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BookingAlpha Option Trading Advisory

Wednesday, December 28, 2016

Introducing the Unbalanced Elephant

It all started with the Unbalanced Iron Condor. Then the Lazy Elephant was invented. Both ideas came from the need to fight the most unfavorable environment for Option Sellers: the sustained market rallies. 

Losing the battles on the Call side is much more tragic than losing on the Put side. Adjustments are less than ideal: premiums are low, you can't get far out enough with the new position. As a consequence, you end up with more losses, which are by the way also greater than the Put side gone awry. There is also a psychological factor: at least when the Put side loses, the market has gone down several percentage points. So, you are better off, unlike the losses on the Call side, where the indexes are rallying and passive buy/holders make you look, well, dumb.

Although both strategies (Unbalanced Iron Condor and Lazy Elephant) have allowed me to mitigate the Call side headaches, the adjustment game is still there. It is still dangerous. It is still stressful and frustrating, as evidenced in my 2016 Options trading reflections. For this reason I wanted to create something that would allow me to never have to adjust the Call spread and still have the potential to lock a winning trade even with a losing Call side.

Introducing the Unbalanced Elephant

The Unbalanced Elephant is just an Elephant with a smaller number of Credit Call spreads than Put spreads.

For Instance:

Lazy Elephant:
20 long Puts
20 short Puts
20 short Calls
22 long Calls

Unbalanced Lazy Elephant:
20 long Puts
20 short Puts
8 short Calls
9 long Calls

To get filled with ease on that extra long Call, the trader can use the corresponding ETF. For example 10 SPY Calls instead of 1 SPX Call. More commissions, yes, but better bid-ask spread and no issues with liquidity. So, it would be an Unbalanced Iron Condor plus long SPY or IWM Calls.

You can also add downside protection, especially during very low volatility environments. This way, you end up putting an Unbalanced Iron Condor (RUT or SPX) along with an Unbalanced Long Strangle (IWM or SPY) as illustrated below:

Unbalanced Lazy Elephant Variation:
20 long Puts
20 short Puts
8 short Calls
8 long Calls

Up to here this is just an Unbalanced Iron Condor.
Then we turn it into an Unbalanced Lazy Elephant adding 10 SPY Calls:

20 long Puts SPX
20 short Puts SPX
8 short Calls SPX
8 long Calls SPX
10 long Calls SPY (1 SPX Call is approximately the same as 10 SPY Calls)
1 or 2 SPY Puts (if volatility is too low)

Of course, by doing this you are collecting less credit overall. But now, if you are threatened on the Call side, you can simply close it for a smaller loss and still end up with a winning trade thanks to the credit collected from the Put side, greater than the loss from the Call side, which is simply closed and never adjusted.

The way I will be playing this position, I should be able make $1300 - $1500 when neither side is threatened; around $500 when the Call side is closed at a loss (and never adjusted); and losses of around $1,000 when the Put side loses (which unlike the Call spread, will be adjusted).

Here is the risk profile of a typical Unbalanced Elephant:
(Click on image to enlarge)

A new 19 page e-book has been added to the collection inside, with all the step by step details on how to design this position; the thought process to determine the right proportions of contracts to use (Calls vs Puts) in different situations, as well as the number of contracts to play on the Strangle portion of it. The book also contains a chapter that discusses how to make Elephant positions small-account-friendly. A Trading Plan is also included with rules for Entries, Exits and Adjustments.

Starting in 2017, I will be trading the Unbalanced Elephant instead of the traditional Lazy Elephant. I will also start deploying more capital (instead of the 7K-8K I used per Elephant the last 4 months of 2016).

- Easier to get filled on the whole position
- Completion of the position in only two steps instead of three
- Small accounts friendliness
- No Call side adjustments ever.

Only time will tell, but I see great potential in this conservative strategy and think it is going to be a great addition to the arsenal.


Related Articles:
The Iron Elephant options strategy explained

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