Iron Condor Trading Strategy
Table of Contents Heading
- Iron Condor
- Why Is The Iron Condors Strategy So Obscure?
- What Is Iron Condor Trading Strategy?
- What Is The Iron Condor?
- Long Iron Condor
- The Iron Condor Options Strategy
- Day Trading Using Options
A Christmas tree is a complex options trading strategy achieved by buying and selling six call options with different strikes for a neutral to bullish forecast. A vertical spread involves the simultaneous buying and selling of options of the same type and expiry, but at different strike prices. By selecting different strike prices, it is possible to make the strategy lean bullish or bearish. For example, if both the middle strike prices are above the current price of the underlying asset, the trader hopes for a small rise in its price by expiration. In any case, the trade still carries a limited reward and limited risk. The iron condor strategy has limited upside and downside risk because the high and low strike options, the wings, protect against significant moves in either direction.
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Iron Condor
We shoot for collecting 1/3rd the width of the strikes in premium upon trade entry. For example, if we have an iron condor with three point wide spreads, we will look to collect $1.00 for the trade. This gives us a probability of success around 67%, which is acceptable to us. An Iron Condor is a directionally neutral, defined risk strategy that profits from a stock trading in a range through the expiration of the options.
The position is so named because of the shape of the profit/loss graph, which loosely resembles a large-bodied bird, such as a condor. In keeping with this analogy, traders often refer to the inner options collectively as the “body” and the outer options as the “wings”. The word iron in the name of this position indicates that, like an iron butterfly, this position is constructed using both calls and puts, by combining a bull put spread with a bear call spread. Because the long, plain Condor combine a debit spread with a credit spread, that overall position is instead entered at a net debit . Our max profit on the trade is whatever price we collect to put the trade on.
Why Is The Iron Condors Strategy So Obscure?
One of the worst things you can do is quit trading Iron Condors after a bad period, because chances are a good period is right around the corner. There’s an argument to be said that you should trade them in a consistent manner ever week or every month.
Iron condors will make money in the middle 3 situations and sometimes, if they are managed well, can make money in ALL of the five scenarios. Earlier today, I sat down with Andy Crowder to dig into his amazing income trades. You didn’t explain the formula to determine at any instant whether one is ahead or behind in profitability for a condor i.e. when to get out. This is because you’ll make a larger profit if you turn out to be right on your prediction. The width of one side of the spread is $5, since the difference between 100 and 95 is 5. Now, understanding when implied volatility is actually high is out of scope of this post, but you can check out a post I made just about this topic. So, when you initiate this strategy, you are actually receiving cash upfront.
Within a few days, RUT had dropped from 1575 to 1508 and the trade was becoming skewed with too much positive delta. The first one was opened on January 30th, 2018 and was a long-term Condor trading the June expiry. Another thing to consider is to adjust allocation levels depending on the current level of volatility. Allocation levels depend on risk tolerance so some people may prefer to go higher. The decisions of when and how to adjust should all be part of your trading plan and you should know in advance what you are going to do should a big move occur. Likewise, an option with a gamma of -0.05 will see its delta decrease by 0.05 for every 1 point move in the underlying.
What Is Iron Condor Trading Strategy?
With Iron Condors, this means trading longer-dated positions as discussed earlier. For this reason, the last week of an options life is referred to as “gamma week”. At the end of the day, all trading is risky, no matter the strategy. Unless the market makes a catastrophic move, you are unlikely to suffer a max loss on a trade. Even if you have $200,000 available for trading options, just start with $10,000 and get a feel for how things work. Ideally, you want to have around $5,000 to $10,000 at a minimum to start trading options. The only way to 100% eliminate this risk is to close out the options on the Thursday before the close.
In fact, in some respects, it’s better to start with a small account while you are learning. The main reason to exercise an option early is to receive the dividend, and the option would have to be deep in-the-money to do that. While not a huge consideration, ETF’s pay dividends while index’s do not. When an ETF goes ex-dividend, the price usually drops by the amount of the dividend. There are a lot of brokers offering commission free trading these days so commissions are less of factor than they used to be. Slippage can really eat into your profits and it takes some practice and experience in order to get good fills. But, we are concerned that further downside will see our losses start to pile up pretty quickly.
What Is The Iron Condor?
