Options Trading for success. Option Samurai offers you the sharpest option scanner to guarantee the constant edge that you seek. Receive vital information from a variety of sources, easily, clearly and quickly.
This week we released some new features in our scanner!
Launch!
The features we’ve launched:
New predefined scans with multi leg strategies – We now have dozens of scans for you to choose from. These predefined scans can help you find trades for any market environment: From iron condors to options for stock replacements. From hedging trades to dividend capture. Check out the complete list in our help section (and we are constantly adding more)
In order to better understand each scan, we’ve added a description to all of them.
And even better, we’ve added tags to all of scanners to help you find the best scan for every market environment.
As part of our premium plan, we send our users a weekly sector report. This report analyzes all sectors of the market from a bird’s-eye view. It measures the current distance of each sector from the ‘normal’ range – and highlights sectors that are in over-bought / over-sold and present a quantitative edge for entering. We use this report for two main reasons:
Highlighting the interesting sectors in the market. This allows us to find trade ideas in those sectors
Gain confidence in our trades using a quantitative measure for expected out-performance, based on past events.
In this post we will give an example on how to use this report from start to finish. The goal is to learn how to integrate this report in your trading.
Weekly MA Report
This report is generated each week based on each sector’s ETF. We measure the distance of each ETF from it’s 200 days moving average. This value is then compared to the past year, which gives its percentile. This means that we know for every distance, how it compares to the behavior in the last year. We then backtest to see how the ETF behaved after that event and compare to regular conditions.
The normal behavior of the sector is to move from over-sold to over-bought conditions and vise verse. We try to time our entry to profit the most from those movements.
Let’s use an example to gain better understanding:
Moving Average Report Example
In this Example we will focus on the XLY and XLF rows. We will not go in-depth to each column as it is explained in detail in our FAQ section here.
When we look at the XLF sector, We can see that it is in an up trend and it is in an over-sold condition. This means we should look for a bullish trade. When we look at the column projected edge we see 2.7%. From this we can expect XLF to outperform the normal behavior by 2.7%.
From this we can learn the expected return for an over sold condition: If the normal return of the XLF in the last 5 years is X% a month, then in this case, for an over sold condition (like at the date of the report), we can expect the following month return to be X+2.7%.
Now let’s look at the XLY sector: here we see that it is in an up trend, but the status is natural. past events lead us to believe that the current edge is negative -0.6%, which means that if the monthly return in the past 5 years was X%, we can expect X-0.6% for the next month. This implies that this sector has less of a technical edge in this and we should look at different sectors.
As you can see, using this report can help us focus on sectors with more edge in them. We can then trade the ETFs directly or use Samurai to find trades in those sectors.
On April 22nd we released a report to our users. In this report we saw several over-sold sectors, but XLP, XLK and XLF showed the greatest upside edge.
MA Report 22-4-18
When I looked at the different ETFs, I preferred the formation in XLP over the formation in XLF as the latter already started its move. I felt that XLP would be safer bet. I also had several trades in the XLK sector (You can see in our Stocktwits account) so I wanted to diversify. I chose to look more in-depth in the XLP sector.
I ran Samurai option scanner and found a trade I liked on $PG (See here)
PG Trade
The reasons for the trade:
There was a quantitative edge in the sector, and since stocks in sectors are highly correlated. I wanted to enjoy the edge while holding an individual name.
P&G is a dividend aristocrat – in the last 25 years not only it distribute dividend every year, the amount has risen every year. The current dividend yield is 3.8% and expected to rise.
support on 68-70 levels. The stock kept above those levels for more than 5 years.
Selling put on $70 gives me another 5% margin of safety (and it already dropped almost 20% from the $90s level it was previously) .
Margin efficiency: At the prices I executed I got about 8% annualized return un-leveraged. Assuming I need toallocate 2000$ as margin (currently the margin requirements are less than 800$) the return will be 24% annualized.
At the moment I’m publishing this article, the trade is still open, we are above the 70 strike, but the trade is losing as the stock continued down a bit more. I’m still holding this trade as time works for me and I have 3 options going forward:
If I’m aggressive and the stock continues down, I can open another naked put on a lower strike.
