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From Mark Wolfinger, Options For Rookies Yesterday I wrote a guest column for Barron’s Mark, I have a suggestion and a couple of questions. First the suggestion: Since some brokers (like mine: TOS) calculate as margin requirement the full margin amount (ie $1000 for a 10 pt IC) do you think is a good idea to stick to the following terminology: margin=full margin amount, max theoretical loss (or max risk) = margin – credit received Now the questions: (I fully understand that the targets set are not very strict and there is flexibility in your plan): 1. What is your plan if you make a quick profit, for example in the traditional IC, of 30-40% of credit received in less than five trading days? 2. What is the logic behind the very high target profit for the CTM IC? If we use the above suggested terminology, the target profit for the traditional IC is 150/1000=15% ROM and for the CTM IC is from 215/1000=21.5% to 265/1000=26.5% ROM. My thinking is that the target profit for the CTM IC should be the same or less than the traditional IC, for two reasons: a. With the CTM IC our max risk is lower (less risk, less reward) b. Since the short strikes are closer to the money and our target exit date is four weeks before expiration, in the best scenario (no touching), the short strikes will remain close to the money during that period, hence, most of the time, it is not realistic to expect to reach a profit >$200. (time decay is more linear for OTM strikes but in this case they are CTM so most of time decay will take place in the last four weeks) Thank you, Dimitrios Margin Requirements Some brokers (Fidelity) charge margin on each half of an iron condor. They do the same for the short spread in a butterfly. What nonsense! Thus, your $1,000 margin is $2,000 for Fidelity customers. No matter which margin requirement I choose, it is not going to be ‘correct’ for some members. If readers want to voice an opinion, I will abide by the majority. In my, opinion, ROM (return on margin) is a nice number to know, but it does not really affect my trade decisions. When the trade works well, the return is outstanding, regardless of how we measure it. I ask: If we are risk-conscious traders and do not use maximum margin, does this really make any difference? When it comes to ‘maximum theoretical loss’ I use that term to describe a position held to expiration. Why? Because the theoretical max loss occurs when the trader covers one side at $10 and then covers the other side at $10. I know no one who understand how to trade options would do that, but some traders do take a big loss on one half and then suffer the same fate on the other half. Thus, the max theoretical loss is far more than $1,000 (less premium). I choose to ignore the possibility of paying $2,000 to exit – assuming sane risk management – to calculate a meaningful return on risk. Answers 1. I decide whether to exit based on how well I like the current position – and risk/reward are very much a part of that decision. If one week passes, the market is steady, and IV gets crushed (especially when the crush is even larger for the expiration date of our position) there is a good chance I will choose the exit. In truth, it depends on more than only the nice, quick profit. It also depends on dollars earned. If I collect only $0.80 for an iron condor and earn a quick $0.32, I am not going to be anxious to exit. Commissions eat up too much of the gains. However, if it were a typical (for me) $300 iron condor, and if I earned north of $100 in one week, I would be far more likely to take the quick profit. If there is nothing else to trade; if I cannot find another iron condor or position using a different strategy; if being on the sidelines does not feel like the best plan for myself, then I am likely to hold – looking for the volatility crush to continue. My bottom line is that I want an opportunity to use my judgment, rather than depend on a ‘rule.’ That said, in your scenario, I think it very likely that I would exit quickly with a smile and a big ‘thank you.’ 2. I look at the CTM this way: Although it is very unlikely that it will happen, one of the benefits of adopting the CTM approach to iron condor (or credit spread) trading is thepossibility of earning a large profit. To allow for that possibility, I must be willing to hold. It’s a tradeoff. Not seeking that bigger gain allows for an early exit – and the safety that it brings. That trading philosophy leaves me holding a CTM iron condor when the reward to risk ratio has changed from (for example) $500/$500 to $350/$650. [in other words, the spread has earned $150. If I am not pleased with that ratio under the then current market conditions, I will take the big profit and quit. But I may not want to do that. That is why I allow for a higher reward as my target, along with the longer holding period (exit 4 weeks before expiration). A target is a ‘goal.’ I am not required to hold until I earn that target. That’s a point many traders miss. They believe that the trade plan’s target is a mandatory price and accepting a smaller profit means that the trade was a failure. That’s why the the target too low. I prefer to write that big target profit in my trade plan. I also want to exit if I earn the target. By setting it high (not foolishly high), I allow myself to go for it – or to quit earlier with a smaller profit. i) ‘Less risk, less reward’ makes sense. I may choose to exit with a smaller profit. But I want to give myself a chance. With iron condor trading, the big money comes from the big wins coupled with the small losses. We never want to get greedy. Here is my suggestion: If it makes you more comfortable to sit on the sidelines (with a nice gain in your pocket) until it is time to enter a new trade, then that should be your choice. However, if your expectations for any given trade are good enough to ‘hold for one more day’ then do it. Make a new decision the next day. Do not lock yourself into generating trading rules that you are not happy to follow. ii) Our CTM options are not ATM, but if they were, we would expect to earn one half of the time premium after 75% of the initial # of days to expiration have passed. That means we would expect a 4-month (120 day) iron condor to lose half of its value when 30 days remain. So in that respect you are correct, we do not expect to earn $200 in only 60 days (2/3 of the option’s lifetime). However, our credit may be nearer to $450 or $500. We plan to hold until 25 days remain before expiration (Monday following the previous monthly expiration is my target). Those numerical changes do make it reasonable to hope for $200. But don’t forget that $180 or $190 is essentially the same target – especially when we look at it when writing the trade plan. If that’s a better target for you, and if you are comfortable holding to seek that target, then choose accordingly. I am NOT suggesting that everyone hold that long or have the high goal. I truly suggest that you follow your own profit objectives. I do not want you to exit a comfort zone that has been working well for you. When tracking a trade or making decisions in my personal account, I do what I believe is best for myself at that precise moment in time. I know that it would not necessarily be the correct decision for other traders. Mark Wolfinger Options For Rookies

Well, after being inundated today on posts and PMs, here is some basics on covered calls using DITM LEAPS. First, why would we use a LEAP for a covered call using DITM LEAPS, as opposed to just buying the stock outright? Simple -- higher returns using the leverage of options. For this example, we'll use AAPL, using last Thursday's prices. AAPL cost $663. You could sell the weekly call (making it a covered call), at the following strikes/prices: 660 $10.50 665 $7.80 670 $5.60 675 $3.95 At this point you want to allow some room for upside, so you pick the 670 strike. What are the possible outcomes? 1. AAPL stays the same, you earn $5.60 on the covered call, or 0.84% (yes less than 1%, but remember it is weekly); 2. AAPL goes up, but stays under 670, lets say to 669. At this point you keep the $5.60 in premium, and your stock has appreciated (a good thing). If you were to exit, you would have a gain of $11.60 ($6 in capital gain, $5.60 in premium), or 1.749%; 3. AAPL goes up, above 670. Well this is the same result as number two, except your stock would get called away at 670. So it doesn't matter how much it goes up in price, it still would get called away at 670. So your maximum gain is $12.60 (let's not consider rolling yet); 4. AAPL goes down. Well you again keep the premium, but lose value in the underlying stock. Why CAN (not necessarily, but why can) using LEAPS be better? Well you can do the same strategy for "cheaper" (the cost being higher risk in terms of losses -- as discussed further below). For starters, to sell a call on AAPPL requires you to own at least 100 shares, at a cost of $66,300.00. Let's instead look at the Apr 2013 600 option. That can be purchased for $101.00. I typically would go further DITM, to get my delta closer to 1, but for this example, we'll stay at 600 to keep the math simple. For the price of $10,100.00 you can own the equivalent position as outlaying $66,300.00. But you can get the same amount of premium selling the weekly option short. In other words, I still get $5.60 for selling the weekly 670. So my return is now 5.54% per week instead of under one percent. Over the course of an entire year, this is the difference in turning $10,000.00 into $165,000.00 and turning that same $10,000.00 into $15,549.00. (compound interest is fun). (side note -- that won't happen -- don't expect it -- it won't). Still that difference gives you the flexibility needed to make the trade worthwhile. So what are the outcomes of selling against a LEAP, as opposed to just the stock? If the price stays the same, or rises, the outcome is just as good, if not better, than owning the stock. 1. AAPL stays the same -- keep the premium, return 5.54%, theta is basically zero, so gain; 2. AAPL increases, but to under 670 -- again the same result, keep the premium, and keep the gain in the April call. However, the gain in the april call well be more than just owning the stock on a percentage basis. Let's say the price goes up to the same 669. You keep the $5.60 in premium and the call option has increased in value by $6.00, so now $107.00. So you've gained the same $11.60 on $101 instead of on $663 -- a much better situation. 3. AAPL increases above 670 -- well your gains are capped at $12 (rolling will be discussed later) At this point, this seems like the perfect trade. Unfortunately it is not -- dealing with losses is also leveraged up. If the price of AAPL falls 50 points when you own AAPL, you're looking at a 7.5% loss ((663-50)/663)), whereas you're looking at a FIFTY PERCENT loss on owning the LEAP ($101 - $50 = $51). So, before ever entering this type of trade, realize the potential losses are MUCH larger than in just owning the stock itself. The returns are also much larger -- that's the power of options. Part 2 of this column will discuss how to handle the trade when it starts moving against you. A preliminary suggestion though -- always known when you are going to get out and at what levels and stick to those loss points. If you say I can take a 25% loss on this trade, get out at that point, don't hold "hoping" for the price to rebound).