This article will focus on one issue: selecting short strike prices that are outside of the average true range (ATR) on the timeframe that we are trading.
Recently, I was teaching a class in Northridge, Los Angeles County, and was able to find an almost ideal short option spread trade. However, due to the fact that the ATR was greater than the distance between the short strikes, I had to pass on the trade. This discrimination of an almost perfect trade caused a long and elaborate explanation that dragged on; hence I chose to write an article about it with visuals.
The example used was AMAZON, and the trade entertained was an Iron Condor on the July cycle of the current year. Figure 1 shows the chart of AMZN.
Figure 1: AMZN monthly chart
As can be observed from the figure above, we are looking at a monthly chart with Bollinger Bands (BB) superimposed over the price action. The default setting for the BB was used, meaning the center line is the 20 period (SMA) simple moving average. The two horizontal lines represent the range between levels on the monthly time frame because each bar on the figure is a monthly bar. Specifically the red horizontal line shows the 235 level acting as a (SZ) supply zone. It is at that level that the buyers were rebuffed several times in the past. If we count how many touches of the 235 level were there, the answer would be at least four; hence it is somewhat safe to assume that the 235 zone might act again in the future as a level of resistance. The idea is to sell the 235 call for credit,… Continue Reading