I can wait closer to expiration and then roll the option down and out in time. Usually I can do it without taking a loss.
If the stock will be under 70 at expiration I can buy the 100 shares, and start selling calls above the market. I’d then enjoy the call premium and the dividend cash-flows.
Summary and tips going forward
In this article I described how I used the Moving Average report and gave an example to help you integrate it in your trading. Here are some more tips:
The sectors move from over-bought to over-sold. We need to be patient and time our entries. We will always find another idea in the future.
I always look for another confirmation for my trade. In the $PG trade example above I had the (1) technical sector edge, (2) Fundamental strength and (3) technical support on $70. It is always good to have another confirmation from macro, technical, fundamental, volatility etc on your side as well.
The sectors move in groups. It is very good to take note of two characteristics: (1) the strongest moving sector and (2) the sectors that are not part of the group. These sectors will be prime candidates to trade: the strongest sector if you want to trade in the direction and the outlier if you expect a reversal in the market.
Be mindful of the large market mechanic. If we are in a sideways move (like today) it is better to enter contrarian trades. If the market is trending we might want to be faster to enter.
If you expect a strong move -> look at debit strategies (like buying options) as usually they will offer a limited risk and unlimited reward. If the market is choppy and you can have a reasonable stop-loss – sell options as they have higher profit probability. It is best to mix those strategies in your portfolio to have more diversification.
Check out the scanner here to start your free trial:
As you might know by now – we are traders ourselves, and we built SamurAI as we felt the tools out there are not satisfying for our needs. We constantly share the actual trades you make views you our subscribers. Be it privately in emails or publicly via social media: Twitter and Stocktwits. For the later, we constantly update an open trade log where everyone has access and can see the trades we preformed, and more important – their outcome.
Though the log updates constantly, form time to time we also share with our readers a summary giving better insights on out trading methods. As the first quarter of 2018 is approaching its end, we thought its a good opportunity to give you a short recap of the last moths.
First, let’s see the current stats:
The currently trade log has 102 trades, with 83% winners, and 32% average profit. The average loss is higher, at 41%, but due to our high win probability the expected value is positive and is around 20%.
Some of our recent trades:
Selling Iron condor on UPS gave 106% profit on the risk (held for about 3 weeks to 2153% annualized return)
We called the short in KODK after the Block-chain jump and gained 43.9% on risk (translated to almost 700% annualized return)
$KODK Play
Sold puts on GE (twice) and earned 2.8% and 1.8% on a low risk-high probability trade.
Sold put spread on $WB and earned 4 times the risked amount (held for 2 weeks).
Today we will discuss one of the most popular strategies in options trading: iron condor. The Strategy became very popular due to the limited risk profile while maximizing the time value derived from selling options on both directions. Option Samurai scanner makes it easier to find relevant trades while applying this strategy.
What is Iron Condor strategy?
Iron condor can be described as selling a put spread and call spread (both OTM usually). Since this position can lose only on one side it provides more premium per day compared to spread (this allows the trader to close the position early for profit).
Iron condor profit profile
The Iron condor profit profile consists of limited profit and limited risk (the potential risk is usually greater than the potential profit). If the stock remains in the middle of the profit range the seller will be profitable. If the stock breaches one side, the trader will lose. There is a great deal of adjusting trades we can do in these cases, but this is a topic for another article.
When to set up an Iron condor?
Iron condor is a neutral strategy that profits from volatility decrease and the passage of time. Your goal is that the stock will expire in the ‘profit zone’ to keep maximum profit, staying in the profit zone before expiration can lead to daily profit and you might consider to take the profits before expiration.
There is an edge in setting up an IC in high IV environment (IV rank >80) where there is a greater chance of a volatility decrease. Another good practice is to sell the options on the other side of support and resistance level, to allow for more security in the position.
How to set up an Iron Condor?
