TALES OF A TECHNICIAN: THE PERFECT STRATEGY FOR BUYING DIPS AND SELLING RIPS

Want to know which trading adage is as old as time? “Buy low, sell high.” It’s as intuitive as putting on pants in the morning. But as many traders quickly discover, saying the phrase is one thing, but successfully employing it is quite another. Fortunately, there’s an options strategy that does this automatically, without any thinking or meddling on your part.

It’s known by many as a cash flow strategy designed to bank coin from option buyers. It thrives in neutral environments and capitalizes on the perpetual overpricing of options.

It is the Iron Condor, the focus of the Condors for Cash Flow system.

And one of its lesser-known qualities is to get you long on dips and short on rips. Such an approach works particularly well during range-bound markets, one where mean reversion rules the roost and trend traders are sad. The reason it doesn’t work in trending markets is that buying a dip that keeps dipping or selling a rip that keeps ripping delivers pain.

It’s buying a dip at the end or selling a rip before it bends that delivers the dough. And that’s much easier to do in when the stock is locked in a range.

Got it?

So how does an Iron Condor do this automatically? The answer lies with its greeks — negative gamma to be specific.

Negative gamma is the force that gets you shorter as prices rise and longer as they fall. And isn’t that what buying the dip and selling the rip is?

Buy the dip = get longer as prices fall

Sell the rip = get shorter as prices rise

By design, an Iron Condor strategy acquires more positive deltas prices fall and more negative delta as prices rise. This works against you if prices keep trending but for you if they eventually revert to the mean. And isn’t that what you expect if the stock is in a range — that rallies will ultimately come back down and sell-offs will eventually come back up?

Buy the dip = get longer as prices fall = acquire more positive delta as prices fall

Sell the rip = get shorter as prices rise = acquire more negative delta as prices rise

Let’s look at an example with Costco Wholesale Corporation which currently finds itself in the middle of its trading range. From a price perspective do you see how it would make sense to be a seller of rallies and a buyer of dips here? In other words, would it make sense to get short COST as it rises towards $165 while getting long as it falls towards $150?

An Iron Condor would do all that automatically. Here’s a risk graph of the November $145/$150/$165/$170 Iron Condor. That is, selling the $145/$150 bull put spread and the $165/$170 bear call spread.

Notice how the trade begins delta neutral (risk graph line is flat). But as the stock price rises, it becomes delta negative (line slopes to bottom right). Alternatively, if the stock price falls, the trade becomes delta positive (line slopes to bottom left).

That is the visual depiction of a negative gamma position.

So what’s the takeaway?

Next time you find a situation where you say, “Gee, I’d like to sell that stock at higher prices or buy it at lower prices!” then an Iron Condor may be worth a look. And if implied volatility is high, that’s a bonus.