10/31/2020 Neutral Strategies | Option Alpha

Neutral Strategies
How do I know if a stock is going to stay range-bound or neutral?
What are the best options strategies when you are neutral on a stock and IV
is low vs. high?
How do I select strike prices on a short strangle?
How do I select strike prices on a short straddle?
How do I select strike prices on a short iron condor?
When should you choose to do a strangle over an iron condor?
Given high implied volatility rank - when do you use a credit spread vs. an
iron condor?
What is a skewed iron condor?
How do I select strike prices on a short iron butterfly?
What is a broken wing butterfly spread?
If implied volatility is low and you don't have a directional preference on a
stock what strategy is best to use?

How do I know if a stock is going to stay range-bound or neutral?

In most cases our underlying assumption for nearly all the trading that we do is that stocks remain
within a defined range of one standard deviation (or 68% confidence) based on current implied
volatility. This has been historically proven to be true, and in fact, implied volatility always overstates
this expected move giving us our "edge" as an options seller. Having the ability to sell options far out
on either end of the stock price provides us with a huge range of confidence and ample area for the
stock to move and still profit. Whenever we have conflicting signals, whether we use technical analysis
or charting techniques, we will always decide to stay with a neutral trade over making a directional
assumption.

What are the best options strategies when you are neutral on a stock and IV
is low vs. high?

When implied volatility is low and you don’t have an opinion on the direction of the stock, the best
option strategy is not to make a trade. If you don't know the direction of the stock and you don't have
an assumption on where implied volatility is going to go you're simply best off to sit on your hands and
not make a trade at all. When implied volatility is high and you're neutral on the direction of the stock,

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you can choose between a couple different strategies. All of these strategies focus on the option
selling and include straddles, strangles, iron condors and iron butterflies. The latter two are going to
be best when you have an IRA account or a retirement account that restricts trading undefined risk
positions.

How do I select strike prices on a short strangle?

One of our favorite strategies is the short strangle and strike price selection starts with knowing what
probability level you want to target. For example, if you want to make a 70% probability of success
trade that means that each side of your short strangle will need to be placed at the 15% probability of
expiring ITM level (because 15% on each side is a 30% chance of losing in both directions together).
This would also equate roughly to a 0.15 delta on each side.

How do I select strike prices on a short straddle?

Because short straddles are very high implied volatility strategies, strike selection is very easy as you
will sell both the ATM put and ATM call option. If the closest ATM options are not near the current
underlying stock price then choose to play the strategy a little bit directional and select a centered
strike price either just above or just below the market.

How do I select strike prices on a short iron condor?

Strike price selection on an iron condor is virtually identical to that of a short strangle. You want to
place the short strikes of your iron condor at the targeted probability levels that you are looking for and
from there you can buy further out options for protection and a reduction in capital requirement to hold
the trade.

When should you choose to do a strangle over an iron condor?

Choosing to do a strangle over an iron condor starts first with your account size. For most smaller
accounts (less than $20k) we do not suggest trading strangles because they take up a lot of margin
requirement to hold a position which ends up being too much risk. With larger accounts where you
have the capital to do either one, it comes down to a question of return on capital and overall
availability of funds in your account. Iron condors by their nature have a higher return on capital but
also offer a lower total dollar profit potential long-term. In most cases you are better off, total profit-
wise, to trade strangles in larger accounts. Here’s our suggestion; if you currently have a lot of
available capital in your account you might opt to go with the strangle and if you have a lot of positions

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on already and don't have that much capital available to trade then you might consider the iron
condor.

Given high implied volatility rank - when do you use a credit spread vs. an
iron condor?

Since iron condors are created out of two separate credit spreads you can use them interchangeably
whenever you want. We preferred to use iron condors when we want to be neutral on the direction of
the underlying stock versus using a credit spread when you want to go bullish or bearish on the stock
by trading only one side of the iron condor.

What is a skewed iron condor?

These types of iron condors have unbalanced strike spreads which creates skew in one direction or
another. For example, you could have the put spread side 5 points wide and the call spread side 10
points wide. This would create skew to the bearish side because that side has the smaller strike
spread. The call side would also carry more risk should the stock rally because the strike spread is
wider. To skew the condor to the bearish side you would simply do the reverse of the above and make
the put spread side wider.

How do I select strike prices on a short iron butterfly?

Think about a short iron butterfly as basically a straddle over where the stock is trading right now with
protection on either side. So, you'd want to sell both an ATM call and put and then buy options a
predefined distance out on either end. You’ll want to go fairly far out on either end to buy your
protection as you'll want to pay a very cheap price for these options since the cost will be coming out
of the short option premiums you collected selling the ATM contracts. Notice that we didn't say you
should try to pay almost nothing for these options. You still want to pay money for these to give you
protection and to make sure that you're even and balanced on both sides. Our suggestion is always to
go out the same distance on either end. For example, if the stock is trading at $50 and you sell the
$50 strike calls and puts, you might want to purchase the $45 strike puts and the $55 strike calls.
Each end would be $5 wide and 100% balanced.

What is a broken wing butterfly spread?

A broken wing butterfly is when you skip a strike on one end of the spread. A regular butterfly would
have for example the 10/11/12 calls. A broken wing butterfly would have 10/11/13 where you skip over

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the 12 strike and buy a further out strike. This should typically be done for an overall credit so that you
don't have risk to one side of the trade and they work better in high implied volatility markets.

If implied volatility is low and you don't have a directional preference on a

stock what strategy is best to use?

In this case, the best strategy is not to make a trade at all. There is no point in forcing a trade into the
market when volatility is low and our edge is minimized when you don't have a directional preference
on the stock. Full disclosure, here at Option Alpha we often find that this is the "trade" we make more
often than not as we are very picky and choosy about our trades. We always want to ensure we are
not trading just for the sake of trading and that our overall portfolio maintains the highest probability of
success possible.

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