Option Trading Myths

03/14/2014 9:31 am EST

Focus: OPTIONS

Kerry Given, PhD

Founder and Managing Director, Parkwood Capital LLC

Kerry Given discusses some of the more popular option myths and also explains what strategy he likes the best.

SPEAKER:  I'm here with Kerry Given talking about myths and marketing hype related to options trading, and, boy, one of them that I always hear is that you've got to look for a low-risk, high-probability trade.  Does that even exist, and what are the other myths or hype that we hear about options? 

KERRY:  You're absolutely right.  Unfortunately, there are an awful lot of these kinds of myths being told out there, and the low-risk, high-probability trade is impossible simply because if you have a low-risk trade, that means automatically it's a low-probability trade.  That's just the nature of the beast. 

SPEAKER:  I've also heard that if volatility is high, I ought to—now correct me if I'm wrong—sell a credit spread.  Is that right? 

KERRY:  That's a common statement.  Again, it's a falsehood, and you can prove it yourself.  Just simply go out, pick your favorite stock, wait until volatility is very high, and then sell a credit spread like put spread at the money, and then take those same two strikes and buy a call spread, and you'll find the returns on both are identical. 

SPEAKER:  Well, let's assume that the market is highly volatile right now, and instead of—of course, there are lots of myths—what kind of approach could an options trader take in a really high volatility environment? 

KERRY:  Well, one of the advantages of spreads in general in high volatility is that you're buying that expensive option, but you're also selling one, so it helps you offset that volatility, because normally if you were just simply buying options or going long or short or whatever, when volatility is real high, you hate to buy options because they're so expensive, but you can buy a spread, and it saves you some of that volatility expense. 

SPEAKER:  Do you have a favorite options trade?  Do you have a favorite setup that you like to talk about or do? 

KERRY:  Probably the one that I trade the most long-term for just income generation is an iron condor on indexes, either SPX or Russell. 

SPEAKER:  For a possibly unseasoned options trader like me, what's an iron condor?  I hear this thrown all over the place. 

KERRY:  Yeah, it's a popular trade.  It's simply selling a call spread up out of the money, way above the price or the index, and then selling a put spread way down below the money, and so, in effect, what you have is a channel defined by those two spreads, and as long as the index trades in between those two, the options expire worthless, and you make your profit. 

SPEAKER:  That's the first time anybody's ever explained an iron condor in a way that I could understand. 

KERRY:  Sure. 

SPEAKER:  Thank you, Kerry.  You're watching the Money Show video network. 

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