A Bearish Iron Condor in SPY

We, as options traders, have the ultimate advantage over other investors.
Unlike most investors, we have the ability to structure our positions in a way that generates profits regardless of the direction of the underlying stock or ETF.
Take for instance the iron condor: an options strategy that thrives when the market goes nowhere. It generates above-average profits when the underlying security remains range-bound for the duration of the trade, which in our case is typically 30 to 45 days.
The best part is that we have the ability to choose our return. Just keep in mind, the higher your expected return, the higher the risk.
Here’s my step-by-step approach to iron condors in basic terms. If you wish to learn more about how I trade iron condors, check out my upcoming webinar. The educational webinar will be followed by an extended Q-and-A session to help get you started.

The Bearish Iron Condor

OK, let’s get started.
First, a disclaimer of sorts. If you don’t understand the terminology, don’t be discouraged. Focus on the concept. Pay attention to the numbers; you’ll learn the terms with repetition. Best of all, if you need some help, just email me at [email protected] and I will gladly attempt to answer your question.
An iron condor strategy is a non-directional options strategy that profits when the option on the underlying stock or exchange-traded fund of your choice expires within your chosen range at expiration.
The basic premise of the strategy is easy. You choose the price range of the trade. Increasing the range will decrease your potential profits, but will increase your likelihood of success.
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, at least in most of the ETFs I trade.
For instance, take the heavily traded SPDR S&P 500 ETF (NYSEArca: SPY).
The ETF was recently trading for $182.86.

SPY is just one of 50 to 60 ETFs that is considered “highly liquid” among most options traders. I focus my attention on roughly 30 of those ETFs.
I then move on to my mean-reversion indicator, otherwise known as RSI.
RSI can be seen at the bottom of the SPY chart above. You’ll notice peaks (overbought) in green and valleys (oversold) in red. I typically want to place a trade when the indicator is in between those areas. It’s called being in a neutral state, but I’m going to offer a slight variation to the strategy today due the bearish nature of the current market. I’ll get to that soon.
An appropriate implied volatility rank and implied volatility percentile is also needed.
Without going into great detail (I’ll save that for the webinar) the IV rank and IV percentile simply tells us if the implied volatility is high or low in the highly liquid stock or ETF that we want to trade.
If it’s normal to high, we want to trade it. Of course, there are a few exceptions, but I’m not going into the details here. I’ll save that for another time.
A normal-to-high IV rank and percentile just means we can sell options for fair-to-inflated prices. And as anyone who sells anything for a living, your preference is to always sell your product for inflated prices. Options are no different.
Typically this type of setup occurs when a security moves from an oversold state back into a neutral state. When a security is oversold, it has trended lower, and as a result, fear has increased. The increase in fear inflates the price of the option, because more investors are buying options for protection. And that’s the reason why prices are skewed slightly higher for put options.
So, assuming SPY’s implied volatility is at least slightly above historic volatility, we can proceed to the next step: choosing your return.
Again, SPY is trading for roughly $183.
I typically like to start with a trade that has a probability of success around 80%, if not higher. But I use 80% as my starting point.
First I look at the call side of the iron condor, also known as a bear call spread. I want to find the short strike with an 80% probability of success.

The March 193 calls fit the bill, as it has an 80.02% probability of success.
Next I take a look at the put side with the same goal in mind: a probability of success of 80% or higher. However, since I am little bearish on the market I want to increase my probability of success slightly. I’ll have to forgo some of my potential return to do so, but it’s a reasonable approach given my view on the market.

At 85.64%, the March 162 puts work. If I were to go with my typical 80% probability of success I would need to sell the 167 strike. But again, in this example I want to take a more conservative approach, so adding a 3% margin of error to increase my probability of success by 5% is worth forgoing an additional $0.08 in total premium on the iron condor trade.
So, right now I have my starting range of $193 and $162 established. Obviously, I can alter it as needed, but first I want a good base for my iron condor trade.

What’s the Return?

By selling the 193/191 bear call spread and the 162/160 bull put spread simultaneously – thereby forming an iron condor – you can make $0.48, or 31.6%, over the next 33 days.
Again, with SPY trading at $183, the liquid ETF would have to breach the break-even levels of $193.48 or $161.52 by March expiration before the trade begins to take a loss.
It would take a 5.8% move to the upside or an 11.4% move to the downside over roughly a four-week period before the position is in jeopardy of taking a loss.
Best of all, the probability of success on the trade is a staggering 80% on the upside and over 85% on the downside. I like those odds.
I typically manage the trade by taking a loss if the spread increases to around $0.90-$1.00 – roughly double the premium sold. I want to keep my losses small, knowing that I can make up for the loss if all goes well in the next trade.
Remember, we are trading math here. It’s all about allowing the probabilities to work themselves out, so we want to try and keep losses to a minimum, knowing that if the statistics play out, our wins should far outweigh our losses.
Again, if you wish to learn more about how I trade iron condors, check out my upcoming webinar.