How Karen the Super Trader Makes Money
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Karen the Super Trader was a Certified Public Account (CPA) and she quit her CFO job to become an options trader. From 2007, she turned $100,000 to $41 Million by 2011. And that’s not all — on YouTube, you can find updates from her in each subsequent year. In 2014, she was managing $390 million dollars for investors.
Obviously, she’s smart and mathematically inclined, but Karen represents the top .001% of retail traders who have been able to make highly consistent returns. And she does it without betting where the markets will go.
Instead, she takes a mathematical approach to trading by selling way out-of-the-money puts and way out-of-the-money calls –a super wide strangle. She bets that the market will stay within where it is statistically like to be 95% of the time.
In math, assuming a normal distribution, this is the 2-standard-deviation range based on where the stock has been in the past — where it is 95% likely to stay within in the near term.
Karen specializes in the S&P Index (SPX) and legs in with both bull and bear credit spreads — which form iron condors when combined together.
Example
So if you imagine an index trading at 100 (for simplicity purposes). Based on how this index has fluctuated in the past (volatility) – there is a mathematical probability of 95% that it stays between, say, 85 and 115.
What Karen does is she bets that the index will indeed stay between 85 and 115. Hence, her probability of success from a mathematical point of view is 95%. She is placing 95% probability bets.
However, whenever the mathematical probability increases, the amount of money you can make from that bet gets smaller and smaller. We’re talking collecting pennies per option contract at the low-end wing of 85 and the high-end wing of 115 — versus 50 cents or a dollar or more.
So she’s placing high-probability bets but receiving just a small amount.
Typically, brokerages don’t let you place these kinds of bets in huge quantities — they require you to put up margin. Like a lot — in order to execute one of these trades.
Say you have a 95% chance of making $1. But a 5% chance of losing $20.
In this kind of set up, the brokerage will want you to put up the $20 upfront just in case you lose. The numbers might even be more — depending on the trade and the brokerage house. If you want a 95% chance of making $1,000, you’ll need to fork over $20,000. So you can’t put on any other trade. You can’t adjust or anything.
For most retail investors, this is not a good idea. And for Karen, it’s not great either.
Portfolio Margin
But here’s the difference: Karen takes advantage of something called “portfolio margin” — an extra feature restricted generally to accounts of over $100,000 that let you reduce the required margin for these edge case type trades that she does.
So instead of putting up $20, she may only need to put up $10 to make that 95% chance bet of making $1.
This changes the game – as Karen says in the video.
So the typical retail investor with trying to use this strategy will probably be limited to peanuts even if they max out their account with this trade.
But Karen’s portfolio margin account doesn’t require as much margin, so she’s able to make more than just peanuts on her trade. She’ll trade large quantities — big bets that the market won’t hit those lower or upper edges within a certain time period. As long as that doesn’t happen, she collects the maximum profit of her trade.
In the event she is wrong, she’ll know she is on track to being wrong early on and she’ll adjust her trade.
Adjusting the 2 Legs of the Trade Individually, Not Together
For example, let’s say the index is at 100 and she shorts the 85 strike put — betting with 95% probability that the index won’t close below 85 by expiration (which is usually 56 days or 2 months out) . Her 85 strike put has a 2.5% probability of being “in-the-money” by a certain date.
When the index drops from 100 to 88 — and her 85 strike put that she shorted increases from 2.5% to 30% chance of being in-the-money—then that’s typically when it gets her attention.
At this point she can do any one of the following:
- sell the 102 calls – Now that the index is at 88, the value of the 95 calls (which were previously below 100 and not worth that much) — are now above where the index is trading (88) — and are now worth at least $7 (the 95 call – 88 index = 7) –plus a little bit of time value. Selling this $7 means she gets to collect $7 — and this can help offset her unrealized loss from her original bet of shorting the naked put.
- get rid of the 85 put — take the loss and move it to the 80 strike put–and perhaps double the size of the 80 put. In the event there is a bounce in the index from $88 to $92 — then she’ll take off some of her position to realize gains from the bounce.
- keep the 85 put — but take the loss and move it to the next expiration month so there’s more time
Each time she is adjusting a trade — she is making a trade that is 2 standard deviations away in either direction — so it is extremely unlikely that her trade will be wrong. It’s just that in the event that it is — she adjusts it one side at a time.
This differs from how most options beginners are taught to trade. Most options beginners are told to sell a strangle as a single trade. And if it goes bad, then cover the strangle at a loss. But Karen manages it differently. She treats each side separately, individually. If the index drops a lot, her puts will lose money, but she’ll gain money on the call side. She might realize the gains on the call side and re-initiate yet another short call.
So by constantly adjusting when needed – she is able to be highly consistent. She is rarely wrong
Analysis
Here’s a good analysis of Karen’s strategy
How We Integrate This Philosophy Into Our Trades
Karen takes the philosophy of focusing only high probability trades to the extreme — looking far away from where the index is trading and betting that the index will never get past the 2-standard deviation 95% zone of where the index is statistically like to be. She is able to take such an extreme view and still be profitable because she is extremely nimble and takes advantage of portfolio margin — so she is able to scale her trades to larger quantities — something the average retail investor with <$100,000 cannot do.
We share Karen’s philosophy of focusing only on high probability trades — just not to the same extreme. We take it down a notch so we have a slightly lower probability of success — but still pretty high — in the 75% probability range —and we use wave theory and other technical analysis to help us increase that probability beyond the mathematical probabilities.
Since we don’t use portfolio margin – we are not able to sell naked puts and naked calls with unlimited risk in large quantities. Instead, we do the next best thing — which is super wide iron condors — which effectively mimic super wide strangles.
The benefit with this approach is that we don’t have unlimited risk — the downside is that we limit our gains on either side — and we don’t capture the time decay as well as the super wide short strangle strategy. But hey, this is as close as you can get to her strategy — without constantly monitoring and adjusting on a daily basis.
So how exactly are we implementing this strategy?
Well, we are are legging in credit spreads and you can subscribe to our trade of the week to find out exactly how and when we are legging in credit spreads mimic this strategy. We have a bit more of a directional strategy and we use weekly options rather than monthly options – so we generally get results within a week or so.
