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So what do you do when your most successful strategies suddenly become much riskier? The answer: you are looking for new opportunities. Our long time contributor @Yowstercame with the following idea: For those of you not familiar with RIC (Reverse Iron Condor) - it is a limited risk, limited profit trading strategy that is designed to earn a profit when the underlying stock price makes a sharp move in either direction. The RIC Spread is where you buy an Iron Condor Spread from someone who is betting on the underlying stock staying stagnant. This is not a new strategy for us - we have traded it successfully back in 2012, but the current version is slightly different and more suited for the current environment. Our first RIC was opened on November 27, 2018: This is how P/L chart looked like: Fast forward to Dec.4 - NVDA moved to $170+, and the trade has been closed for 81.4% gain. It is worth to mention that such high gain is not typical for this strategy. Normally, we aim for 15-20% gains. But sometimes stocks gap in the right direction, and you can get much higher gains. As @Yowstermentioned in the strategy description on the forum: Reverse Iron Condor (RIC) trades can be used during periods of elevated market volatility to take advantage of stock price movement that is more common during these timeframes. A RIC trade is buying OTM put and call debit spreads. RICs are vega positive trades, meaning they are helped by rising IV and hurt by falling IV. However, the degree by which IV changes affect the RIC are much less compared to hedged/unhedged straddles – this is simply because they have equal number of long and short legs using the same expiration and the strikes are relatively close to one another. Therefore, using RICs instead of straddles during elevated market volatility has 2 main advantages: Better handle the scenario of IV significantly falling back down closer to normal levels – Straddle RV can decline 10% or more in one day that has the VIX drop significantly, and 30% or more during a multi-day significant VIX decline. It will take a lot of gamma gains due to stock price movement to overcome that drop, and if it’s a hedged straddle its more likely that short strangle losses will exceed long straddles gain when this happens. RICs can still get hurt by IV decline (especially if the stock price winds up being near the mid-point) but if you get some stock price movement away from the mid-point the RIC will be in better shape. Easier to make good gains despite IV decline – if the significant IV decline comes with a larger stock price move (fairly common when IV spikes downward) then the RIC can still have a very nice profit if the stock price movement takes the stock price near one of the wings. The biggest negative of RICs compared to hedged straddles is that you’ll need the stock price to move to make a profit. Hedged straddles can make gains due to short strangle credits when the stock price doesn’t move, and this is why hedged straddles are great trades to initiate during low volatility times because its less likely that any market wide volatility decline will significantly hurt the trade (and any IV rise will help it). Since starting trading RIC strategy in late November 2018, we closed 12 winners out of 12 trades: BABA +20.3% FB +20.0% GS +15.4% AXP +10.2% GS +5.7% GS +19.9% MSFT +19.7% FB +20.5% MSFT +15.9% GS +17.9% NVDA +38.4% NVDA +81.4% Of course, the strategy is not without risks - you need the stock to move in order to make a gain. However, in the current environment, if you select the stocks that have tendency to move, you improve the probabilities significantly. When the market conditions change, you need to be flexible and trade what is working. And this is exactly what we do at SteadyOptions. Related articles: Reverse Iron Condor Strategy Straddle, Strangle Or Reverse Iron Condor (RIC)? How We Trade Straddle Option Strategy
Introduction Reverse Iron Condor Construction Buy 1 OTM Put Sell 1 OTM Put (Lower Strike) Buy 1 OTM Call Sell 1 OTM Call (Higher Strike) Reverse Iron Condor has a limited gain and a limited loss potential. The maximum gain It is attained when the underlying stock price drops below the strike price of the short put or rise above or equal to the higher strike price of the short call. In either situation, maximum profit is equal to the difference in strike between the calls (or puts) minus the net debit taken when initiating the trade. It will result in a loss if the price doesn't move far enough in either direction, or if it stays the same. Compared to a straddle option strategy, RIC has limited gain potential, but it also needs the stock to move less to be profitable. It is basically a combination of bull call debit spread and bear put debit spread. You can adjust the strikes based on your expectation of the move. Constructing the trade with further OTM options will provide a better risk/reward, but lower probability of success (the stock will need to move more to produce a gain). One of the common uses of the Reverse Iron Condor strategy is betting on a sharp move on one of the high flying stocks after earnings. It can be used on stocks like NFLX, AMZN, GOOG, TSLA, PCLN etc. Using Reverse Iron Condor through Earnings GOOG was scheduled to report earnings on April 21, 2016. The At-The-Money weekly straddle ($760 strike) was trading around $41, implying $41 or 5.3% move. If you believed that GOOG is going to move, you had two options: Option #1: buy a straddle for $41 debit Buy 1 760 Put Buy 1 760 Call Option #2: buy RIC (Reverse Iron Condor) for 1.75 debit Buy 1 745 Put Sell 1 740 Put (Lower Strike) Buy 1 775 Call Sell 1 780 Call (Higher Strike) Straddle would need $41 move just to break even, but