How To Trade Iron Condors

Iron Condors like Butterflies are a popular options strategy for beginning spread traders. They are conservative non-directional trades and many traders use them to bring in consistent returns, at least that’s what you’ll read. The reality is a bit different but in theory Iron Condors are a popular strategy for a market trading in a range.

As with Butterflies, which I’ve written about before, the strategy itself is simple to learn and to understand. The psychological effect as the market moves, the evolution of the trade, and entry/exit are a bit more complicated to manage and take practice, trial and unfortunately, a fair amount of error.

A fully constructed Iron Condor looks like this:

-1 OTM Put
+1 OTM Put with lower strike
-1 OTM Call
+1 OTM Call with higher strike

Here’s an example P&L Diagram.

iron-condor

It’s possible to find yourself with an Iron Condor with a max loss of $0 and these are the most rewarding of Iron Condors. Personally, that’s always my ‘target’ when I construct an Iron Condor. But, lets take a step back. We’ll look at two ways to get into an Iron condor, you can construct it at all at once or you can build it with two spreads.

I’m going to use Microsoft and Apple as examples. Microsoft, because it’s slightly range bound, we’ll fully build the Iron Condor from scratch, and let it run it’s course until just before expiration. With Apple I’ll consider a strategy in a trending market and we’ll construct the Iron Condor in two steps.

+10 42.5 $0.17
-10 43 $0.25
-10 45 $0.25
+10 45.5 $0.15

msftpandlironcondorHere you’ll see that the max profit is about ~$200 and max loss ~$300

With the Iron Condor I’m proposing, we’ll need Microsoft to expire between 43-45. Look at the MSFT chart. Looks to be a safe bet. Will it be? The market tends to fall faster than it rises on a short term basis. If I was really going to make this trade, I might consider lowering both of my ranges, yet the trend is still clearly upwards. Note: Look for reasons MSFT might break down (earnings), and if you find any consider targeting a lower band.

msft-1mo260215Using an Iron Condor with a trending product is a bit more complicated, but more rewarding as a trader. Look at the Iron Condor as two spreads, A bear call spread (45/45.5) and a bull call spread (42/43) – in the Microsoft case.

For Apple I’ll give you an example of how you might end up with an Iron Condor. What we’ll attempt to do is construct a bull call spread (the trend direction should be your second leg), let the market continue along it’s trend, start to accumulate profit and then lock that profit in, by adding a bear call spread. That sounds a little complicated, but in the end, if things go as planned (they never do…) we’ll have built our Iron Condor, locked in some profit and created some down-side protection if things go crazy. This works best when Volatility is higher than normal.

First the Apple Chart:

aapl1mo270215

We see the trend channel rising, let’s look for our first spread. Lets see if 126/128 works.

+10 126 $6.10
-10 128 $4.80

aapl bull call

On first glance that looks like a bad trade, but keep in mind Delta, and what time will do to the value of these two strikes. Which will lose value quicker? And what is that called???

Lets look at one option for the second spread we’ll be targeting at some point in the future. This rests open, and will depend how the market evolves.

-10 134 $1.97
+10 136 $1.65

Today that P&L looks very similar to the Bull Call. But what happens to these P&L’s as the Vol changes or if the price continues in it’s upward channel?  If it falls?

AAPL Bear CallIf you’re considering constructing an Iron Condor in two stages in a trending market, watch Volatility, and trade with the trend, your first leg should fit a strategy that fits the trend. If things go your way, adding the second leg protects your ‘good’ trade and limits any losses should things turn south. This takes some practice, but using an Iron Condor to protect profits is as equally a satisfying strategy as is building one from scratch.