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Speaker: I got an email today from a member. Actually I'm not sure if he is a member, but
I got an email today and it was a question about the � how do you find the credit on
a credit spread, how do you find the ROI. So I figured I do a video called Iron Condor
Math and in this video, I aim to make it easy for you to understand the dynamics between
the math behind the Iron Condor and how the numbers play into effect, how to find your
ROI, how to find the credit, math loss, etcetera.
So on the screen here is the actual email that I received. The person here has looked
at a Amazon Iron Condor and he has set it up for me. So basically what this is saying
is that he is doing sell to order � sorry, sell to open three November 250 calls at a
price of $0.53. He is buying three November calls, 255 calls at $0.33. He is selling three
November 195 puts at $1.64 and he is buying three November 190 puts at $1.17. So the first
thing to look at is this is condor itself setup correctly and it seems that it is setup
correctly, the prices seem to be about right. It does look like it's much more skewed for
� on the put side, it's close to the puts than the calls, but that might just be because
the puts have more value.
So basically he is asking � he is setting this up anything that has commissioned for
$55, so he had a credit of $164. He�s taken out minus the one 500, minus the 164 which
is 36 in session [00:02:00]. But I looked at this and this is basically incorrect right
here. So let�s go through this step-by-step and we can see what he did wrong and basically
how to do it right.
So the step one, what is the credit on this tree. Here is the actual tree that we have
here and what I want to do is I'm going to break it up to make it easy. So let's do the
calls and then let�s do the puts. So basically for the calls, we have $0.53 is what we�re
getting as a credit because we�re selling these and we�re paying $0.33. So it�s
$0.53 minus $0.33, so we have that here. $0.53 minus $0.33 were left over, we got $0.20 left
over. Now we have to multiply this by a hundred, because we�re getting $0.20 per share and
in every option there were 100 shares. So it�s $0.20 times 100 shares and here we
have times three because he is doing three credit � he is doing three condor if you�re
doing three spreads. So we multiply it by three and we guess we get $60 of credit for
the call side, only on the call side.
For the puts we have $1.64 minus $1.17 right down here, $1.64 minus $1.17, you get $0.47
credit times a hundred, because we got to multiply per share and then we got three spreads,
so we�re doing by three, $0.47 by 100 by three equals $141 for the puts. You add these
both up together; you have a grand credit total of $201 on this trade, okay. So that�s
how you do the credit. Basically you take whatever you got minus whatever you paid times
the hundred, you always have to time it by hundred and then as many spreads as you did.
So if you did only one spread then we wouldn�t have done � we wouldn�t have to multiply
it by three. It [00:04:00] would have just been 0.2 times hundred equals 20. But since
you did three spread, then you have to multiply it by three, all right.
Step two, what is the max loss. So now that we have the credit, we have to find out what
is the maximum we can lose. And the formula for that is the max loss is the difference
between the strikes times a hundred minus the credit. So let�s do it and example that.
Now in this scenario, the difference between the strikes is $5, because he did say $200
in $205 strikes. So there is $5 difference between the strikes in the calls and the puts.
Now you take that and you multiply it by a hundred again, because there are hundred shares
in every option, so we have $500 per spread, that�s the value, $500 per spread. Now we�re
doing three spreads, so we have to multiply it again by three, so we have a value of $1,500,
okay. Now we minus the credit from that, so we got $1,500 minus $201 which was our credit
equals $1,299 which is our max loss. Now this is the most we can lose on the trade, $1,299,
the credit which is $201 is the most you can make on the trade.
So you got the most you can make and then the most you can lose. This is our max loss
right here. This is also called the margin, because that is the amount that�s going
to be required that you have in your account to cover this amount. The broker is going
to make sure that you have this $1,299 in your account in order to do this trade. If
you don�t have this, you can�t do the trade. Now if this is an Iron Condor trade,
the margin is only taking on one side and it�s also a balance trade meaning that the
difference between the strikes is $5 on the calls and the puts. If he had done $5 between
the strikes and the calls and $10 between the strikes and the puts [00:06:00], then
we would have had to use the $10 number as the difference between the strike.
If you do other trades, then depending on the broker you might have to have a margin
on both sides. So in this case, you're doing balanced and it�s on the same month and
it�s on the same underlying, so you only have margin on one side of the trade, okay.
So now step three, how to find the ROI. The potential Return on Investment is found by
dividing the credit that we got by the maximum loss. So now if you remember the credit we
got with $201, we divide that by the $1,299 maximum loss and we come up with a potential
Return on Investment of 15.47%. This is the maximum you can make on this trade.
Now keep in mind that this is before commissions. Once the trade is done, you can subtract the
commissions from the ball fit and figure out the ROI. So I like to do the commissions at
the end of the trade. I don�t like to put them in the middle, because the commissions
that he accounted in were only for getting in. You might get out of the trade early if
you don�t let it go to expiration, you might get out early and if you get out early you
might have commissions for that as well as you might have to do some adjustments on the
trade. And if you do adjustments on the trade, then that will change your maximum credit,
it will also change your commission structure.
So the best thing to do in my opinion is to wait till the trade is over then you subtract.
If you have a profit on the trade, then you subtract the commissions as your cost from
the amount that you made and then the leftover is your actual profit. You divide that by
the maximum loss and you get the total ROI. If you have a loss on the trade, you have
to add in your commissions and then you divide that by that max loss and then you get your
ROI on the trade or your profit and loss on the trade from that. So basically there is
three steps, number one, what is the credit, step number two [00:08:00], what is the max
loss and then step three is dividing the credit by the maximum loss that gives you your potential
ROI.
So I hope this little video made sense. If you have any questions, please feel free to
email and we'll hope to answer your questions either via email or in another video. Thanks
a lot. Happy trading and hope to see you soon at optiongenius.com.