would have unlimited profit potential if the stock moved big time. It also would not lose as much if the stock moved less than expected. RIC would need only $20 move (above $780 or below $740) to make money. The next day GOOG moved $40 and closed at $719. Since it was below the short put strike, the RIC made a nice 43% gain (2.50/1.75), while the straddle was barely breakeven. The Risks The biggest drawdown of the RIC strategy before earnings is that if the stock doesn't move enough after earnings, IV collapse will crush the options prices. The risk of 80-100% loss is real. Unfortunately, many options gurus present this strategy as almost risk free money, completely ignoring the risks. Here are two examples. A Seeking Alpha contributor suggested the following play on GOOG earnings on April 12, 2012 with GOOG at $632: What is completely missing in this comment is the disclosure of the options trading risk. The next day GOOG closed at $624, and the trade has lost 100%. As our contributor Chris (cwelsh) mentioned in the comments section: "Earnings are wild and unpredictable. A careful analysis and you can improve your odds, but you always have to factor in position sizing and potential loss into any trade. My entire point of my posts was that I think a discussion of risks should always be included in any article that discusses huge potential gains." I recommend reading the comments section of the article, it can tell a lot about different people's approaches to trading and risk. The second example is from a website that is using the strategy cycle after cycle. Here is the quote: "The Debit Iron Condor is used primarily on stocks that have a long history of big moves when announcing their quarterly earnings. We have a very good idea of how big the move will be, in one direction or the other. And the amazing thing about studying history is that history truly repeats itself, and that means a big percentage of wins. The magic works when the Debit Iron Condor is combined with big moves from stocks on earnings day." The problem is, once again, complete lack of disclosure of the option trading risk. Even if the "history truly repeats itself" 80% of the time, in 20% of the cases when it doesn't, the strategy can lose 100%. Big percentage of wins means nothing if your losers are much higher than the winners, and you can do nothing to control the losers due to IV collapse. One way to reduce the risk is using more distant expiration instead of the weekly options. The closer the expiration, the bigger the impact on trade. There is a trade off with respect to time, move and implied volatility drop. If the stock doesn't move, the further expiration trade will lose less because there still will be some time value left. On the other hand, if it does move, the gains will be less as well, and you will have to wait longer to realize the full potential. Unfortunately, we tried this strategy too in 2016, and the results were pretty bad. You can read more here. We don't hold those trades through earnings anymore, but we do use the strategy before earnings and make sure to be before the earnings announcement. The Bottom Line If you expect a stock to move significantly but don't want to bet on direction, Reverse iron Condor is a good strategy to implement. The maximum profit and the maximum loss are both predictable, and you can adjust the strikes based on your expectation how much you the price will move. This strategy can be successfully used for trading stocks with history of big moves. GOOG, NFLX, AMZN, TSLA, BIIB are good candidates. However, earnings are unpredictable, and you need to control the risk with proper position sizing. It is definitely possible to lose 100% with this strategy. I would define it as high probability high risk strategy. One of the members asked me on the forum if we are going to play GOOG and AMZN with RIC. Based on earnings uncertainty and our bad experience earlier this year, I decided to skip. It was a good call. GOOG RIC would be a 100% loser, and AMZN would be a borderline as well, depending on the strikes. Related articles How We Trade Straddle Option Strategy Straddle, Strangle Or Reverse Iron Condor (RIC)? Why We Sell Our Straddles Before Earnings Lessons From Q1 2016 Earnings Season Want to learn more? We discuss all our trades on our forum. Start Your Free Trial
The assumption is that with careful stock selection, this strategy has a very high probability of success. I performed extensive backtesting on number of stocks, and the results were very promising. Stocks like AMZN and LNKD showed average gains of 30-35%. However, I also mentioned that this strategy has higher risk than other strategies that we use since earnings are unpredictable. High Probability High Risk is the right definition of this strategy. Not a good start to a promising new strategy.. Our first trade was NFLX. The stock has been selected based on its historical moves. It moved 13.7% on average in the last 8 cycles. The options predicted 17% move. The RIC trade was structured in a way that it required only 8% post-earnings move. What are the odds that the stock will move only 0.13% post-earnings? Slim to none if you asked anyone before earnings. Yet this is exactly what happened. We had a chance to close the trade at small loss or with some luck, even a small gain. But with 3 days left to expiration, we decided to wait. The stock reversed, resulting a 46.9% loss. Not a good start. The next one was AMZN. This one actually worked not bad. It did not move as much as expected, but still moved enough to produce a 21.2% gain. The real disaster came with the next two trades, GOOG and TSLA. The stocks moved much less than expected, reversed after the initial move and the trades have lost 70.6% and 