NaughtyPines

OPTIONS TIP -- "SCALING" THE BUYING POWER EFFECT OF YOUR TRADES

AMEX:SPY   SPDR S&P 500 ETF
A good, fundamental rule-of-thumb for options setups (and here I am generally talking about premium selling setups such as short strangles, iron condors, and credit spreads) is that you should limit the buying power involved in each trade to approximately 5% of your total available buying power. Naturally, some folks have more buying power than others, and there are a wide variety of techniques to "scale up" the buying power size of your trade to fit your account and/or risk tolerance.

Undefined risk strategies such as short strangles have the greatest buying power effect, and you can scale up from those by merely increasing the number of contracts utilized in the strangle.

With iron condors, however, you can scale the buying power effect by either (1) increasing the number of contracts; (2) widening the width of the wing spreads; or (3) a combination of the two.

Purely by way of example, a Feb 26th TLT             115/118/130/133 1 contract iron condor has a buying power effect of about $245. If you widen the wings from 3 strikes to 5, however, to a 113/118/130/135, the buying power effect increases to about $430 (the max profit increases as well). (Notice that by "widening," I mean moving the long options out farther from the short ones; the "shorties" remain in the same place, i.e., around the 84% probability of out of the money strike).

As with all things, there are practical limitations with certain instruments and/or underlyings as to how wide you can go with your wings. If you play with these setups at all, you'll start to notice that at some point distant from current price, the long options approach virtually worthless and/or there may be a "no bid" for those strikes, indicating a lack of buying interest in that particular strike, and you may have difficulty getting a fill for that wide of a setup.

Additionally, limiting buying power effect also has the unfortunate effect of limiting maximum profit. Naturally, if you limit the buying power effect to too great a degree, the maximum profit potential of the setup will not be attractive after fees and commissions, particularly if you -- like I do -- take a lot of these setups off at 50% maximum profit (e.g., a $25 maximum profit potential setup taken off for 50% max profit = $12, all if not a major portion of which will be eaten up by commissions/fees).
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