The Channel Tools in Platinum Pro allow traders to find high probability trades by scanning specific strategies. Unless you are pretty comfortable with the tool and have a specific reason for changing the ranking criteria settings, leaving them at their default values is a good place to start. Once you have trades to evaluate, you can create "what if" scenarios by completing a Channel Stress Test from the Risk Channel screen and/or changing the statistical volatility [SV] value for the Probability of Profit calculation. You may want to consider not only the high ranked trades for your scan, but those that also hold up well when conditions are less optimal.
After the close on Wednesday 9/16/09, the Channel Tools' Condor Channel scan was selected and the Condor Ranking Criteria (selections on left side of scan) were left at their default settings. Two October Iron Condors for Research in Motion (RIMM) came up at the top of the list, along with an Apple Inc (AAPL) Iron Condor when using the NASDAQ-100® Index (NDX) Optionable stocks list and viewing the top 50 trades sorted by Probability Between Breakevens.
The scan results provide different columns for sorting, one of which could impact either the timing of a trade or whether it is even considered desirable. The Days to Expire column also includes Earnings information, which provides the user with the number of calendar days until the next earnings report. More on that once the Risk Channel is trade is shown.
All settings for the scan are shown in Figure 1 below. The second ranked RIMM trade appears immediately after in Figure 2. This trade had slightly higher profit potential, reduced risk and a slightly lower probability of profit value compared to the top ranked Iron Condor, also for RIMM.
Figure 1: Condor Channel Scan Settings on 9/16/09
Figure 2: Second Ranked RIMM October Iron Condor (9/16/09)
The top ranked Iron Condor had strikes that were higher by 5 for each leg. So the trade risks $322 to make $178, which is approximately 2:1 from a risk-to-reward standpoint. Unfortunately that's one thing you give up as you focus on higher probability outcomes. It's simply the nature of the markets. When you first start using a new tool you may want to rank the trades by using the default value first, then checking other ranking criteria.
As always, probabilities reflect expectations going forward assuming the stock behaves the way it has in the past. The number of days used in channel settings and SV partially dictates just how recent the past information is. That's why it's nice to see that earnings date within the stock list results. In the case of RIMM, earnings are due in eight days (Thursday, 9/24). With this in mind, there are two additional things to consider for this Iron Condor:
- Will implied volatility [IV] increase going into earnings on 9/24/09 and
- Will SV rise as the market reacts to the release, pushing it out of the channel?
I personally think the potential for a strong move from RIMM is the bigger concern, so traders really need to think about this impact when considering trade suitability from a max risk standpoint. Of course max risk must be considered for all positions, but knowing there's a pending catalyst for the underlying that may change conditions might give you second thoughts.
If you replicate the scan and bring up the initial Risk Channel display, you can see that there is a sideways channel centered at today's close. The green shaded portion of the Risk Graph then displays this basic price channel projected forward in time, along with two light blue lines to the left 0 profit line which displays the position's breakeven values.
By completing two different Channel Tests, you allow Platinum to look back and provide the best channel, by direction, over the last 40-150 days. As John Broussard commented at OASIS, these periods were shown to be optimal in his back-testing-in other words, don't change the default settings unless you have a specific reason for doing so. Figure 3 displays the Risk Graph after a Sideways Channel Test was completed.
Figure 3: Risk Channel for RIMM October Iron Condor Using Sideways Channel Test
Now there is a much wider channel that uses past data to view the potential outcome on the Risk Graph. The green shaded portion is well within the upper breakeven for the position and about $3-4 below the lower breakeven. Since sideways price action is optimal it seems like a good idea to be a bit more critical of this particular channel. While there was a bit of support provided for it prior to its construction, it appears there are only two touches of the channel's upper and lower extremes. Price is approaching the previous high (upper channel line), so a trader may want to monitor RIMM to so if this level serves as resistance for the stock, making a better argument for the channel.
Another alternative is to look at the possibility of a stronger channel in place given the reason bullish action for the stock. By selecting Up for the Risk Channel Projection and repeating the Channel Test, new channel projections are displayed on the Risk Graph (displayed in Figure 4).
Figure 4: Risk Channel for RIMM October Iron Condor Using Up Channel Test
Interestingly, the best upward channel is more narrow and completely within the breakeven eves displayed as light blue horizontal lines to the left of the 0 value. If this channel persists, prospects for the position actually appear better. As a last look, Figure 5 provides the Down Channel Test. In this instance the channel widens once again and is only slightly different than the sideways channel.
Figure 5: Risk Channel for RIMM October Iron Condor Using Down Channel Test
The last channel slightly lowers the projected move, resulting in a price move that is now possibly $4-5 below the breakeven if RIMM moves to the lower channel line of this channel.
As a non-channel reality, a look at the Probability of Profit information shows an 88% probability when using the 20-day SV (25%). Changing the scenario and assuming next week's earnings announcement will increase SV, the higher 90-day SV (38%) yields a 75% probability of profit. It does appear the trade holds up pretty well under a few different "what-if" scenarios. The real test of course will come next when earnings are actually announced. I'll provide an update next week which will include risk graphs and SV one day prior to earnings.
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Clare White
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
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