High Probability Option Strategy

What are the characteristics of this option strategy?

High probability option strategies aim to win more often than they lose, usually by constructing spreads with defined risk and limited reward. The trade-off is the point: a higher win rate is bought by accepting a maximum loss that is normally larger than the maximum gain, so a few losing trades can undo a long run of winners. These spreads are built to profit when the underlying stays put or moves only slightly. Examples are the short iron butterfly and the vertical options spread.

Is this a bullish, bearish or neutral strategy?

This is a neutral strategy since it does not involve a directional bias.

Is this a beginner or an advanced option strategy?

This is considered an advanced option strategy due to the complexity of the setup and the need for an in-depth understanding of the pricing of options.

In what situation will I use this strategy?

Typically this strategies will work well in conditions of low volatility, when the underlying security might not have a big move. This strategies are also very popular in times when the market makes small moves.

Where does this strategy typically fall in the range of risk-reward and probability of profit?

This strategy usually has a higher probability of success but a relatively low reward. The risk is defined, because every short option is covered by a long option further out, but defined is not the same as small. On a credit spread the maximum loss is the distance between the strikes minus the credit received, which is typically several times the credit itself. On a debit spread it is the debit paid. Either way, the number to look at before entering is the worst case in dollars, not the win rate.

How is this strategy affected by the greeks?

The impact of the Greeks will depend on the nature of the spread. For example, a short iron butterfly will be affected mostly by the change in implied volatility, Delta and Theta.

In what volatility regime (i.e VIX level) would this strategy be optimal?

This strategy is best used when there is low volatility, with the VIX below 15, as that is when there is the greatest chance of small moves in the underlying security.

How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?

Adjusting a high probability option strategy when the trade goes against you can be difficult and it also depends on the nature of the spread. Some adjustments can be done easily, such as rolling the options to a later expiration date, while others will require more intricate steps.

Where does this strategy typically fall in the range of commissions and fees?

High probability option strategies tend to be more expensive due to the additional cost of the options involved in setting up the spread. They also require more complex setup and adjustment, which can mean additional commissions.

Is this a good option income strategy?

High probability strategies are not necessarily options income strategies. Their returns per trade are small because the reward is capped, and the risk behind that small reward is defined but usually larger than the reward itself. The credit versions do collect premium, so some of them can be used as part of an income programme, provided the maximum loss on each position is sized against the account rather than against the credit received.

How do I know when to exit this strategy?

It is important to have an exit strategy before entering into any option strategy. For high probability option strategies, it is recommended to have a trailing stop loss (to minimize losses) as well as a profit target (to maximize gains).

How will market makers respond to this trade being opened?

Market makers will typically take a neutral stance when it comes to this strategy, since the risk and reward are both defined and the position is easy for them to hedge. They will, however, quote each leg on its own bid-ask spread, so a four-leg structure like an iron butterfly can give up a meaningful part of the expected credit on execution alone. Working the order as a single spread rather than leg by leg is what keeps that cost down.

What is an example (with calculations) of this strategy?

One example of a high probability option strategy is the Short Iron Butterfly [https://marketxls.com/short-iron-butterfly-explained-excel-template/]. This strategy sells a put and a call at the same at-the-money strike and buys a further out-of-the-money put and call as protective wings, for a net credit. The long wings are what make the risk defined and let the position profit when the underlying stays near the short strike.

Take MSFT trading at $285 and build one with 30 days to expiration:

Sell 1 MSFT $285 put and sell 1 MSFT $285 call
Buy 1 MSFT $265 put and buy 1 MSFT $305 call
Net credit received: $12.00 per share, or $1,200

The maximum profit is that $12.00 credit, and it is only realised if MSFT closes exactly at $285. The maximum loss is the $20.00 wing width minus the $12.00 credit, so $8.00 per share ($800), and it is reached at or beyond $265 on the downside or $305 on the upside. The breakevens are $273 and $297. That is a defined loss on both sides. Unless MSFT lands exactly on $285 one of the two short legs will finish in the money, so early assignment on that leg is a live possibility, but the long wings cap what it can cost.

It is worth being honest about the probability here. This butterfly needs MSFT to hold inside a band roughly 4% wide, which is not a high probability outcome over 30 days. An iron condor built from the same idea, with the short strikes moved further out, collects a smaller credit but widens the profit zone considerably, and that is where the high win rate actually comes from.

Another example is the Vertical Options Spread [https://marketxls.com/vertical-options-spread/], which involves the purchase of an in-the-money option and the sale of an out-of-the-money option of the same kind at the same expiry date. With MSFT at $285:

Buy 1 MSFT $280 call for $12.00
Sell 1 MSFT $300 call for $4.00
Net debit paid: $8.00 per share, or $800

The maximum loss is that $8.00 debit, incurred if MSFT closes at or below $280. The maximum profit is the $20.00 distance between the strikes minus the $8.00 debit, so $12.00 per share ($1,200), reached at or above $300. The breakeven is $288, only about 1% above where the stock sits, which is what gives this version its higher probability of finishing in profit.

How MarketXLS Helps

MarketXLS is a comprehensive stock and options toolsheet that allows you to easily analyze complex option strategies. With MarketXLS, you can create and track multiple high probability option strategies in one place, getting real-time research and analysis on stocks, ETFs, and options in stocks. You can get insights into pricing of options and also set up stop loss and target prices, making it easy to track and manage your high probability option strategies.

Here are some templates that you can use to create your own models

Search for all Templates here: https://marketxls.com/templates/

Relevant blogs that you can read to learn more about the topic

The Benefits of Using Call Credit Spreads for Trading
Iron Condor Options Strategy – Video Explanation
Vertical Options Spread (Using Marketxls)
Long Butterfly Spread With Puts (Using Excel Template)
Iron Condor (Excel Template)