In MTM’s daily group coaching class, we have modeled out several iron condors recently including one in Boeing that we’ll explore below. A short iron condor is a generally market-neutral strategy that combines two credit spreads. A call credit spread is implemented above the current stock price and a put credit spread is implemented below it. The objective of any credit spread is to profit from the short options’ time decay while protecting the position with further out-of-the-money (OTM) long options. If the spreads continue to trade OTM, they each will produce positive theta.
How an Iron Condor Works
The iron condor is simply combining both the call and put credit spreads as one trade. The trade is based on the possibility of the stock trading between both credit spreads by expiration. Let’s use made-up XYZ stock as an example. If you have noticed the stock has been trading between a range of $75 and $80 over a period of time, an iron condor might be an option with an expiration of a week or two. Generally, option traders who do iron condors prefer a shorter expiration to maximize the potential positive theta.
A call credit spread with the short strike call at 80 or higher would profit if the stock stayed below $80 at expiration. A short strike put at 75 or lower would profit if the stock stayed at $75 or higher at expiration. Both short options would need to be protected by further OTM long options. Both spreads would expire worthless, and both premiums are the traders to keep if XYZ closes at or between the short strikes. The total risk on the trade is also reduced because of both premiums received.
Max profit is both credits from each credit spread. Max risk is the difference in one set of strike prices minus both premiums received. Maximum loss would occur if the stock is at or below $75 or at or above $80 at expiration. No matter what happens, one of the credit spreads will always expire worthless. This, of course, does not guarantee a profit.
Our Boeing Example
We recently looked at The Boeing Co. (BA) in group coaching class and did a successful iron condor. Looking at the hourly chart below, you can see the stock at the time was trading in a range from about $200 to $215. In fact, it had been trading in that channel for about three weeks. Because of the potential resistance from the horizontal level at $215 and the potential support from the horizontal level at $200, the stock has a good chance to stay within that range.
Let’s model out a short iron condor. A call credit spread was implemented by selling a 215 call and buying a 200 call with just under a week left until expiration. At the same time, a 200 put was sold and a 195 put was bought to complete the put credit spread side of the iron condor. Rounding the numbers, a $1.00 credit was received (0.60 from the put spread and 0.40 from the call spread), which means the total risk was $4.00 (5 – 1). If the trend continues, this iron condor should be successful as well.
Final Thoughts
Iron condors are a great way to take advantage of time decay when it looks like the stock will be traveling in a range for a certain amount of time. Although they can be used directionally, most option traders use them as a neutral strategy, and they can be very effective. The key is to have your management plan in place before entering any trade, including the iron condor.
One Response
Great explanation of this stand-by strategy,