When initiating an IC position we need to consider many variables, chief among them are the distance of the sold call and put options (can be different) and the ‘width of the wing’ – meaning the distance of the protecting option from the sold option. There are two main ways to set up an Iron condor, but because it is hard for traders to optimize IC with 4 different parameters, both ways are sub optimal:
Vanilla (static) Iron Condors
Dynamic Iron Condors
Vanilla Iron Condor
The most common way to start using Iron Condors is by using a vanilla Iron condor. This IC is usually symmetrical on the calls side and on the puts side. This leads to similar maximum risk on either side and usually the break even point is the same distance on both sides.
An example for this can be:
Static Iron Condor Strategy example
This is an example of Iron condor on SPY:
The current price is $274.5
We can sell 268 put and 281 call (7 strikes away (from 275/274 strikes)
We will buy 265 put and 284 call (3 strike risk)
As you can see – The result is symmetrical with the same risk on both sides, and the current stock price is in the middle of the profit zone. Even so, You can see that the aggregated delta of this position is negative (-30) so at the moment we will profit from a decrease in stock price.
Static ICs have many disadvantages mainly due to the fact that they don’t take into consideration option pricing, market timing, skew and other parameters.
Dynamic Iron Condor
Dynamic Iron condors are iron condors that are built with taking into consideration the options pricing such as skew, IV and more. When traders set them up they usually use the delta of the options to choose which strikes to sell and buy. This leads to a predictable delta of the overall IC (usually around 0) and takes into consideration the options skew, IV and probability implied by the market.
For example, if we build an dynamic IC on SPY where we sell the 30 delta options and buy the 15 delta options, it would look something like that:
Dynamic Iron Condor Strategy example
In this example, when we sold the 30 delta options and bought the 15 delta options:
The current price is 275.34
On the call side, we sold the 285 strike and bought the 294 strike – Giving us 10 strikes distance and 9 strikes width.
On the put side, we sold the 267 strike and bought the 254 strike – Giving us 8 strikes distance and 13 strikes width.
We can see that the IC is NOT symmetrical, there is more risk to the downside – both in total $ risked and in the distance. However we can see that the delta is 4.77 (almost 0).
The dynamic IC is an improvement over the static IC as it takes into consideration the option pricing. However the main disadvantage is that the delta thresholds are set as a rule of thumb, or randomly and don’t optimize for current market
Optimized Iron condor – A better way to trade Iron Condors
As mentioned above, it is impossible to optimize IC without a dedicated program. There are too many parameters to control: Implied volatility, Skew, time to expiration, stock volatility the distance and price of 4 options and more.
This is why we designed our Iron condor to check all possible combination of Iron condor, and pick the best among them. We maximize the Expected Value in our calculations.
As a reminder: Expected Value is a statistic measure that tries to predict the value of the strategy, assuming you could have executed it many times at different dates but with the same prices/distances etc. It is calculated by summing the payout at expiration multiplied by the probability of that payout.
When we maximize the Iron condor’s expected value we take into consideration the Implied volatility smile, the stock volatility, time to expiration, pricing and more. This solves the disadvantages of the previous ways to set up ICs: It takes into consideration the individual situation of each stock and gives tailored IC for each stock.
Let’s Check the following example:
$AMGN Iron Condor Trade Idea
In the above example we can see that the system recommended the Mar 23rd Iron condor with the strikes 165/167.5/195/197.5:
Max profit $111
Risk is 139$.
Days to expiration is 23 days.
Profit ratio is 80.5% (in 23 days – About 1260% annualized)
Probability of max profit about 69%
Expected value is $104.2
We can also see that the sold strikes are after major key support and resistance lines.
To see why it is better let’s test several variations:
Wider wings: We can buy protection further than the original Idea. This will increase the premium collected, but would also increase the risk. In our case it will add about $18 in premium (using mid prices) but will double the risk. So the profit ratio will be around 38% (much lower than the original 80%), and the expected value will be lower.
Sell options one strike down: Selling further options reduces the probability of crossing the profit zone but also reduces the net premium collected. In our case the probability of profit increase is about 10%, which is about a raise of 15% compared to original probability of profit. On the other hand the reduced premium is 80% less. So the expected value is much lower compared to the original trade.
