Upbeat music plays throughout.
Narrator: Hey there, traders, Jeremy Kuhlman here, Trading Solution Specialist at Charles Schwab. There's a big Fed announcement coming up, so we're going to look at some option strategies to consider based on how you would expect the market will respond to a Fed rate cut. If you're catching this video after the announcement, stay tuned because you'll still learn some techniques that you could apply for any major announcement. I'm going to assume that you have some familiarity with options already, so if you're new to options, consider watching some of our more basic videos before this one. Now let's jump in.
Alrighty. Now, like I said, there is a Fed rate announcement tomorrow. Now, let's say, we're using thinkorswim and we didn't know that was coming up. I'm going to show you exactly where to find information about the upcoming Fed rate cut and Fed announcement on the Market Watch tab in thinkorswim.
Animation: The mouse clicks on the buttons on the left side that will show all announcements of a few such as Econoday event, Dividened, Earnings, and more.
Narrator: So let's go over here to the MarketWatch tab, and you see I've actually already sorted this to show me only economic events. Now, you could certainly use it to look at other stuff, dividends and so forth, but if you want to look at just the economic events coming up, we'll pull that up, and you can see right down here, FOMC Announcement. That's the big one. That's what everyone has kind of been waiting to hear. What we're going to do is come down in the list here, and find that FOMC Announcement. Right here, you see it's at 1:00 PM Central Time. And I'm going to click on that button, and you'll see it tells us right here, 9/17, 1:00 PM. Previous zero change. Tomorrow expected a quarter of a percent, or 25 bps. If you weren't aware of this or you wanted to, you could actually create an alert for yourself to stay in touch with this type of event that's coming up. But for the purposes of this demonstration, we're just going to go ahead and skip that part.
Now, depending on what you expect to happen tomorrow, there's a lot of different strategies you could deploy. We're going to look here at the chart to see what's going on with the S&P, what's going on with the market. Now, for today's examples, we're going to be using the S&P 500 Index option, symbol SPX. The reason for that today is because this Fed announcement could potentially move the market, and we wanted to look at a broader method of using options, rather than something as nuanced as an individual stock. You can see we're certainly on an uptrend right now at the moment, coming all the way up here to the top of a Bollinger Band. I have two studies on this chart right now. I have a Bollinger Band, and I have an RSI. The Bollinger Band is helping us understand trend, overbought, oversold, as well as the RSI helping us trying to understand overbought, oversold signals.
Now, if you look up here on the S&P 500, you can see a red candle, meaning that we had a slight pullback today. It has come down, I believe, about 11 points last check.
Now, there's a lot of different ways this could go tomorrow. We are expecting a quarter of a percent rate cut. That could make the market go up further, that could make the market go down, or maybe not move at all. You know, a lot of people are speculating that this is already priced into the market. The market has been on an uptrend, as we can see on the chart here. So let's look at three different strategies, depending on what you believe is going to occur in the market. We'll look at one that's bullish, one that's bearish, and one that's neutral.
Now, in order to decide what to use, what options to use, we're going to look at the option chain and the risk profile. Now, keep in mind this is for educational purposes only, and not a recommendation of any specific strategy.
So let's jump over there. I'm going to go over to the Trade tab. I'm going to pull up SPX again. We're looking at different options here, different expirations. Like I said in the beginning of this video, I'm going to make something very timely here, just a few days. And you can see right here we have a 19th of September expiration that expires in three days. I'm going to go ahead, and open that and we're looking at strike prices. We've got 30 strikes.
Animation: The mouse points at a dropdown menu titled Volume, Open Interest which allows the user to change the option table columns.
Narrator: I have selected the volume and open interest. I think this is generally an important thing to look at. You know, you want to understand if there's enough open interest in the options you're trading. It also might point you to… the volume might point you to an area that the market is sort of positioning itself at. If you come down here on the call side of things, you can see that we have quite a bit of volume on the 6640 call. We have quite a bit of volume on the 6650 call. There's also a lot of open interest on both of these expirations. Now, this would be a bearish trade if we sold the call vertical, and that's one example we're going to use.
But before we do that, we're going to go over here to the put side, and we're going to also look at the puts, picking the volume. Look, 1,175 puts traded here. Not as many traded in the two lower strikes, but this is definitely, there's a large amount of volume and open interest on this particular put, the 6570.
Now, let's run through first the bear trade. I'm going to go to the call side. I'm going to use the open interest as the way I'm selecting the strikes. I'm going to sell the 6640 and I'm going to buy the 6650. That's going to create a credit spread, a credit vertical. In order to do this, it's actually a nice little trick with thinkorswim, if you hold down the control button while you click on the bid and ask, it allows you to create a custom width spread. This is a $10 wide spread, and if I click there and click there, one on the bid, one on the ask, you can see I have created a 10-point-wide vertical that's giving me a credit of $3.80. Now, there is a default in the platform that defaults you to 10 contracts. For today's purposes, we're going to change that over to one, and we're going to go look and lock in the price at 3.80.
Now, at this point, what I want to do is decide if this is the right trade for me or the right trade to use. And what we're going to do for that is we're going to analyze it. So we're going to right-click on the link area. We're going to go to Analyze Trade, and you see that takes us over to the Analyze tab under the Risk Profile, and our vertical spread is shown here on the risk graph. The blue line is representing our profit and loss on the expiration of these options, and the pink line is representing our profit and loss today. Now, this is a $3.80 credit on a $10 wide spread. So our risk is the difference between the legs, less the credit. If you look on the right-hand side, this bottom line here is representing our maximum loss, and if you look in the lower left-hand corner of the screen that says $620, and if we go up here to the top, our maximum profit, $380. So exactly the difference between the two legs, less the credit. This is also representing our breakeven point on expiration, and this is showing our breakeven point today.
