Options Trade #38 - CVS Iron Condor - Is this the best trade?

VTS Community,

I had myself a pretty busy weekend going through everyones emails about potential option trades on CVS.  I'm sorry I didn't follow up on them, to be honest I didn't anticipate that kind of response but it was great that so many people were into the "homework assignment."  

Just to recap for anyone who didn't participate, one of the stocks on my watchlist is CVS Health Corporation.  I've traded it a lot in the past and several times in the Discretionary Options Strategy.  The reason we're talking about it now is that it has crashed pretty hard lately.  So the question was, what's a good options strategy for it right now?

The one thing I was very happy to see is that pretty much everybody was leaning towards being a net seller of the options.  That's one of the basics we talk about a lot.  We always check the current level of volatility as a basic filter for the list of potential trades.  If it's high like it is right now, it's more advantageous to be on the short side  (short Vega).  When volatility is very low, that's when long volatility  (long Vega)  can be considered.  I've done a related article called Why selling options beats buying if interested.

So here's a short list of what I would consider good trades in this situation.  Now I will say there's several other types that would work as well such as broken wing iron condors or butterflies, diagonals, even a longer term "calendar roll" which is another one of my go to strategies I'll share soon.  I do like to write extended articles and do a video for those though so everyone understands them, so today I'll leave those out.

Bull Put Spread:  These are great and I use them a lot in my trading, both Bull Put Spreads and Bear Call Spreads.  On CVS today it would actually be just fine, but the issue is it is a directional trade.  That means it's far more advantageous if it goes the desired way.  I'm not sure I'm willing to take a directional stance on CVS right now.  When stocks crash in that fashion, it's very hard to pick the bottom and there may be a little more bleeding to come.  I'd rather not try to catch the falling knife today.  If I did though, I'd be looking at the 18 April 19' 50.00 / 47.50 Bull Put Spread.

Wheel of Fun Put:  For the Youtube video explanation, click here.  So naturally this one made the list, it's a favourite here.  There have been 37 trades so far in the Discretionary Strategy and 12 of them have been wheel trades.  And I would say that aligns well with how I trade when I'm more active.  About 25% of all trades are wheel puts or calls.  So no reason at all this wouldn't make a good trade.  If it was me, I'd be a little more aggressive with it and sell the 18 April 19' CVS 52.50 Put.  And of course I'd use a 10% stop-loss just in case CVS isn't done crashing.

Short Straddle / Strangle:  This is another trade type I use a lot, the short straddle.  To me right now, the 55.00 straddle is looking pretty good.  Now the main issue here is, it's an unlimited loss trade which not only scares a few people off  (it really shouldn't, but I understand)  but it also requires a higher level of options approval in the brokerage account.  You can always contact your broker and apply for a higher level and see what they say, but just to avoid the issue of perhaps a few of you not being able to execute it I won't do this one now. 

But one great way to view straddles is as a modified Wheel of Fun Put.  Remember in Wheel trades I consider the put to be cash secured, meaning I still reserve the full amount of capital in the account in the event shares get assigned.  With naked short straddles I can technically do the same thing.  Selling 1 contract I'd just make sure I have 5,500$ reserved for the trade, even though it won't require nearly that much.  That way I can also manage the trade with a 10% stop-loss, meaning for every 1 x 55.00 contract open, I'd be setting my stop-loss at 550$.  If it's down more than that, it's time to get out.     

* More to come on straddles soon, as they are on my short list of favourite trades.

The winner:  Today though I'll go for an Iron Condor.  I think it's a great set up and exactly what I'm looking for right now. 

1)  Higher implied volatility is always good for Iron Condors.  It means I can widen the short strikes of the trade and still bring in a decent premium.  For more detail on this, check out my article Iron Condors perform better in higher volatility environments.

2)  Market neutral.  Right now with CVS crashing so hard, I'm not prepared to pick a directional outcome.  If I had to guess, I'd say most of the bleeding has stopped and I'm expecting a little bounce soon, but the Iron Condor gives a little margin for error on the downside which is a nice buffer to have.  

3)  When traded on individual stocks, Iron Condors have a good return on capital.  The flip side though is that they do have higher potential for movement so stop-losses are very important.  Also, it's always a good idea to avoid Iron Condors on individual stocks if there is an earnings call within the expiration cycle.  CVS recently had earnings so I'm good, but I wouldn't do it if there was as the risk of a gap price move is too high.

Here's all the trades I discussed, and the Iron Condor winner:

The Trade:

Iron Condor on CVS Health Corporation

BUY to OPEN 6 x 18 April 19' CVS 60.00 Call SELL to OPEN 6 x 18 April 19' CVS 57.50 Call SELL to OPEN 6 x 18 April 19' CVS 50.00 Put BUY to OPEN 6 x 18 April 19' CVS 47.50 Put Credit:  ~ 0.85 * prices move around intraday, so the higher the better

Margin Requirement:

Since these are defined risk trades, I consider margin on Iron Condors to be the maximum loss for the trade.

1 option contract  =  100 shares The maximum loss is the strike gap minus the premium (2.50  -  0.85)  *  100  =  165 per contract 6 contracts  *  165  =  990 margin requirement

The reset annually model portfolio is at 25,000 990  /  25,000  =  3.96%

* You can scale your trade to roughly 5% of available capital


I don't use hard stop-losses for Iron Condors.  Instead, I have developed a proprietary method of measuring the risk-reward profile day to day and determining if it's still advantageous to remain in the trade or close it.

However as a rough estimate, I typically stop-loss out of trades at 1.3 - 1.6 x the premium collected.  

So if the roughly 0.85 premium I collect for the trade rises to about 1.30 I will consider closing it for a loss.

Thanks everyone for participating.  The number of responses was a little overwhelming but it was fun, we will do more.

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