Let’s define the iron condor option trading strategy. This strategy profits when the stock or index being used does NOT make significant moves. Usually option trading investors use trading techniques that best leverage current market conditions. However, many times the options being use expire worthless due to the fact that many times there is no significant movement in the market. These types of trading range markets are ideally suited for the iron condor option trading strategy.
You can imagine the iron condor strategy trade as a purchased strangle and a sold strangle. A “strangle” is where a trader buys an an out-of-the-money call as well as an out-of-the-money put option. Strangles’ premiums are less than those of straddles due to the fact that the contracts are out of the money. A different way to imagine the iron condor option trading strategy is to think of it as 2 credit spreads – a bull put spread and a bear call spread. The trade has purchased calls and put options above and below the short options to protect from a large unforeseen movement in the underlying.
Say that the SPX is at 1290 and you purchase the July call option at 1360 bringing in a credit of two hundred fifty, and at the same time you buy a put option for five dollars. As long as you have chosen a broker that is options friendly – you just need to make sure that you have the funds available to margin the difference between to the strikes. In our imaginary scenario you’ll need $1,300 for this spread.
The calculation would be:
1375 at $2.55
1355 @ 4.50
That means that the premium that has been brought in is right around 2 dollars.
Here it is broken down – $15 dollars minus $2 dollars: $13 dollars – times 1 spread of one hundred contracts of the underlying = $1,350
If the underlying finishes the trading cycle below the sold options, the trader gets to keep the entire credit which can translate to a great return in a short period of time.
The above is one wing of the iron condor, and it’s the call spread. To construct a fully placed iron condor, one would need to add a bull put spread – which is a put credit spread – below where the underlying is trading at.
The iron condor options strategy works beautifully when you know what you’re doing and there are options traders who use it almost exclusively. However, of course there are risks involved.
Some of the essential elements to trade the iron condor strategy effectively is to understand how to pick the underlying – knowing how to enter, exit and adjust properly – and knowing when to get out of the trade if the position starts to go bad. And perhaps the most important of all of these is understanding how and when to correctly manage and adjust the position. Not having a solid grasp on how this trade works – or not having a plan in place for what you will do if one of these trades ever moves against you (which it will eventually do) could wind up costing significant losses. Try to guess how I know.
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