Change expiration: What about keeping the same strikes, but choosing another expiration? If we pick closer expiration we enjoy from higher probability of profit, but lower premiums, and the opposite if we pick further expiration: The premium will be higher, but the probability of profit will decrease. In our case, the positive effect has lower percentage change than the negative effect in both expiration date before and after the 23 of Mar, this lower the expected value and from a mathematical stand point the edge is lower.
To summarize – from mathematical perspective – the suggested Iron condor is the best and provides the best combination of profit, risk and probability of profit. It doesn’t mean that we shouldn’t make changes (in strikes or expiration), sometimes we want to take less risk or prioritize different expiration due to liquidity or periodic buying/selling pressure. However it is important to be aware of the trade offs.
Tips to find Iron condor in Option Samurai:
To find optimal IC in Option Samurai you can go to our Iron Condor scanner
Iron condor strategy scanner
Our scanner check all possible iron condor combination for all stocks that fit the criteria and shows you the best Iron condor for each stock for your consideration. We take those results and analyse them further to find the best trades.
Some tips to increase the amount of good trades:
Add ATR to upper breakeven and ATR to lower breakeven – ATR (Average True Range) is a volatility measure and can help us find trades where the break even point is further than a threshold. Read more in this article. (We usually set the default at more than 2 ATR)
Add bid-ask spread filter – We usually set the bid-ask filter to find trades with bid-ask spread in all options of less than $1
Customize the spread profit, moneyness, expiration date and max loss to better suit your trading style.
You can loosen the profit filter, remove the upper limit from the profit ratio filter and loosen the max loss filter to see more results and pick it up from there.
Check out the scanner here to start your free trial:
(small update: The Vix gave more than 30% and faster than we projected. If you took our idea it might be good time to take some profits off the table)
Indeed an historical event, an event that can affect the lives of many. But the Eagles win over the Patriots in Super Bowl LII is old news by now . The media cycle has moved to the “downfall” of the stock market: the Dow Jones Industrial Average (DJIA) has suffered one of its largest loss in one day – that is in points (1,175). When looking on percentage loss, things look a bit different: the 4.6% put it somewhere in the 500th largest drop – but who will click on that?
The S&P isn’t different and though there isn’t a sign for panic. But by using the VIX indicator you get a better understanding on how the market might go:
As we can see, Vix is in the 4th highest value it has ever been. What is interesting here is that the other top 3 are some of the biggest economic crisis of recent decades. Does this mean that we are heading towards a meltdown in one or more sectors? This is less likely, and this is probably the market adjusting itself due to two recent trends:
Large amount of retail (and professional) volatility sellers
Abnormal recent gains.
In the short term we can expect to see an increase in the volatility, especially due to the extended period that the market didn’t have a correction. But in the medium and long term we are seeing this as a bullish market indicator.
This is something a bull will run into
The change in Vix was so extreme (an increase from 10-11 to about 40 in few days) that we can expect it to over shoot and correct to more ‘normal’ volatility.
Based on our back-test for the last 10 years, we can expect in the next 30 days a -26.97% decrease in volatility.
You can trade this on the VIX future or on the ETFs, but this will effect the entire market. You can use the bull put spread scanner to find the best trades for these market conditions.
Recently many users have shared stories with me about successes they had with our ‘buy cheap calls’ pre-defined report. This report is located on our scanner. The main component in that scanner is the ATR filter. So I thought it could be a good opportunity to share more information about the ATR filter in Option Samurai and how to use it.
What is ATR
ATR or Average True Range is a technical analysis indicator to measure volatility of an asset. Originally developed by J Welled Wilder for commodities, it has gained popularity among technical analysts and is now widely used. The goal of the indicator is to find the “true” movement range for a stock in order to assess its volatility.
The calculation of the True Range (TR) is:
TR = The maximum of:
Current High – Current Low
Yesterday’s close – Current High (Absolute value)
Yesterday’s close – Current Low (Absolute value)
True Range Example
The ATR is usually a 14 days average of the TR value.