Now, the first thing I do when I come over to this page is I want to check the probability of this trade working out for me. So I'm going to follow this over to the right side. I'm going to click on this menu icon. I'm going to go to Set Slices, and I'm going to go over here to Break Even and pick 9/20. What you notice now, we have one line that crosses directly over our breakeven point 6643.92.
Now, if you look at this chart, it's showing you a percentage on the right side of the graph and a percentage on the left side of the graph. This percentage is the probability, theoretical probability, of this being a successful trade, meaning this is the probability of our profit, and if you look on the right side, probability of loss. So this trade has about a 63-, 64% chance of success, and about a 36% chance of loss. I like that percentage. I think that looks pretty good for me. 63-, 64% and 36%. And I'm also taking in $3.80 for this trade.
Alrighty. Now this is going to be our bearish trade. This is if we believe the market would go down from the Fed announcement tomorrow. Now, let's say, we want to do the opposite. We believe the market is going to go up tomorrow. So we're going to go back to that Trade tab, and we're going to pull up the option chain. We're going to go to the put side. If you remember I was showing you before, we have lots of volume here on the 6570, and there's a fair bit of open interest on the 6560. We want to do the same width spread. So I'm going to go over to the 6570, and I'm going to click on the bid of that option. Again, hold down the control key, go to the 6560, and now we have a credit put vertical. This is a bullish trade.
Now, I'm going to go ahead and right-click on that again, choose Analyze Trade, and go back up to the Risk Profile. Now you notice this looks a little strange right now. That's because we have both of our options on here. Let's go ahead and uncheck the call vertical, and we're going to change that quantity back down to one. Now, we are analyzing almost the exact opposite trade here. If you look, the direction is reversed. Maximum profit is up here, maximum loss down here, and breakeven, again, on the two lines.
Now, our breakeven point is off now because that was set to the call side before. So now let's set it over to the put side. We follow the price slices over here to the right, click on that, set slices, go to Break Even and pick 9/20. Now again, both of these options that we're looking at today expire on the 20th of September. So very short-term, very timely. Depending on what happens in the next couple of days, these could work out, or, you know, who knows. But we are using this tab to help us understand that. A very, very beneficial area of the platform for anyone trading options. And we have lots of education on this particular area. It could be quite complex. So we're covering some high level items today, but there's always more to learn.
Now, let's look on the left hand side. You can see our probability success on this trade is actually giving us 64% chance probability success, and 35% probability of loss. This is a breakeven point, so making a penny or more, or losing a penny more on the trade, not probability of maximum profit or maximum loss. So you can see I actually got these very close to one another. Our other one was about 64%. This one was about 35%. And I did that just by looking at a general open interest and volume, help me understand kind of, again, where the market is sort of positioning.
Now, this trade is successful if the market goes up. This is our bull side. Now, let's say, we want to look at the other one where it goes down. Now, if I unchecked this, you can see this one is successful as the market goes down.
Now, guess what? I said I was going to position a third trade for you, and that was if the market doesn't move at all. And guess what? It's adding these two together. So if I come down over to this vertical spread and check this box, you can see I have created another type of trade called an iron condor, and this is allowing us to position ourselves in the center of the market. So if the market doesn't move up or doesn't move down, that's when we win. And you can see our top here. This is our maximum profit. Our maximum loss is on the right side wing and on the left side wing. Now, an iron condor has two breakeven points, and they'll be based on each vertical. So the put vertical and the call vertical will dictate our breakevens.
Now, we're going to follow this over here to the right-hand side. Again, price slices, set slices, Break Even, 9/20 again, and you can see right here. So we're looking at this iron condor. You notice there's three different probabilities. A 36% chance of this stock going above our breakeven, a 30% chance of it going in between the two breakevens, and a 34%, 33.97% chance of it being below our breakevens.
Now, if you remember, we were looking at each individual vertical before, and those were giving us about a 64% chance of success on the trade. And if we look at this iron condor, well, this is only giving us about a 30% chance of success on the trade. So let's say we're not really happy with that percentage. What we can do is actually make adjustments to the individual strike prices, widen out the call side, widen out the put side, and increase this range that we're creating, and thereby increasing the probability of the iron condor working.
Now, keep in mind if you make those kinds of adjustments widening out this spread, well, you're going to lower the credit you take in, and you're going to also lower your potential gains, as opposed to your overall risk.
Now, I'm going to show you a little trick that I really love to use when we're going to be using these breakevens. If you follow this over to the right-hand side, we're going to go to set slices. We're going to set slices to charts, and I'm going to click on this little square right here. And what I've done is actually add those two breakevens to my chart. So now I can come back, do some technical analysis, look at the upper and lower levels of this trade working out, and make my decisions to place which one I want to make.
Now, for today's purposes, I'm going to look at the bearish trade, rather than the bullish. So we're going to go back over here, Analyze. I'm going to uncheck that put vertical. I'll just raise this up a little bit. Uncheck that put vertical. I'm going to send the call vertical. Go ahead and see if I can get this filled. Go back up to the Monitor tab. Looks like I filled. And you can see SPX down here. Two options, short one, long the other, three days, hoping the Fed announcement makes the market come down a bit. And we have a very short-term trade here, only three days to expiration.
So that's three different ways a trader could use options around a big event like a Fed announcement, whether you're bullish, bearish, or neutral. Out of the money credit spreads can be a versatile strategy because they allow you to choose the probability that best fits your preferences.
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