An option trader who considers a short iron condor strategy is one who expects the price of the underlying to change greatly, but isn’t certain of the direction of the change. This trader might also consider one or more of the following strategies. A long iron butterfly is very similar to a long iron condor, except that the inner, short strikes are at the same strike. A short strangle is effectively a long iron condor, but without the wings. It is constructed by writing an out-of-the-money put and an out-of-the money call.
The iron condor is formed from the short positions – which form the body and the long positions which form the wings; the iron portion of the name comes from the fact that both call and put options are used. To avoid taking a full loss, if the market does what it typically does and trades in a range, then you don’t need to do anything, and you can let the whole position expire worthless. However, if the market moves strongly in one direction or another and approaches or breaks through one of your strikes, then you must exit that side of the position. A combination generally refers to an options trading strategy that involves the purchase or sale of multiple calls and puts on the same asset. The profit/loss diagram of an iron condor trade is similar to a large bird with wings.
Long Iron Condor
They provide enough implied volatility to make a nice profit, but they don’t have the real volatility that can wipe out your account very quickly. The probability of loss can be reduced, but reward potential is also reduced (choose further out-of-the-money options). Most often, the underlying asset is one of the broad-based market indexes, such as SPX, NDX or RUT. But many investors choose to own iron condor positions on individual stocks or smaller indexes. An iron condor spread is constructed by selling one call spread and one put spread on the same underlying instrument. In the figure below we can note Twitter shares trading in a price range. Simply choose the strike prices that are outside of the range price.
For example, if we sell an Iron Condor for $1.00 then our max profit is $100 per spread. We make money on the trade as long as the stock or ETF price stays between the strike prices of the call and put options that we sold to open the trade. Step 1 is where the trader sells cash secured put options and collects the premiums on a stock that they wanted to buy at a specific price for a long term position in. If the short put options expire worthless or they are closed for a profit before expiration then the premiums end up being a 100% profit.
The Iron Condor Options Strategy
Outside of those two break even points, this trade will be a loss. You take 1 minus the ratio of your initial credit collected to the width of the spread.
An iron condor is an options strategy consisting of two puts and two calls , and four strike prices, all with the same expiration date. The iron condor earns the maximum profit when the underlying asset closes between the middle strike prices at expiration.
Remember, the long call that we bought for protection helped us to minimize our loss on the total trade. So we made money on the initial positions that we booked by Selling the options but we lost them on the positions that we booked for protection. Anyone who trades in Option is well aware that they are constantly fighting against time decay, especially when you are on the buy side. A lot of strategies that are being practised are designed with an objective to have the time factor work for them rather than the other way around. One such strategy that can make the time decay work in your favour is the ‘Iron Condor’. Watch a video to learn how you can approach risk management when trading options.
Conservative investors seeking monthly income, such as those using “The Monthly Income Machine,” understand the recurring income producing power of plain option credit spreads. Then we’ll review a powerful Iron Condor strategy for screening for what we consider the best Iron Condor option spread candidates among stock-, ETF-, and Index-underlyings.
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Now, I’m not trying to oversimplify things and create straw man arguments because a veteran iron condor trader would argue that there are things you can do to avoid those maximum losses. Iron butterflies can also be inverted so that long positions are taken at the middle strike price whileshort positions are placed at the wings. This can be done profitably during periods of high volatilityin the underlying instrument.
An option with a gamma of +0.05 will see its delta increase by 0.05 for every 1 point move in the underlying. The psychological aspect of trading a $200k account is much different to a $10k account. Then, when you’ve been trading for a year or so, SLOWLY build your account from there.
An iron condor spread has two break even prices because you can potentially lose to the downside on the put credit spread or to the upside on the call credit spread. This is because the iron condor strategy is defined risk, so you know going into the trade what you could potentially lose if things go south. Calculating your maximum potential loss on an iron condor trade requires a little bit of math. You need to initiate the iron condor in high implied volatility environments and wait for a volatility contraction. Doing this will let you sell expensive options that will quickly decay when implied volatility contracts. Implied volatility is the “extra dimension” to the price of an options contract that many beginner traders miss. This is also the reason why the iron condor options strategy is such a high probability strategy (greater than 70%).
You can see that the market went from Contango to Backwardation and the impact of the volatility spike was greatest in the front month options. The spike was nearly twice as big as the previous biggest spike.