The Best Income Trade for Tomorrow

Market price action continues to tick up in volatility while still holding a wide range. For this reason, when I trade I’m choosing option chains that hold a fair bit of premium and choosing a stock that shows reflexive buying when prices dip into monthly support lines. One in particular has caught my eye.

Today, we'll consider what this stock does from a purely technical perspective while we collect revenue from it through another short iron condor. This is typically called an options income generation spread. 

Let me show you.

When we position with short iron condors, we attempt to collect time decay while a chart bases or settles before heading in a new or continued direction. As always, we assume that we don't know the direction but are able to estimate the magnitude of the move using the ATR (average true range – measured on the weekly chart, this time) and the implied moves that the market makers have priced into the move over the months ahead. 

The short iron condor consists of two spreads – a short call spread and a short put spread that define a range of motion that we estimate the price action will not exceed:

• Sell to open 1 PSTG 21 Feb 70 calls 
• Buy to open 1 PSTG 21 Feb 75 calls 
• Sell to open 1 PSTG 21 Feb 55 puts 
• Buy to open 1 PSTG 21 Feb 50 puts 

At this writing the credit received is $1.09 and this credit is also the maximum profit we could collect overall. With this kind of position, we collect a premium and as this premium erodes, we collect revenue from the position. 

Our maximum risk is calculated in the following way: the distance between strikes (here they are both the same at $5), so $5.00, minus the amount of the credit we collect, which is $1.09 = $3.91 

Why take a trade where the risk is often more than twice the size of the reward? The answer is this – the probability of the short iron condor with strikes far out of the money (meaning far away from the price of the stock currently) potentially returning gains is often as much as 6 times more likely than the long iron condor in this specific example. 

Trading on the side of probabilities, rather than the possibility of outsized gains, is the way most traders who sell options as their primary revenue generation lean on the law of large numbers – what happens over a long period of time – converging to net gains, generally speaking. 

The price for PSTG is currently range bound with resistance near $70 and support near $55, which is how I picked the strike prices for the trade. 

The strategy result provides three choices to exit the trade:

1. To buy back the iron condor once it gets to an acceptable profit margin for you. I customarily look for 30%-60% profit for these kinds of trades in the current environment of volatility. 
2. To buy back the iron condor once it hits a loss threshold as determined by personal risk – this will happen with extreme movement. I customarily look at about 50% though depending on my size 
3. To buy back the spreads into the week before expiration, if all is going well and you have decided to hold the trade into closer to the end of expiration (I have had many a trade go sideways taking it down to the wire and not capturing gains, so I do not advise this). 

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