A good portion of my trading career revolved around making directional bets.
I relied on very basic options strategies like buying calls and puts.
When I discovered option sellers started with a statistical advantage…I knew that was something I wanted to be apart of.
But now I’m ready to take my game to the next level with more advanced option selling strategies… specifically… Iron Condors.
I absolutely love these trades. They’re so easy— that once you understand them your decision making goes on autopilot.
Iron Condors work in nearly every market environment. These market neutral trades can payout quite consistently if you follow the rules.
And today I’m going to teach you all about them.
Iron Condor Structure
Let me start by saying that I am referring to short iron condors. A lot of people, including myself, don’t always specify which they are talking about. You can assume when I reference iron condor as I am talking about short iron condors.
Iron condors combine a put credit spread and a call credit spread. Each of these spreads is referred to as the ‘wings.’
You receive a credit for each spread that you sell. This is known as the ‘premium’ and is the maximum profit you can expect on the trade. In order to get this full credit you want the stock’s price to land between the closest option contracts above and below the current stock price.
Here’s what the payoff diagram looks like for an iron condor.
The different colored lines represent the payoff diagram as you get closer to expiration. As time ticks by, the sloped of the curve steepens. At expiration, the payoff diagram becomes the blue line.
Here’s how you would set up one short iron condor:
- Sell one put contract at an expiration date in the future with a price (strike) that is below the current price
- Buy on put contract at the same expiration date at a price (strike) that is below the put contract you sold
- Sell one call contract at the same expiration date at a price (strike) that is above the current strike price
- Buy one call contract at the same expiration date at a price (strike) that is above the contract you sold
Let me walk you through an example using the payoff diagram above for the stock TLT:
- The current stock price is $138.47
- I sell one put contract that expires in 41 days, with a strike price of $136 for $0.97
- I buy one put contract that expires in 41 days, with a strike price of $135 for $0.71
- I sell one call contract that expires in 41 days, with a strike price of $139 for $1.73
- I buy one call contract that expires in 41 days, with a strike price of $140 for $1.34
The total amount I receive for this trade (and the maximum profit) is:
Maximum profit = $0.97 – $0.71 + $1.73 – $1.34 = $0.65 x 100 shares = $65
Note: You multiply by 100 shares because each option contract controls 100 shares of stock.
The maximum profit occurs we get to expiration and TLT is between $135 and $140 per share.
Now, assuming that the distance between the strikes is the same for the call spread and the put spread – which in this case they are – your maximum potential loss is the difference between the strikes minus the premium you received.
In this case, the distance between the strikes (wings) is $1.00. So, my maximum potential loss would be:
Maximum potential loss = $1.00 – $0.65 = $0.45 x 100 shares = $45
Let me explain how this works. First, you cannot lose on both spreads at the same time. If the stock crosses over the put credit side that means the call credit side is not in any danger of losing, and visa versa.
The further you make the wings from current price, the less of a chance the stock has to get to those wings. However, you get a smaller premium. Conversely, the closer the strikes are to the current price the more you get paid, but the greater the chances the stock will move past the strikes.
The tricks to making this work
One thing most people don’t realize is that you can take this trade off early for a partial profit. Remember the payoff diagram above? You don’t need to wait until you get to expiration. You can take the trade off early at 30%-50% of the maximum potential profit. In fact, that gives you an even greater statistical advantage, while boosting your win-rate substantially.
I like to set up my iron condors the following way:
- Pick expirations 30-45 days away
- Collect a premium that is 1/3rd the distance of the wing size
- IE if the wings are $1.00 wide I want to collect $0.33
- Take the trade off at 30%-50% of maximum profit, or let it go to expiration
- Make the closest strike that I pick for each credit spread at the 16 delta (AKA one standard deviation)
Note: Most trading platforms will display the ‘Delta’ of an option in the option chain (quote board). Call options show positive numbers (IE 0.16 delta) and put options show negative deltas (IE -0.16). Look for the options that show 0.16 for the call side and -0.16 for the put side as the contracts that you sell.
You can learn more about the basics of Delta in my previous newsletter here.
Will this work 100% of the time?
Not a chance. But, if you execute it right, you put yourself at a statistical advantage to build up base hit after base hit and create a consistent stream of returns.
There are certainly other ways to enhance your profitability and win-rate. But I reserve those for my Total Alpha Members.
I offer them not only a live stream of my trading, but training to help them improve their trading and incorporate strategies just like these.