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Over the next three days I will be discussing, in depth, my approach to one of my favorite options strategies, iron condors. It’s a strategy that requires skill, but once learned, the strategy can provide a consistent source of income.
It’s not that the strategy is difficult. It isn’t. It takes some time to learn a few basic concepts and the mechanics. Yes, the iron condor options strategy requires being mechanical in your approach. That means discipline and a consistent plan of attack (risk management) is of the upmost importance. If you don’t have those skills in place, I promise you, you will fail.
Again, over the next three days I am going to go over the basics of the iron condor options strategy followed by an hour-long webinar on Wednesday. Click here to attend.
On Wednesday, I’m going to explain how to run the strategy like a professional. This will include take a $10,000 example and running various position-size techniques and risk-management strategies. Moreover, I will go over three, if not more, real-time trades. I look forward to seeing you all there.
Since we introduced our Iron Condor Portfolio back at the beginning of 2017, we’ve been fortunate enough to have a win ratio of 90.9%, with a 9% average return per trade.
If you have any questions prior to the webinar please feel free to email me at [email protected].
The Basics
An iron condor is a defined risk, non-directional option strategy that by my definition is designed to have a large probability of earning a small, limited profit on a highly liquid underlying security. An iron condor benefits from the passage of time and a decline in implied volatility.
Trade Setup
The first requirement when trading iron condors is to make sure you are using a highly liquid security, in most cases an ETF. Highly liquid, in the options world, just means that the bid-ask spread is tight, say within $0.01 to $0.10.
If an underlying security is in a neutral state, as stated by the RSI (5), I will create a range that is as equidistant as possible from the current price of the security. If the RSI (5) of the underlying security is in an overbought state I will skew the range towards the downside. If the RSI (5) of the underlying security is in an oversold state I will skew the range towards the upside.
- Sell an out-of-the-money call vertical spread with at least a 75% probability of success, preferably higher. This consists of simultaneously selling a call at strike price C and buying a call at strike price D. Again, this is known as a bear call or vertical call spread.
- Sell an out-of-the-money put vertical spread with at least a 75% probability of success, preferably higher. This consists of simultaneously selling a put at strike price B and buying a put at strike price A. Again, this is known as a bull put or vertical put spread.
Max Profit
The maximum profit potential for an iron condor is the net credit received by selling the out-of-the-money call and put vertical spreads. A max profit occurs when the underlying security settles between the short strikes (B and C) of the iron condor at expiration.
Breakeven Point(s)
- Vertical Call: short call strike (C) + credit received
- Vertical Put: short put strike (B) – credit received
Now, the Good Stuff
So, now that we hopefully have a fairly firm grasp on the mechanics of a basic iron condor trade, let’s take a look at how I approach iron condors and why they are one of my favorite options trading strategies.
The basic premise of the strategy is easier to understand in the chart below. But the key part, and the real advantage of this trade is:
You choose the price range of the trade. Increasing the range will decrease your potential profits, but will increase your likelihood of success.
Here is an example of a typical Iron Condor trade in the SPDR S&P 500 (SPY).
The blue lines define how far the SPY can move up or down before the position I am interested in pursuing is in jeopardy of taking a loss. You can clearly see that this range is from $250 and $228.
Notice that I am a bit wider on the downside. Simply stated, markets crash lower, not higher (although recently I think I could argue this alleged truism.)
The underlying SPY is trading for $243.77 and I would like to establish an iron condor for August expiration.
I typically go out 45-60 days and ladder the positions about every 15-20 days, which is a different approach than most. The reason: it allows me to increase my defined range while simultaneously bring in more premium on a consistent basis. I do not intend to allow my iron condors to expire worthless. In fact, my intention is to take off the trade when there is 15-30 days left until expiration. There will be some exceptions, but I have found through extensive research that going out roughly 60 days and taking off the trade when there are 15-30 days left until expiration is the most profitable approach.
Here is a theoretical trade:
Simultaneously:
Sell to open SPY August 250 calls
Buy to open SPY August 252 calls
Sell to open SPY August 228 puts
Buy to open SPY August 226 puts for $0.50.
How do I select my strikes…it’s all in the probabilities
Call side of the Iron Condor:
Put side of the Iron Condor:
I wanted to choose an iron condor trade with a probability of success around 80% to 85% which is why I sold the 250 calls and 228 puts. In using my approach, I want to have a probability of success over 80%, in most cases over 85%.
Again, it’s all about the probabilities when selling options. The higher the probability of the trade the less premium you are able to bring in. I tend to side with the odds, which is why I choose a higher probability of success for most trades. I would say at least 70% of my trades fall hover around an 80% probability of success. The rest are typically more aggressive, but as always, I have a disciplined plan of attack with a consistent position-size per trade. This keeps my levels of risk at reasonable levels.
So, with a range of 22 points (250-228) and SPY trading for $243.77, the underlying ETF can move higher 2.6% or lower 6.7% over the next 64 days before the trade is in jeopardy of taking a loss. Of course, the goal is to take off the trade early, preferably with 30 days left until expiration.
The iron condor options strategy will make 33.3% if it closes within the established range by August expiration, but I am more than happy to take the trade off when our profit potential reaches 50% of the premium. By taking off the trade for $0.25 we are still able to reap a 14.3% gain. An average gain of 14.3% per trade is certainly worth the high-probability of success.