Using an iron condor to swoop to trading profits
USING options strategies can allow investors to take a position on an underlying asset – whatever direction it goes in.
Though it might sound like the name of a bad 80s hair metal band, an iron condor is an options trading strategy that involves buying and holding four different options and taking advantage of their different strike prices. For call options, the strike price is where the security can be bought, while for put options the strike price is the price at which assets can be sold.
The strategy is constructed combining two different strangle strategies, both with a call and put with different strike prices but with the same maturity and underlying asset. A strangle is created by buying or selling a call option and a put option with different strike prices, but the same expiration date – the strategy limits potential for profit or loss as an offset strangle is positioned around the two options that make up the strangle at the middle strike prices. It could alternatively be viewed as a combination of a bear call spread and a pull put spread – in doing so you are taking neither a bearish nor a bullish position, just a view that the move will not be strong in either direction. The strategy isn’t going to make you huge gains, but is designed as a limited-risk strategy for profiting when the underlying asset has low volatility.
CONSTRUCTING THE CONDOR
A put option is out-of-the-money when the strike price is below the current trading price of the underlying asset. Inversely, a call option is out-of-the-money when the strike price is above the current price of the underlying.
The strategy is built by buying an out-of-the-money put, buying a lower strike out of the money put and then constructing the other side of the trade by selling a higher strike out of the money call and buying an even higher out of the money call.
MAKING YOUR MONEY
The iron condor strategy can be viewed as if you are drawing a box around the price of the underlying asset. As long as the price remains within the box that you have drawn around it, you stay in profit. Obviously, if it strays outside this box, you’ll make a loss. The greatest gains are made when the price of the underlying asset falls between the strike price of the call and the put sold. This profit is equal to the net premium less the commissions paid in buying and selling the four options on the asset. Should the price manage to leap out of the pen that you have made around it, then you’re in for a loss. And while this loss is limited, the maximum loss is much higher than the maximum profit, so take care when setting up the trade. When the price of the underlying asset falls either at or below the strike price of the put or if it rises above the second, higher strike price of the calls bought. The potential loss is the difference between the strike prices of the calls or puts (depending on whether the price moves above or below the range) minus the net premium received on the trade and the commissions paid on buying and selling the options.
KEEPING THE APPLES IN THE BOX
To give an example, Apple is currently around the $560 per share mark – give or take a few dollars and cents to give us a round number. If you take the view that Apple is going to trade between $550 and $650 for the next month you could sell a 1 June $650 call, buy a 1 June $660 call, sell a 1 June $550 put and buy a 1 June $540 put.
As you sold a $650 call and bought one at $660, as long as Apple stays in the box you have drawn below $650, the trade makes a profit – if it goes above, the $660 limits your losses. On the other side, the $550 put is the bottom of the box on the downside, with the $540 put limiting your losses.
The iron condor strategy relies on the assumption that the underlying asset is going to see low volatility – whichever direction it travels, you want to keep it within your ranges. This isn’t something you’d want to be setting up before an earnings report, for example. But, though it requires careful planning, it is a strategy that can allow you to make non-directional gains from a relatively straightforward strategy.