[Options] Let the Consolidation Continue

Sean McLaughlin
April 28, 2021

The ASC team has been writing a lot recently about how markets are looking a bit "messy" right now. This isn't a bullish or bearish declaration, it's just an indication that many of the recent moves we've seen are likely to hit into some consolidation.

And as an options traders, the word "consolidation" should trigger thoughts of delta neutral credit spreads.

With this in mind, I've identified a good short strangle candidate.

Check out this chart in the bonds ETF $TLT:

 

We've had a pretty significant pullback off 2020 highs and we've been chopping around this support level for a couple months now. I think this consolidation continues for a few weeks longer, and with implied volatility in these options a bit elevated, this gives a good opportunity to collect some premium while $TLT sorts itself out.

Here's the Play:

I'm selling a $TLT June 133/144 strangle for around a $2.20 credit. This means I'll be naked short an equal amount of 133 puts and 144 calls. Because of the naked short options, this position will require margin (about $2400 per 1-lot).

Due to the theoretically unlimited risk in this spread, we'll be vigilant with our risk management.

There are people that love to make adjustments to spreads like these to bring in additional credits which move the breakeven levels. But I like to keep my life simple. When I'm holding multiple positions in my portfolio, I don't have the time or inclination to micromanage each position.

So with this position, I'll keep it simple. If at any time $TLT closes below my 133 short strike or above my 144 strike, that will be my signal to exit the position, win or lose. This is a clear indication that my thesis about sideways consolidation is wrong and I don't ever want to put myself in a situation where I'm hoping the trend will reverse in my favor. Hope is not a sustainable edge in trading.

If neither strikes are breached, then I'll look to exit this spread for a profit when I can buy it back for around $1.10 -- which is roughly 50% of the original credit I received when the trade was initiated.

~ @chicagosean

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