Crazy Market? Consider an Iron Condor

Posted on Thursday, February 20, 2020 at 1:51 PM

This market is enough to make some option traders crazy and broke. Who would have thought new highs would be consistently made almost on a week-to-week basis? For the most part, the major indexes have moved higher over the past several months, but there have been times when the market inexplicably has done a reversal at some resistance levels, as it did last Thursday. There is an option strategy that can possibly help. Let’s take a look below.

An iron condor is a 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. 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 long options.

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 ABC stock as an example. If you have noticed that the stock has been trading between a range of $75 and $80 over the past few weeks, an iron condor might be an option with an expiration from about a week to about a month.

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 out-of-the-money (OTM) long options. Both spreads would expire worthless and both premiums are the trader's to keep if ABC 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 though.

Iron condors are a great way to take advantage of time decay when it looks as if the stock will be traveling in a range for a certain amount of time even in a market like we have seen. The key is to have your profit and loss parameters set before entering the trade.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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