ATR is a Volatility measure of the stock based on past price action. It is a much more intuitive measure than standard deviation for example.
Using ATR when trading options
One of the most important characteristic when trading options is the assumption for the asset volatility. When we use ATR we can standardize the volatility for different assets and compare trades on different stocks, although the different stocks have different volatility.
For example:
ATR Example – SPY AAPL GOOG
In the following example we can see search results for SPY, AAPL and GOOG.
SPY has a lower volatility from these stocks, and we can see that the ATR % for SPY is 0.58% (this means that average DAILY move of the SPY is 0.58%)
AAPL and GOOG have similar volatility in percentage ~1.4%.
If we would only look at the break even point, we can see that the BE point for SPY is 0.6% from the current price, while AAPL’s BE point is 1.36% away and GOOG is 0.7%.
When we take into consideration the stock volatility however, we can see that GOOG is most likely to pass BE point (GOOG daily range is 1.4% and the BE point is 0.7% – the daily range is twice the break-even point).
Although AAPL Break even is 1.36% and SPY BE point is 0.6%, when considering the volatility, we can see that BE point is 1 ATR away from both stocks.
This is the main power of using the ATR in option scanning – the standardization allows you to compare different stocks and different parameters and adjust the volatility. Because it takes into account the volatility, it is superior to regular percentage measures.
How to use the ATR in trading
The ATR will allow us to standardize volatility of different assets and look at distances in “ATR-units” which will allow us an ‘apples to apples’ comparison of different assets. We can use it in several ways:
1. Find cheap options
When we buy options, the option premium should be enough to cover the potential move of the stock so the option seller will have enough margin of safety to expect profit.
Using the ‘ATR VS Break-even Point‘ filter we can make sure that the premium we pay is relatively low compared with the stock volatility (see more in the example). Since we can’t lose more than the price we paid, buying cheap options can give a real edge in the market compared with buying the stock.
2. Choose the right strike to sell options
We can also use the ATR to find the right strikes to sell. Using ATR you can find strikes that are N amount of “ATR units” from current price. This means that the distance depends on the stock volatility – the more volatile the stock, the further away the strike will be.
Using the filter ‘ATR vs Strike’ you can easily find strikes that are far X amount of ATR units from current price. This saves you time and allows you to compare different trades for different stocks and ETFs.
3. Wide profit zone
When trading Iron Condors you can make sure that the ‘profit zone’ of the iron condor covers what you are looking for. There are 3 filters you can use:
ATR to Upper Breakeven
ATR to Lower Breakeven
Profit range ATR
These filters give you more control when scanning for Iron Condors, as you can control the distance to the upper break-even point, lower break-even point and the total width of the profit zone – all in “ATR units” (see examples below for usage).
Example 1: Using ATR when buying calls
In our predefind section you can find the ‘Buy cheap calls’ scanner. We discussed it’s edge in an previous blog post.
Buy Cheap calls scanner
This filter is looking to buy calls that have more than 15 days to expiration, max loss of less than 5% compared to buying the stock (serves as a stop loss) and break even point is less than 3% (meaning if the stock rises 3% by expiration the position is profitable.
The most important parts of this scan is no dividend (which adjust the price down) and ATR needs to be 3 times the Break-even point (ATR vs BE point). This increases the probability to exceed the break-even point and show profit.
Some more ideas on how to integrate this in your trading:
You can sort by ATR vs BE point to see the ‘cheapest’ opportunities
You can add the ATR vs BE point to your watchlists to see this data column in your results.
You can change the value from 3 to a higher or lower value in your screens to better adjust your results.
Iron condors are a very popular strategy. It allows users to enjoy the time decay of the options (increases the probability of profit), while benefiting from a limited risk trade.
In this example, we will use our Iron condor filter to check all possible combinations (hundreds of millions of option combinations) and find the best Iron Condors (IC) that fits our cretiria.
Below are the results for Iron condors that:
Up to 30 days to expiration, any IV rank and total option volume > 5000
IC profit is above $200, loss is below $5,000 and expected value is profitable
We added ATR measures: the break even point above should be more than 1 ATR, below needs to be more than 2 ATR and the entire range should be more than 5 ATR.
