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How to create options spreads using delta

When I started trading options a few years ago I used all sorts of analysis, predictions, chart reading, but mostly my trading was based on direction prediction. It was all wrong. No one could ever predict where the market or any particular stock will go nor ends up in any particular day in its life span.

There are many traders out there who use all sorts of analytics to enter a trade. Some use unusual options activity others volatility value, or technical analysis only.

In the past I always struggled with one task, how do you choose your strikes when trading options? You do not want to be too close to the underlying price and you do not want to leave money on the table to be too far away.

I wanted my trading simple and easy. I wanted a process which could be simply defined and repeated every day, week, or month. A system, which has given rules or steps and it is easy to implement.

Lately, I finally created such system. It is so easy that I always question myself why it took so long to create this strategy.

Here is my way of trading Iron Condors or spreads against SPX. It can be used against any optionable stock, not just the index. I trade index only because I want to focus on one trade, one market, be in tune with it and not be distracted by other trades.

Here are my steps.

 · Find Delta

To find delta to trade I use my Cash management strategy. Deltas used in the table are arbitrarily chosen. I simply decided to trade 0.10 delta when the market is closer to all-time high, for example 5% – 10% below all-time high. You can choose your own level. If you want to be more aggressive, you can trade delta 15 or delta 20!

But I look at it this way, if the market is at all-time high, the risk of a decline or crash is higher than after the crash and the market is for example 20% below all-time high.

The table showing deltas I decided to trade is on the Cash management page. If you go there, the spreadsheet inserted in there tells you the current delta I will be trading (see “Traded Delta” line). As of this writing it is Delta 0.10.

 · Example of creating a put spread

  1. Once you know the Delta you will trade, the process is very simple. Go to your trading platform, find the delta you want to trade for the short put strike.
  2. When you find delta 0.10 you want to trade, it will tell you its corresponding short put strike price.
  3. Sell the put option from the Bid column of that strike.
  4. Determine how wide spread you can trade.
  5. Let’s say you can afford to trade 10 dollar wide spread, subtract 10 dollars from your short strike to get your long strike.
  6. Now you know your long strike, go and buy that option in Ask column.

Now you are done. Because pictures are worth thousand words, below is the above described process shown:

Creating put spread

The picture above shows how to create a put spread. You can follow the exact same steps to create call spreads, or if you do both together, you create an Iron Condor.

 · How to choose selling price

Once you build your Iron Condor or spread, you need to choose the selling price. When you create a Condor or spread in your platform, it will offer you a price you most likely will not be able to get. So I typically lower the asking price. For Iron Condors I usually want 6% – 15% of the spread width.

For example, if I trade 10 dollar spread or $1000 wide spread, my selling price will be between $100 – $150 dollars. I start with $150 (1.50) and if it doesn’t execute I lower it a bit, let’s say to $130 (1.30) all the way down to $100 (1.00), etc. This also depends on the delta you are trading and time of expiration. The lower the delta and longer expiration the harder it will be to get the desired price.

If you only trade separate spreads, then I usually go for 5% of the spread width, but not less than $30 dollars (0.30) per trade. The $30 dollars premium is my absolute minimum I am OK to trade for. If I cannot get it, I skip the trade whatsoever and wait for the next week.

 · What to do after you place an order?

After you are done, send the trade to your broker and if it executes don’t forget to place your stop loss order and 50% credit capturing order (OCO order) to protect your trades or collect gains as soon as they occur.

You can place your stop loss order based on the underlying price or spread value. The goal is to get out of the trade quickly before you get trapped in never ending battle with the market.

Hope this helps you to start trading. Let me know if you have any questions or need help. You can also subscribe to my free newsletter and follow my trades I trade in my account.

Good luck!

 





3 responses to “How to create options spreads using delta”

  1. M.S. says:

    Hi Martin, I just stumbled upon this site. Thanks for putting together this information about the vertical spreads. I was wondering how far out in time do you go to sell the the spreads? Thanks much!

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