100% respectively. With better risk management, all three losers could be closed for a small loss or even a small gain. I posted a full post mortem here (members only forum). Some members with higher risk tolerance decided to hold longer and were able to book 30-40%+ gains on AMZN and GOOG. In some cases the difference between significant loss and decent gain was a pure luck. What went wrong? This strategy is based on probabilities. If a stock moves xxx% in the last 8 cycles, there is a high probability that it will follow the same pattern the next cycle. However, probability is not certainty. There is always a chance that this cycle will be different. What are the chances that ALL 4 stocks will not follow the last cycles pattern? Not high, but this is exactly what happened. This is why you always need to have plan B. You always need to know in advance what to do if the trade does not behave as expected. It's called an exit plan to cut the loss. Instead of trying to cut the loss (and give up some potential gains), we continued holding, "hoping" that the stock will eventually make a move consistent with its historical patterns. It just did not happen. It all comes to what kind of trader you want to be. Is your goal to limit the losses or to maximize the gains? You cannot have it both ways. Higher gains come with higher risk and inevitably will produce some big losers. My first priority has always been limiting the losses. This time I tried to go for higher gains instead of limiting the losses, and it fired back big time. To be fair, all four trades could easily produce 30-40% gains with some more luck and more favorable market conditions. Main lessons Look for a good setup. Even if a stock is a good candidate historically, the options might be too expensive this time, decreasing your chances. Get out quickly once it becomes clear that the stock did not produce the expected move and the trade is borderline. Most of the time it should be possible to limit the loss to 10-20%. This rule might miss some gains, but at least we won't have catastrophic losses like we had this cycle. Close the short options of the losing side early, especially if there is still couple days till expiration. This way if the stock reverses, the losing side will benefit more. The probabilities will eventually play out, but while they don't, do everything you can to stay in the game. Limiting losses is all that matters. Always follow the rules. Generally speaking, if you consider this (or any other) strategy too risky, reduce your allocation or don't trade it. In a broader context, I always recommend that new members start with paper trading, then start small and increase the allocation gradually. Prove yourself that you can make money with 10k account for few months, then increase it to 20k etc. Don't jump right away from 10k to 50k or 100k. What's next? I feel the pain as much as my members do since I trade the exact same trades in my personal account. This was a very expensive lesson for all of us. However, I believe each lesson should benefit us and make us better traders. After a losing streak, your first impulse might be to overtrade in attempt to recover the losses. HUGE MISTAKE. The market doesn't know that you have lost money. And it doesn't care. If you tell yourself "now I really need some nice winners to cover for the losses", it's a safe path to more losses. What separates good traders from bad is how you react to your losses. "There's a difference between knowing the path... and walking the path." - Morpheus. To paraphrase Morpheus sentence, "there's a difference between knowing that there will be losers... and actually experiencing them". In a probability game, it is guaranteed that we will eventually experience a string of losses. The right thing to do is continue to execute our trading plan that has worked so well for us in the last 4+ years. Summary It gets tough when we experience losses or poor performances and that's where most traders quit because in the first place they never accepted emotionally that they are playing a probability game. As soon as a few losing trades and/or a drawdown of any kind occurs they hit the eject button and continue in their search for the Holy Grail strategy that always wins. Jumping from one trading system to another will only lead to more frustration. Only when you will accept emotionally that you are playing a probability game, you will be able to take your trading to the next level. We present a variety of strategies to our members. Some are more risky than others. Members have different risk tolerance and should take the risk levels of different trades into consideration before trading. Before entering each one of those trades, I made a full disclosure that those are relatively risky trades, so members have all the information to make an educated decision. To put things in perspective, the current string of losers is our biggest losing streak since inception. I encourage current and prospective members to look at the big picture. The big picture is that SteadyOptions produced over 770% non-compounded ROI since inception. The big picture is our history of 800+ trades and not only the last 10 trades. One bad month does not erase 4+ years of exceptional gains. Losses are part of the game, and if you can not endure losses, you should not be trading. Your maximum drawdown is ahead of you, not behind you. We will continue executing our trading plan, and those who have the discipline and patience to stay the course will be greatly rewarded. Start Your Free Trial Related Articles: Are You EMOTIONALLY Ready To Lose? Why Retail Investors Lose Money In The Stock Market Are You Ready For The Learning Curve? Can you double your account every six months? Big Drawdowns Are Part Of The Game