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Hi, I'm Seth Freudberg, and I'm the head trader of SMB Capital's Ops' trading desk here in Manhattan. And if you've been trading for any length of time, you know by now that trading can be pretty tough. And even the greatest traders have losing streaks and tough drawdowns. It's just part of the game. And if you don't watch it, you can start losing faith that you can ever become a successful trader, which is a very destructive mindset to get into and, in fact, can become a self-fulfilling prophecy if you don't get yourself.
out of that mindset quickly. And so the purpose of this video is to teach you a trade that has the potential of pulling you right out of that mindset, a trade that has such a high probability of winning that it can restore your confidence and get you back on track. And so if that sounds of interest to you, then stick around because I think that this could be very helpful for you. Now, before we get into the option strategy that we'll be teaching you in today's video, If you're absolutely brand new to options trading and you don't know much about how options work, we've put together a video for you to understand options basics.
And if you click the video appearing on your screen right now, it will lay the groundwork for you to understand the options strategy that we're going to be sharing with you in this video. Then when you're finished, you can come back and watch the rest of this video. Like we were saying, traders get into losing streaks and that can be demoralizing. You set up a bullish trade on a stock and the stock goes down and you get stopped. Or the reverse, you short a stock and it rallies again, you get stopped.
And at that point, you may throw up your hands with the belief that you're just flat out bad at predicting the direction of stocks. And you ask yourself, without that skill, how can I ever succeed? And the good news is that there is a trading style where you can make a profit whether a stock goes up or down. And even though that might sound impossible, I can assure you that it's not. And so...
Let me show you an example of what I'm talking about and it will become clear. So let's head back to September 16th of last year and we'll take a look at a chart of an ETF named IWM, which many of you may know is an exchange-traded fund that contains a basket of stocks that mirrors the Russell 2000 Index, which is the small cap stock index. And so on that day, as you can see, this stock closed at 217.61. And so let's say that on that day you pull up an options chain that expires in 60 days exactly, which is the November 15th options chain.
And you look at a column which will be available on any options trading platform that you may be using, and that column is called the delta column. And you'll scroll up to the first call option with a delta of at least 10, which in this case is the $2.45 call, selling for $1.31, and we'll sell 10 of those. And then we'll head five points higher up to the 250 strike price and we'll buy 10 of those for 91 cents. Then we'll move down to the put side of the options chain and we'll sell the lowest put with a delta of at least 10, which in this case is the 188 put, and we'll sell 10 of those for $1.29 and we'll go five points below that this time and we'll buy 10 of the puts at that 183 strike, five points below the puts we sold. and we'll buy those for 95 cents.
And so when we do that, selling a call at about 10 deltas on the call side and buying a call above that on the same options chain and selling a put with a delta of about 10 on the put side, and this time buying a put below that on the same options chain. In other words, a short call and a short put surrounded by a long call and a long put. When we do that, we're executing what options traders refer to as a 10 line. Delta Iron Condor, in this case, expiring 60 days.
Now, before we go any further, you may be wondering why we picked those 10 Delta put options to sell, and that's really important. So we're going to take a minute on this before we go on. You see, the delta of an option is a mathematically arrived at prediction of how much an options price is likely to move based upon how much the stock itself moves.
And while it's a bit of a complicated subject, suffice it to say that an options delta has also been found to be highly correlated to the probability that an option will expire with value on the day it expires. And so, for instance, with a 10 delta call option, there's an approximate 10% chance that the stock will close above that call option strike price on the day that call expire. So if you think about it, that also means there's a 90% chance that the stock will close below that call strike price on expiration day. And when does a call have value on expiration day?
Only if the stock closes above that call strike price, right? Because if the stock closes higher than the call strike price, then you have the right to buy the shares at a lower price than they're selling in the open market, which means that the call is valuable at that point. But in the case of a 10 delta option. there's only a 10% statistical chance of that happening. And so there is a 90% chance of the stock closing below that call strike price, the 245 call in this case.
And so therefore, there is a 90% chance of that call expiring worthless because there's no value to a call that gives you the right to buy a stock for a higher price than its open market price. And so what that means is that there is a 90% chance of both... the 245 calls we sold and of course the 250 calls above those that we bought, there's a 90% chance of both of those expiring with no value. Now that may sound crazy to you for us to be trading options that don't have much of a chance at all of having value when they expire, but stay with me here and you'll see that it's not crazy at all.
In fact, it's exciting and you're going to see why shortly. And the same thing is true for the put side. just in reverse.
The stock has only a 10% chance of expiring below those 188 puts we sold because they are at about 10 deltas. And so obviously the puts five points below those that we bought, the 183 puts, have an even lesser chance of expiring with any value. And so the chances of both of those expiring worthless is 90% also.
