In mid-2023, choices dealer Tom King (with 30 years of buying and selling expertise) printed this video explaining his favourite technique, referred to as the 1-1-2.
It’s known as the 1-1-2 as a result of it consists of 1 out-of-the-money lengthy put choice, one quick put choice under that, and two quick put choices under that.
Sure, that’s right.
You’ve got two bare short-put choices.
Or ideally, it must be cash-secured put choices.
The commerce is supposed to run to expiration except it reaches its exit loss set off first.
Doubtlessly, you’ll be obligated to buy inventory on the strike worth ought to the quick put expire within the cash.
Though, this might be an unlikely state of affairs.
Based mostly on how the commerce is about up, it has a theoretical win price of 95% (as a result of the 2 quick places are sometimes out on the 5-delta location).
Nonetheless, it’s best to do that commerce on liquid property the place you don’t thoughts buying the inventory at a reduction.
That is akin to step one of the Wheel technique.
In case you get assigned, take the inventory and promote coated calls, exit, or no matter you want.
Whereas more often than not, when the inventory isn’t assigned, you accumulate common credit.
This can be a commerce initiated for a credit score to attain no upside danger.
Let’s take a look at the evaluation graph. Whereas Tom King likes to commerce this on futures, we’re doing this instance on SPY (the S&P 500 ETF).
The graph was constructed with an out-of-the-money put debit unfold at across the 25 delta, After which the sale of the 2 quick places additional out-of-the-money to get a internet credit score.
Date: June 23, 2023
Worth: SPY @ $433
Purchase one Sept 15 SPY $415 put @ $5.06
Promote one Sept 15 SPY $410 put @ $4.34
Promote two Sept 15 SPY $360 put @ $1.10
Internet credit score: $147
The proceeds of the quick places must be better than the price of the put debit unfold in order that we get a internet credit score, which in our case is $147.
The web credit score is what makes the commerce don’t have any upside danger.
You’ll hold this credit score if all of the put choices expire out of the cash.
If the value expires within the lure (the excessive hump on the expiration graph), the commerce will make about $650, about 4 instances the credit score.
The shopping for energy discount relies on your account and dealer, however a commerce like this sometimes makes use of up $7273 of shopping for energy.
$147 / $7273 is 2% in 81 days, as much as 9% annualized. This instance commerce has been configured for a smaller revenue potential than what Tom King would do. However it’s extra conservative for a bearish market.
Tom King tries to focus on at the very least 3% monthly, or 36% annualized.
The construction is versatile sufficient so that you could regulate the strikes relying on how bullish or bearish you are feeling.
If extra bullish, then set it up with better upside credit score.
This credit score is seen in what is named the “tail” of the expiration graph.
If extra bearish, then set it up with a bigger draw back lure.
The hump within the expiration graph is named the lure as a result of if the value falls in there at expiration, your good points will be 3 to 4 instances as massive as what you get on the tail.
Alternatively, you may view the commerce as promoting premium from the quick places hedged by a put debit unfold.
If the quick places have gained 95% of their potential revenue, purchase again the quick places to shut them.
Now you simply have a free hedge to your portfolio in case of a black swan crash.
If the commerce loses an quantity equal to the max potential revenue of the commerce on the lure, exit the commerce earlier than dropping any extra – except you’re prepared to take project on the underlying and hold it as a long-term holding or use it for the Wheel technique.
It’s also possible to take into account rolling the quick put out in time to obtain a credit score and doubtlessly delay or forestall the project.
In any other case, maintain the commerce to expiration (or at the very least very near expiration) to seize the complete revenue potential of the commerce.
This isn’t a tough rule.
If, for instance, the value is within the lure and also you see the value about to rally out of the lure, you would possibly wish to shut the commerce to lock the revenue as an alternative of taking the smaller revenue of the tail.
Alternatively, you may lock in earnings by narrowing the width of the put debit unfold.
We’ve used 81 DTE (days to expiration) on this instance. You are able to do the 1-1–2 wherever from 45 days or larger DTEs.
There are benefits to utilizing a good long term, though I do know a few of you will not be used to those super-long DTE trades.
Tom King is utilizing 120 DTEs.
How is the 1-1-2 totally different from promoting a strangle?
Each are non-directional premium-selling methods earning money as time passes.
The quick strangle is extra environment friendly as a result of it might probably generate better earnings with much less shopping for energy.
It’s extra environment friendly as a result of the strangle has no hedges (therefore no “friction”).
Nonetheless, it has dangers on either side ought to the market go up or down considerably.
The 1-1-2 is a extra conservative commerce with no danger on the upside.
It has a debit unfold as a hedge. By being safer, it has much less return potential.
How is the 1-1-2 totally different from a cash-secured put?
A cash-secured put and the 1-1-2 are undefined danger methods with limitless danger on the draw back.
Nonetheless, the 1-1-2 has a put debit unfold hedge; the cash-secured put doesn’t.
This makes the 1-1-2 draw back danger additional out; therefore, some would say it’s a extra conservative commerce.
How is the 1-1-2 totally different from the put-ratio unfold?
It is rather much like a put-ratio unfold in that each will be constructed with no upside danger.
And each have limitless draw back dangers.
The distinction will be seen on the expiration graph, the place the ratio unfold has a triangular peak.
The 1-1-2 has flattened out that peak in order that its max potential revenue is much less however has a wider vary by which it might probably revenue.
This can be a good income-style technique so as to add to your portfolio.
Nonetheless, as Tom King talked about in his video, he doesn’t danger greater than 2% of his portfolio in any single commerce.
He makes use of solely half of his account dimension for buying and selling.
And he by no means allocates greater than 30% of that to any buying and selling technique,
We hope you loved this text on the Tom King 1 1 2 earnings technique.
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Disclaimer: The knowledge above is for instructional functions solely and shouldn’t be handled as funding recommendation. The technique introduced wouldn’t be appropriate for traders who are usually not conversant in trade traded choices. Any readers on this technique ought to do their very own analysis and search recommendation from a licensed monetary adviser.