How to Use S&P 500 Options to Profit From the Passage of Time

NEW YORK (TheStreet) -- Most traders follow the S&P 500 Index (SPY) closely, but few equity or futures traders are able to structure trades that are profitable based solely on the passage of time. Option traders use a variety of trade structures called credit spreads to actually make the passage of time a profitable endeavor. Unfortunately there is one catch -- the price of the underlying asset has to cooperate.

What many readers may find interesting is that I structure my option portfolio around being positive-theta. This essentially means that the portfolio collects the option premium as time passes, which will be converted into profits if prices cooperate. I attempt to consistently capture close to 1% of my account value per day in positive time decay.

The answer: multiple iron condor spreads. An iron condor spread is a credit spread where a trader takes a call credit spread and a put credit spread simultaneously. In many cases, the trader expects the underlying asset to consolidate or trade in a specific range.

I have several high-probability iron condor spreads in my portfolio all the time. I trade the same trade structure using the same underlying assets over and over again. In many cases, I will have more than one iron condor spread on the same underlying asset on my books at the same time. The underlying assets that I focus my iron condor strategy around are primarily index options and index ETFs.

I trade the S&P 500 index (SPY), the Russell 2000 index (IWM), the Nasdaq 100 ETF (QQQ), and the Dow Jones Industrial Average ETF (DIA). These are just a few of the underlying assets that I trade using the iron condor strategy. I traditionally enter the trades at about 50 days to expiration, using a probability of success of around 80%. Most of the time, the broader index would have to move roughly two standard deviations from the current price at entry to create losses in my portfolio.

Back in early July, I entered an August S&P 500 iron condor spread. It's presently boasting profits of around 10% on maximum potential risk. However, I wanted to show readers that recently I entered a September S&P 500 iron condor spread with about 50 days to expiration. The probability of success was around 80% for the trade to be profitable.

The following chart of the S&P 500 demonstrates the price range where the new September S&P 500 iron condor spread will be profitable if held to expiration.

Chart1 (1)

As can be seen above, the new September S&P 500 iron condor spread is profitable as long as the index price stays between $1,785 and $2,050. The trade was entered on July 22, in addition to the August S&P 500 iron condor spread that I was holding at the time.

The chart below shows the price range in the S&P 500 which will be profitable if both S&P 500 iron condor spreads are held to expiration.

Chart2 (1)

If both S&P 500 spreads are held to expiration, the profitability range for both trades held simultaneously is $1,820 to $2,020. The probabilities are quite favorable that one if not both trades will be profitable at the August and September expirations.

The combined strategy offers a probability of close to 80% to make a positive return. Based on maximum possible risk, the typical return is between 10% and 15%, depending on implied volatility changes during the holding period of the trade. At first glance, many traders write this strategy off as a poor strategy based on risk vs. reward.

But what other strategy offers nearly a 10% to 15% return on maximum risk with a near 80% probability of success at the time of entry?

When paired with other directional trades, having multiple high-probability iron condor spreads on the books at the same time builds a high level of positive theta that helps support consistent portfolio profits. So far, the recently launched Technical Traders' option service is boasting two closed trades thus far. Both trades that have been closed were quite profitable.

The first winning trade was in Facebook (FB), which was directional biased to the upside. A call diagonal spread was the trade structure chosen. The trade had a maximum risk of $493 per spread and produced a gross gain of $111, or 22.51% per spread.

The other big winner was a CurrencyShares Euro Trust (FXE) put butterfly spread, which was designed to profit partially from the passage of time and from lower prices. The trade was entered with a maximum risk of $141 per spread and produced a gross gain of $53, or 37.59% per spread.

Inquiring minds might ask how I accomplish this task.

Overall, the new option service is off to a great start and currently has several additional trades which are profitable at this time. For more information, check out our new cheaper, upgraded options service.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.


TheStreet Ratings team rates FACEBOOK INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:

"We rate FACEBOOK INC (FB) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its robust revenue growth, largely solid financial position with reasonable debt levels by most measures and impressive record of earnings per share growth. However, as a counter to these strengths, we find that the stock itself is trading at a premium valuation."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • FB's very impressive revenue growth greatly exceeded the industry average of 11.4%. Since the same quarter one year prior, revenues leaped by 60.5%. Growth in the company's revenue appears to have helped boost the earnings per share.
  • FB's debt-to-equity ratio is very low at 0.02 and is currently below that of the industry average, implying that there has been very successful management of debt levels. Along with this, the company maintains a quick ratio of 12.48, which clearly demonstrates the ability to cover short-term cash needs.
  • Net operating cash flow has slightly increased to $1,341.00 million or 1.43% when compared to the same quarter last year. Despite an increase in cash flow, FACEBOOK INC's cash flow growth rate is still lower than the industry average growth rate of 17.57%.
  • Current return on equity exceeded its ROE from the same quarter one year prior. This is a clear sign of strength within the company. When compared to other companies in the Internet Software & Services industry and the overall market, FACEBOOK INC's return on equity is below that of both the industry average and the S&P 500.
Chris Vermeulen

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