We also added the ATR percentage to the table to compare.
Results for top IC with more than 5 ATR range
This table shows us variety of results with different volatility. We can pick the strategies that best fit our risk criteria.
For example:
NTES trade has about 21% profit zone. About 10% to each side. The expected value is $302, which teaches us that this trade has high probability of profit. When analyzing this trade in ATR units: We can see that the Break evens are 3 ATRs on the upside and 2.5 ATR on the downside.
Due to the earning date, CMG allows for a 9 ATR profit range. 5 ATR on the upside and almost 4 ATR on the downside. Expected value is $248 and probability of profit is 73% (but this statistic is skewed due to the earning event prior to expiration (so this trade is not for everybody)
Some more ideas on how to integrate this in your trading:
You can sort by the ATR measures to make sure you have enough margin of safety (or no margin if you are buying straddle)
You can limit results to have more than X amount of ATR and high IV rank
Summary
The ATR is a technical measure of volatility of an asset. We use it in option trading in an effort to compare different trades on assets with different volatility. Using the ATR instead of normal percent measure helps us to save time as we can focus our analysis on the best trades (risk-reward wise) while taking into consideration the fact that different stocks have different volatility.
When selling options, we are looking to sell options that have the most ‘ATR units’ of distance from current price.
When buying options, we are looking to buy options that are the closest to the price (ATR-units-wise) and we do it by comparing the ATR to the break-even point and asking the ATR to be as big as possible compared to it.
The holiday season is coming down the back stretch and this year looks like it will be a winner. According to the CNBC All-America Survey, average holiday spending intentions will top $900 for the first time in the 12-year history of the poll, which is the widest margin on record.
Record spending numbers
CNBC conducts a survey of 800 Americans and found a surge in the percentage of Americans planning to spend more than $1,000, which is up to 29% from 24% in 2016. The margin of error according to CNBC is slightly more than 3%.
To take advantage of increasing holiday spending, traders are buying Wal-Mart ($WMT)and with implied volatility stable using a bull put credit spread, is a prudent way to generate revenue by betting this retail giant will experience a banner year.
You can now easily scan for option spreads using Option Samurai. Just as a refresher, a vertical option spread strategy is one where you purchase and sell two alike options (either 2-puts or 2-calls) simultaneously, that have the same expiration date. The only difference between the options will be the strike price and the premium. A vertical option that is a credit spread allows the seller of the spread to receive a credit, which means the premium of the option you sell is higher than the premium of the option you purchase.
When you look to sell a bull put credit spread, you are betting that a stock will not drop through a specific price before the expiration date. This means it can go lower or higher but will be a winner if it remains above a specific level. The price level you want to avoid is the sold put price, but even if the underlying stock declines below this level you can still make money.
Running an Option Samurai Scan
There are several criteria that are key to finding a robust Bull Put Credit Spread
Bull Put Spread scan
The Option Samurai Scan can include any symbol, but in the case of a stock you want to make sure the earnings are after expiration. You also want to make sure that the implied volatility that is priced into the vertical spread is at least above the lower quartile of its historical range. You can do this by making the implied volatility range in between 25% and 100%. If you want an out of the money bull put credit spread, make the range of “moneyness” less than zero.
The spread profit describes the amount of profit you would receive if you executed 1-contract of a WMT bull put credit spread, and both options expired worthless. You can construct this by using the spread profit above a specific level. The spread profit of $74 means that the price of the sold put (in this case the $92.5 put) minus the price of the purchased put (in this case $90.50) is $0.74.
Since the strike spread ($92.5 – $90.50) equals $2 and the premium you would receive is $0.74, the max loss is $1.26 for each contract or $74 for one contract of $WMT. You can alter the Max loss to make sure you only find spreads that have specific risk parameter.
Lastly, you want to make sure the spread expected value is profitable, or a specific minimum. Spread Expected Value, is a statistical measure that tries to predict the profit or loss of the strategy. It is calculated as the sum of all possible values each multiplied by the probability of its occurrence. The scan will also describe the profit ratio, which is the return you will receive if both options expire worthless.
