“Iron condor” involves selling a OTM (Out of the Money) call and put option of a underlying stock and buying further out (most often the next strike price) OTM call and put option for protection. Below is the example of the trade I took this week. Please note that the trade is now closed. Do not copy and place a trade unless you are an expert and know what you are doing. This writing is only for educational purposes. Trading is risky without proper knowledge, practice, expertise and mentorship.
Beautiful thing about this strategy is that you don’t have to predict the direction of the underlying security. Doesn’t matter which redirection it goes in a short term (up, down or sideways), you can still be profitable. It’s more like predicting a range of price movement rather than predicting the direction.
RUT (Russell 2000 – small cap index) was trading at $1380 on Wednesday 26 April 2017; prices had a strong up move for last few days of trading and were showing strong bull power. It even broke resistant level from all time high on 26 April. Purple lines in the chart is Bollinger band and the white line in the middle is 20 days simple moving average. Whenever prices goes outside the bollinger band, it has tendency to come back inside pretty quickly. On 24 and 25 April prices traded outside the bollinger band, same with on 26 April. Most likely prices would either come back inside in next couple of days if not just probably travel sideways around the upper bollinger band. That gave me the confidence to take the trade. Lower strike prices were way outside the range and below major support level (Red line in the chart show the support and resistance level). My very short term prediction was that prices wouldn’t go higher then $1445 lower than $1330. And based on that, took below trade.
| Side | Quantity | Symbol | Expiration date | Strike price | Type |
| SELL | 10 | RUT | 28-Apr-17 | 1445 | CALL |
| BUY | 10 | RUT | 28-Apr-17 | 1450 | CALL |
| SELL | 10 | RUT | 28-Apr-17 | 1330 | PUT |
| BUY | 10 | RUT | 28-Apr-17 | 1325 | PUT |
As long as the prices stay in between $1330 and $1445, these contracts wouldn’t have any values after 28 April 2017 and expire worthless, as they did in this scenario. Risk to reward ratios is not attractive to this kind of trades, but most often it is compensated by the probability of success. When taking this trade, the statistical probability of not hitting those strike prices was above 90% ($1445 strike price OTM (In-the-money) probability was approximately 93% and $1330 strike price OTM probability was approximately 97%). So, that’s 93% chances that you are going to succeed with this trade.
It was weekly options, took the trade on Wednesday and expiration was Fridays close. As predicted prices came back inside and on Friday closed at $1400.42
If trades go bad due to some extreme news or something, risk is that you may loose all the capital invested. Hopefully, you will manage these trades before it gets to that stage and get out with little loss. With expertise and skills, very often these losses can be turned into even more profits. That’s another discussion for some other day.
Capital requirement to do this trade was $5000 and have received $0.25 credit per share.
| Capital requirement | $5,000 | 10 contracts, each options contract consist of 100 shares, $5 spread between strike prices (10 x 100 x $5 = $5000). Prices can either go up or down at one time, so capital required to do the entire trade based on only either CALL or PUT options. |
| Net profit | $213.05 | ($0.25 x 100 x 10 – $36.95 commission = $213.05 |
That’s 4.25% return on the capital invested in 3 days.