's missing for a lot of traders or people who would like to trade options is a proper understanding of how options really work. There are a lot of moving parts to track. I imagine stock trading akin to flipping a coin. Options trading is more like playing chess.
Two caveats before going forward:
- Caveat #1: By their very nature, condors are high-risk strategies. They can blow up on you and you can lose all or most of the money you put up in the trade. This book takes that possibility into account and points out ways to diminish but not eliminate the risk. You will learn that picking the right instrument to trade, picking the size of your condor, strategically choosing your entry and exit points, limiting your time in the market and, especially, not getting greedy will all help to mitigate risk. But there is always the possibility of total failure regardless of all the risk management in the world.
Caveat #2: This is not an income strategy. In order to entice people to attend classes or buy books, many people would call this an income-generating strategy because of how successful it can be on a regular basis. But calling this an income strategy is misleading and inaccurate.
An options condor is a trade. That's it. No more and no less. If you start thinking of this as an income strategy or, worse still, depending on it for your income, you will lose all of it. You will push this strategy too far and too hard and the condor will swoop down and eat you alive.
Caveats aside, I absolutely love trading condors. I've made a lot of money for myself and my clients even though I've also had many sleepless nights. However, making money is never easy and never without risk. Still, there is a certain pride about making stellar returns even when I am wrong about market direction.
A condor is a big bird with a wingspan that can reach 10 feet. When it flies, it flaps only occasionally and glides most of the way. The silent, patient image of this lovely bird floating through time and space will provide a useful metaphor for the trade you will learn. Like the flapping of its wings, the opening and closing of a condor trade should be done infrequently. The patient drift through calm air reflects the slow and steady time decay and the low volatility that will lift our profits. Treat this awesome bird with the respect it deserves and you can ride on its wings.