If you haven’t noticed, the market has been a volatile mess or, as I like to say, there’s been a lot of slop and chop. With implied volatility levels and option prices still relatively high, it is a potentially good time to sell some neutral premium. One of the best strategies to do that is a short iron condor.
Short Iron Condor
Though it may sound daunting, an iron condor, and specifically a short iron condor, is selling two vertical credit spreads: a call and put spread. Generally, the spreads are set up at levels above which the option trader does not believe the underlying will move and close. For me, this usually means support and resistance levels either from horizontal levels, moving averages or both.
Positive Theta
The main source of potential income from a short iron condor is theta, so patience is needed. With both spreads out of the money (OTM), the position will produce positive theta as time erodes. When OTM the position has negative vega as well. If IV decreases at all, this benefits the position because vega premium would decrease in addition to theta. Let’s look at a recent example from MTM’s Group Coaching class on Meta Platforms Inc. (META), the former Facebook.
Meta Example
From the hourly chart below, you can see that the stock was trading between some potential horizontal support ($155) and resistance ($172.50) for several weeks. Knowing support and resistance have a better chance to stop or hold the underlying from moving through that level gives the trader an edge.
With 3 days to go until expiration (in this case Jul-15), an option trader can sell a 150/155 put spread and a 172.5/177.5 call spread for a credit of 1.00 ($100 in real terms) total as seen below.
The Details
Max profit, which is the credit of 1.00 ($100), is earned if all the options expire worthless at expiration. They would do so if the stock was trading at or above $155 and at or below $172.50 at expiration. However, a smart risk manager should consider closing out the position before expiration. Max risk is the difference in the strikes $5 (155 – 150 or 177.50 – 172.50) minus the credit received of a $1 or in this case $4 (5 -1). The max loss is realized if the stock closes at or below $150 or at or above $177.50 at expiration. Break-evens are at $154 (155 -1) and $173.50 (172.50 + 1) at expiration.
Follow-Up
As it turned out, the day of expiration the stock was trading in the middle of the support and resistance range as seen below. Both credit spreads making up the short iron condor would have expired worthless with the initial credit received 1.00 ($100) being deposited into the option trader’s account.
Finally
If the market continues to be a volatile beast and make things difficult for directional opportunities, there are some options. Short iron condors are just one of them but have worked effectively over the past several weeks. Good luck!
John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.
