NDX a.m. settlement trade in detail; /ES futures give & take away ...

The "fabulous NDX a.m. settlement" trade won again this week, returning over 20% on the amount at risk ... when everything else was going straight down!

A friend from work (hi DW) mentioned that I hadn't shown exactly what I mean by the "fabulous NDX trade" I've been going on about in this blog ... since I had my whole trading strategy built on it
until Nasdaq made it p.m settled for three out of the 4 weeks.

Anyway, here goes:

• The trade goes on at 9:45 a.m. Pacific time on Thursday before a.m. settlement. This last one was December 20; the next one will be Thursday the 17th.
• It's a "one standard deviation iron condor" meaning:
• You sell 1 put and 1 call (or 10 of each, but let's start with 1, OK?), both near the .16 delta ("Delta" is the ratio of the rate of change of the price option at the indicated strike price as the underlying stock moves. So a .16 delta option would move 16 cents for every dollar the underlying stock moves) ... since this is a two-sided trade, you have to add the odds of losing on each side: 16% (rule of thumb .. more about this below) x 2 = 32% ... the obverse of 1 standard deviation.
• You then buy a corresponding put and call, each at least 50 points away from the short strike; more if you can afford it. 
• Settlement occurs not exactly on the opening price, but when each of the 100 stocks in the index posts an opening price. This is given in a daily symbol called NDS.

Illustrations:

This is an example of putting this trade on not the next day, but a month out. But the interface will look the same, just with different numbers. You get less credit (but not that much less ... I still got $10 to $11 on this trade last Thursday) but the short strikes are much closer together. For example, for Thursday's win I sold this one:

1. Sold the 6140 put and the 6370 call (x 2 contracts)
2. Bought the 6080 put and the 6430 call (x 2 contracts)

I got $10.50 credit, so the risk/return formula is like this:

credit received ($10.50) / (width of strikes ($60) - credit received ($10.50))

$10.50 / $49.50 = 21.2% ... not quite this good because of commissions, but I still took in > $2000 for about $10,000 risked.

NDS settlement value was 6244, so nowhere close to losing. Wahoo!

About the "one standard deviation" ... it's only a rule of thumb and in practice it usually overstates the risk of loss and therefore overpays ... I've been running this trade for over a year and have only seen it lose twice, probably in 24 tries. 

Why you want to use as wide "wings" as possible:

If you have $10,000 to risk on the trade, you can do it with 60-wide wings as I did, or 25-wide wings, and just increase the numbers of contracts. 

The return is significantly higher: 36% vs 21%. But you're much more likely to lose 100% of the amount you're risking than you are with wider wings.

Think about it: your "loss window" is 20 points wide instead of 50 points wide as in my example. So when the NDS value is just above your long call or below your short put, you lose 100%. I lose only about 40% on the same value.

Questions? Leave me a message here.

OK, now for the /ES futures saga. Where's a Santa Claus Rally when I need one? Basically it went down all week:

This would have been OK ... had I held onto my short /ES position ... but I was thinking it had been so far down it was due to recover or at least flatten out, allowing me to sell calls against a long position. So I bought one /ES contract (for my personal account only) at 2503.25. Then:

Oops; I get them mixed up. I meant:

So the futures market closed at 2421.25 Friday. Sheesh.

I have to think:

• This'll have to be over before too long ... 
• It's already "priced into the market" so should flatten out at worst or drift higher
• I can sell calls to make up the difference.

We'll see ... more next week!