Let's take a look at a price chart of IWM reaching back over the previous three years from September 16th. And you'll see something really interesting. Remember the 10 calls we sold, which were located at 245, and the short puts we sold, which were located at 188. Well, guess what?
IWM hasn't ever closed above 245 in its history. And the last time that IWM had closed below 188, well, you need to go back to December of the previous year, nine months ago for that. Which makes sense, right? Because with the stock trading at 217, it makes kind of intuitive sense that there's only a 10% chance of the stock closing above 245, especially because it's never been traded there before. And there's also a 10% chance of the stock closing below 188, where it hasn't been for nine months.
And so hopefully that helps you to get a feel for why the deltas of those options are so low in the first place. So now that we've understood that, let's break down what happens to your account cash flow-wise when you do this. And so let's start with the 245 calls that we sold.
We received the price of $1.31 for those, but remember each call option represents the option to buy 100 shares of a stock at the strike price. So we multiply that by 100 and we sold 10 of them. So when you multiply it all together, you'll see that you receive $1,310 in cash.
for selling those 10 calls. And doing a similar calculation, the 250 protective calls we bought cost us $9.10. Looking at the puts, selling those 188 puts resulted in positive cash flow of $12.90 while the 183 puts cost us $9.50.
Netting it all down results in net positive cash flow of $740 that we receive initially when we enter this trade for which incidentally you your broker will require 4260 in capital to initiate this trade in the first place. And so your account's cash balance has now increased $740 as a result of this transaction. Okay, so let's move to the day this trade expires.
And you can see after initially bouncing as a result of the U.S. elections, small cap stocks in general began to sell off, closing it to 2848 on November 15th, the day that this iron condor trade expires. And so having expired, we can now value each of the options to calculate the trade result. And so starting with the initial cash received of $7.40, focusing first on the calls, well, those calls closed far above IWM's price of $2.2848, with the calls having strike prices of $2.45 and $2.50, meaning that they expired worthless because the right to buy shares of a stock way above where the market's trading has no value. And the same is true, of course, for the puts, which expired well below where the stock closed. And so those have no value either, as no one's going to opt to sell their share.
below market. And so all four options comprising the iron condor expired worthless, meaning that the trade result is that you just get to keep the $740 you first collected 60 days earlier as your trade profit, a return of 17.3% in two months, which most people would be pretty happy with. Now, remember when we started out this video and we talked about the low probability of any of the options expiring with any value on the day they expired.
Do you remember that? How the calls were near 10 deltas and the puts were near 10 deltas and therefore logically the protective calls we bought located above the calls we sold would be even less likely to expire with any value because they're even further away from the stock's price and the same for the protective puts below the puts we sold. They'd also be much less likely to expire with any value and you were probably thinking Why are we getting involved in options that had so little chance of having any value when they expire? And now I think you can see why. You see, you start the trade out collecting cash.
And that cash becomes your profit as long as all of the options expire worthless. And the only thing left is the cash. So with iron condors, it's not just a good thing if all the options expire worthless, it's a great thing.
And one other thing. Did you hear us even once mention whether we thought IWM was going to go up or down during the 60 days of the trade? No, we actually don't care one bit whether IWM goes up or goes down. All we cared about was whether all four options expired worthless.
And if you think about it, that happens at any price below where the calls are and at any price above where the puts are. In other words, at any expiration date closing between $1.88 and $2.45. At any point in that 57 point range, we win all of the cash flow we collected at the beginning of the trade. And so that's huge, right? To win a 10 Delta Iron Condor, as long as the stock's price stays inside a pretty wide range of prices above and below the stock's price at trade entry, you win.
the trade and the probabilities are in your favor because all the options have a large probability of expiring worthless as we explained earlier. And so what I'd like you to take away from today's video is that you don't have to be a whiz at predicting a stock's direction to be successful as a trader. If you learn options income strategies like we practice on our trade desk here at SMB, you can make money as long as the stock you're trading remains within a very wide range.
of its current price. You just need to get that range right and you win. That's the beauty of options income strategies. Now, if you'd like to learn three more options strategies that our pro traders use, including the unique options trick that allows you to make money while you wait to buy stocks or ETFs at the price you want, and the options income strategy that allows you to make consistent money, whether the market goes up or down or sideways.
and how to make money on a stock or index trade, even if you're wrong on the direction, then click the link that's appearing right now at the top right-hand corner of your screen. That will open up the free workshop registration page in a new window. So don't worry, you won't lose this video. Or you can register directly for free at optionsclass.com.