The trade:
Sell WMT January 11, 2018 $92.50 Put at $0.90
Buy WMT January 11, 2018 $90.50 Put at $0.16
Your potential gain on the trade is $0.74. You broker will request margin of #contracts * 100 * ($92.5 – 90.5 + $0.74) or $74 per contract. Your return if both options expire worthless is 58.7% ($74/$1.26).
Your maximum loss is the different between the 2-strike prices ($2) minus the premium, = $0.74 or $126 per contract. Your breakeven level is $91.76 = $92.50. (short strike) minus premium of $0.74.
Alternative, you could also go to your dashboard and look for alternative but put spreads, using this scan as a guide. Go to Option Samurai
This article is the first in a series of educational articles that will describe some of the advanced concepts implemented in Option Samurai option scanner. In this article we will focus on Expected Value.
What is Expected Value
Expected value is a statistic measure that tries to predict the value of the strategy, assuming you could have executed it many times at different dates but with the same prices/distances etc. It is calculated by summing the payout at expiration multiplied by the probability of that payout.
The expected value is derived from: Stock price, option prices, Implied volatility, time to expiration, distance of strikes from last price, dividends and risk-free rate. Usually you are aiming to have the highest expected value possible, as it indicates a statistical edge.
Example: Expected Value of put spread
Put spread example
In this example we will see how the Expected value is calculated on a bull put spread. This spread is built with a short put (strike A) and a protective long put (strike B) where both options have the same expiration and A>B.
We can divide the spread to 3 ranges:
Maximum profit range (where the price is greater than A) – Range 1 in the example
Maximum loss range (where the price is lower than B) – Range 2 in the example
Between A and B the spread will show profit or loss that is linear changing depends on the stock price – Range 3 in the example
To calculate the expected value we add:
The probability of being above A * max profit (positive)
The probability of being below B * max loss (negative)
For the area between A and B we use log-normal distribution and multiply it by the payout.
The sum of the 3 components is the Expected value.
How to use Expected value:
After explaining what is expected value we get to the most important part: How can we use it to find better trades.
1. Filter according to Expected value
This is the most obvious and powerful way to use this value. With our option scanner you can instantly find only the profitable trades according to the expected value, in real time. This means that you only analyse trades where you have a statistical edge. This saves you time and in the long run helps your edge compound.
Expected Value filter in Iron Condor scanner
You can also set the expected value filter to be more than $100 or any other value to account for commissions and unexpected scenarios and even increase your edge.
2. Sort from max to min
After getting your results, you can sort by expected value to compare different strikes, expiration and tickers to find the optimal trade when taking into considerations all the different variables (profit, loss, liquidity, growth, trend, sentiment, IV etc).
The sorting helps you manage your time more efficient by looking at the trades with the highest edge first (Important note – The fact that the EV is positive, doesn’t mean you will necessarily make profit, it is just indicating there is an edge in this trade in your favor).
3. Create a ratio using expected value
A more advance way to use expected value would be to create a custom ratio unique to your trading style. The best way to do it is to export the results to excel using our export feature.
Export to Excel
After you have all the data in excel you can start playing with it. Some ratios for example:
Expected value / Max loss – This ratio combines EV (higher is better) and Max loss (lower is better). sorting the trades according to this ratio takes into account the worse case scenario when you analyse a trade
Expected value * IV rank (if credit strategy) or Expected value / IV rank (for debit strategy) – This ratio combines the EV with the Implied Volatility rank. It means that trades with high IV will get precedence if it is a credit strategy and Low IV trades will get precedence if it is a debit strategy.
Expected value * Growth rate – This ratio combines the EV (higher is better) with the fundamental measure of the company expected EPS growth (higher is better). This combines 2 measures from different ‘domains’ and gives precedence to higher growth
You can of course create more ratios that fits your style: Divide by days to expiration (EV per day), use PE (see how expensive the stock), div yield and much more.
