What is a non-directional trade? If you’ve never traded options, every trade or investment most people have ever entered into are directional trades. That means, the trade has to move in the expected direction to profit, (In a bullish trade, the asset needs to go up, and in a bearish trade the asset needs to go down); but if it moves in the opposite direction, the trade loses money.
Buying and shorting stocks are directional trades. You buy a stock, it goes up, you make money; it goes down, you lose money. You short a stock, it goes down you make money; and it goes up, you lose money. Right?
Now, how do we make money in America? Anything you buy, you need to sell for more than you paid for it, and anything you short, you need to buy back for less than you sold it for.
But to do that, in order to realize that profit, the asset that’s being traded…needs to move, in the expected direction, up or down. And it must move in the right direction to profit. If it moves in the wrong direction, you lose money.
Those are directional trades. And that’s investing 101.
Now, in a directional trade, what is the probability of success? And we will define success simply as making a profit? Literally, what are the odds of making a profit when you buy or short a stock? 50/50. Whatever technical or fundamental rational you used to enter the trade, mathematically, in any directional trade, you have a 50% probability of realizing a profit.
In every directional trade you ever entered, if the trade goes up or down even a penny, you’re already either somewhat profitable or starting to realize a loss.
So, what’s a non-directional trade? This is a trade where you not only don’t need the asset to move directionally to make a profit, but it can move in the “wrong” direction and still be profitable, as long as you’re not REALLY WRONG! It can also do nothing, not move at all, or just base sideways for a period of time, and still be profitable.
In other words, you don’t even need the asset to move to profit. This is the strangest concept for new options traders to grasp, as it flies in the face of the traditional buy low/sell high mantra.
So while every trade has risk, and there is certainly no such thing as a risk free trade, what is a low risk trade?
Well, think about it. Do you see by not having to be right directionally to increase your odds of making a profit, and thus reducing the odds of taking a loss, you’ve reduced the risk of the overall trade on entry?
An Iron Condor trade is a combination of two credit spreads…a Bull/Put spread below a demand zone, and a Bear/Call spread above a supply zone. All that would be required to profit is the stock to stay above the demand zone it’s already over and stay under the supply zone it’s already under. Which means the stock can move sideways and still stay under and over the zones. Moving up somewhat staying above and below the zones or moving down somewhat, and still be above and below the identified zones, and remain profitable. Until a defined expiration date.
This is a perfect strategy for a stock which is range bound. We just need it to stay in the parameters of the range. The trade will be profitable if it just doesn’t break the supply zone to the upside or break the demand zone to the downside, until the options expire.
How is this possible? Option premiums have something no other asset class has, which is extrinsic value. This is also called time value. Options, unlike stocks, have an expiration date, where a trade has to be completed. So, when we enter credit spreads, we’re basically selling what are called out of the money options. We are practically selling time.
We are collecting a premium when we enter the trade, and that premium will expire worthless if the options stay out of the money. As long as the stock stays under the supply zone, and over the demand zone, the options will expire worthless, and we’ll keep the premium we collected on entry of the trade, at the expiration date.
So which trade has more risk? Buying something and needing it to go up, shorting something and needing it to go down, or selling something, and just needing it to not go somewhere? In effect we’ll profit where the stock doesn’t go, instead of needing it to go somewhere. We do not need the stock to move; we need to calendar to move.
Whether the stock moves or not, who knows? But I can guarantee the calendar will move! This is both a higher probability trade to see a profit, as well as a trade with lower risk. One thing, I would caution though, if the stock moves out of the limits of the supply and demand zones, then we will start to lose money. As in any trade, appropriate stop losses need to be in place to avoid losses in that scenario. While the loss in an Iron Condor is capped, we always look to lose as little as possible when a trade doesn’t work out.
Options are the only asset class, (stocks, options, futures, or forex), where you can be wrong directionally (within limits) and hope to profit.
Reach out to us at Pinnacle to learn more about options, and the many non-directional options strategies that you can trade in any account, with appropriate broker approval, even IRA’s.
(While this is a high probability, low risk trade, it is not a guaranteed trade. Every trade has market risk, and any trade can go against us at any time for any reason, resulting in a loss of principal or margin.)