In today’s article we’ll be exploring another dimension to risk while trading options. Most people only consider the mathematical probability of a trade, but as an option trader myself I always consider the “Comfort Zone.” You may ask what is this so called Comfort Zone?
The Comfort Zone is a place where I can relax knowing that my option position is perfectly safe. Not only is my position not at risk, but I can also make money in the Comfort Zone. In this video we are looking at traditional Iron Condor. We notice that when we consider the Comfort Zone, the probability of the trade is only about 36%. This is a very low probability. If we consider the probability on the trade ignoring the Comfort Zone then it’s actually about 83%. This means that the majority of the probability on this trade is actually in the “Danger Zone”. To me, this is a very risky and stressful trade to be in.
Observing the Calendars Spreads and ATM Butterflies, it is evident that their Comfort Zone is just like that of the Iron Condor’s. Hence, it could be difficult to handle these trades in an erratic market. The reason why these trades are not a good option at the moment is because of the trends in the stock market. The market usually has an up-down movement as opposed to a sideways one. In the video, when you study the price chart, you will notice that the market moved sideways only three or four times during the last year.
In contrast, the price chart indicates that the stock market went up and down 12 times over the last year. This shows us that we can forecast an up or down move easier and more consistently than a sideways move. Having this information we can conclude that over the recent period of 12 months we will could have found more bullish and bearish trades than we would have neutral trades. And the interesting thing is that with by constructing bearish and bullish trades, we can increase our Comfort Zone probability to about 85%. So not only do we have more trade opportunities within a one year period, but we also have a higher Comfort Zone which increases the quality of our life as well as our returns.
To conclude, the Comfort Zone can be defined as the ‘”Realistic Probability” of a given trade option because we really should consider ‘Risk’ when we analyze our trades.
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