Conclusion
Expected value is a statistical measure that tries to predict how profitable a strategy will be. It uses the market conditions, such as: option prices, implied volatility, stock price, dividends and more to give a dollar amount of the expected profit (or loss) of the strategy.
Though expected value gives a dollar value, it does not mean that this will be the profit from the trade. It is better to think of the EV as the integrated edge in the trade. Over many similar trades you are expected to collect this edge and increase your profits.
You can use the Expected value to:
Filter trades that have positive EV and have edge.
Sort by EV to save time and compare trades
Create your own custom ratios that will help you to uncover the trades that best fit you.
The major indexes continue to hit fresh all-time highs as the calendar flips into the last month of 2017. The combination of robust earnings, the potential for a new tax plan, and bullish sentiment have kept stock prices elevated and has weighed on implied volatility. In fact, S&P 500 volatility is near 52-week lows moving into December. As traders continue to climb a wall of worry, betting that S&P 500 index implied volatility will stabilize using a bull put credit spread, is a prudent way to generate revenue.
You can now easily scan for option spreads using Option Samurai. Our new scan results allow you to find the best possible vertical credit spreads along with straddles and Iron Condors. Just as a refresher, a vertical option spread strategy is one where you purchase and sell two alike options (either 2-puts or 2-calls) simultaneously, that have the same expiration date. The only difference between the options will be the strike price and the premium. A vertical option that is a credit spread allows the seller of the spread to receive a credit, which means the premium of the option you sell is higher than the premium of the option you purchase.
When you look to sell a bull put credit spread, you are not betting that a stock or ETF will move higher, you are in fact speculating that the stock or ETF will not drop through a specific price before the expiration date. The price level you want to avoid is the sold put price, but even if the underlying stock declines below this level you can still make money.
Running an Option Samurai Scan
There are several criteria that are key to finding a robust Bull Put Credit Spread
Bull Put Scan
The $UVXY ETF is a volatility ETF that looks to track the changes of the VIX volatility index, which is equivalent to the implied volatility of the at the money strike prices for the S&P 500 index. The ETF price is attempting to form a bottom despite stock prices surging to fresh highs.
The Option Samurai Scan can include any symbol, and in the case of a volatility ETF you don’t have to wait until an earnings release. You also want to make sure that the implied volatility that is priced into the vertical spread is at least above the lower quartile of its historical range. You can do this by making the implied volatility range in between 25% and 100%.
The spread profit describes the amount of profit you would receive if you executed 1-contract of a UVXY bull put credit spread, and both options expired worthless. You can construct this by using the spread profit above a specific level. The spread profit of $59 means that the price of the sold put (in this case the $13 put) minus the price of the purchased put (in this case $11.50) is $0.59.
Since the strike spread ($13.00 – $11.50) equals $1.50 and the premium you would receive is $0.59, the max loss is $0.91 for each contract or $91 for one contract of UVXY. You can alter the Max loss to make sure you only find spreads that have specific risk parameter.
Lastly, you want to make sure the spread expected value is profitable, or a specific minimum. Spread Expected Value, is a statistical measure that tries to predict the profit or loss of the strategy. It is calculated as the sum of all possible values each multiplied by the probability of its occurrence. The scan will also describe the profit ratio, which is the return you will receive if both options expire worthless.
For this trade you could
UVXY Chart
Sell UVXY December 8, 2017 $13.0 Put at $0.68
Buy UVXY December 8, 2017 $11.5 Put at $0.09
Your potential gain on the trade is $0.59. You broker will request margin of #contracts * 100 * ($13 – 11.5 + $0.59) or $91 per contract. Your return if both options expire worthless is 64.8% ($59/$91).
Your maximum loss is the different between the 2-strike prices ($1.5) minus the premium, = $0.91 or $91 per contract. Your breakeven level is $12.41 = $13 (short strike) minus premium of $0.59.
For this trade you want the UVXY to stay above 13 (2% from current price) until Dec 8th expiration.
Alternative, you could also go to your dashboard and look for alternative but put spreads, using this scan as a guide.