Trade of the Week - Iron Condor (2/1/2010)

I haven't traded an iron condor this year or for the past few months given the strong trend. However, now may be an opportunity to do so.

Iron condor SPY trade setup

Sell SPY 112/110/105/103 iron condor
61% (final)
1. Exit if I can lock in 60% of my initial credit (i.e. $.60)
2. Exit each spread if I can do so for $.20
3. Exit if within 4-7 days of expiration
Credit $1.01

This trade is a $2 wide spread on each side with $5 between the short strikes.

Why this strategy?

Following Friday's sell off at the end of the day and the corresponding break of the support level I outlined around $109, I am now looking at a change in trend. I don't think the trend will change overnight though. As a prelude, we may expect to see some chopping around .

I outlined in the February newsletter some indicators of what to look for. A definitive close above $111 may change my bias at least temporarily but I'd be watching to see if the previous highs get broken as well.

In the meantime, I think the iron condor is the perfect trade when I'm expecting this kind of choppiness.

I continue to trade the SPY due to the high liquidity and the price I'm able to get on the spreads.

Choosing the right strike prices

With my iron condor trading plan, I typically look for options 20-40 days until expiration and with the short strike having about 30-35% probability of expiring.

For this trade, I adjusted a little bit to the downside for the put spread. I went with a short put strike closer to 30% probability while my short call was closer to 35% probability of expiring in the money. By the time I had this captured, the numbers had changed since SPY rallied a bit early in the morning.

iron condor strike selection

When I set this order up, I went with Feb options even though there were only 18 days until expiration. However, with the higher volatility from prior day's selling, I was able to get a decent price.

Position sizing

With this particular iron condor trading plan, I put the trade on with no worst case exit. In other words, I put it on with the expectation that if the worst happens, I'll lose $99 per contract.

As I've mentioned, I trade this portfolio risking just 2% of the portfolio on each trade. My current portfolio balance is just over $18569 so 2% would be about $371. That means I can sell 3 contracts and remain within that limit.

Exit plan

With this trading plan, I typically have some exits to close early when I can lock in profit. My target is to lock in 60% of my initial credit. I usually do this a couple of different ways. One exit is to just close the entire spread for 60% of the initial credit, which in this case would be for about $.40. However, it doesn't happen too often than I can close both sides that way. An addition rule I have is to close each side when I can do so for 1/2 that target price. If I can close each spread for $.20, I will do so.

Because I expect some movement, I'm willing to let the trade ride through it all. However, I had said in the February newsletter that if SPX broke $1100 definitively, I'd consider changing my outlook again. If that happens, I may simply close the trade and cut my loss.

Just to summarize then:

  1. I will exit when I can lock in 60% of the credit, or $.40
  2. I will exit each side of the spread when I can do so for $.20
  3. I will be monitoring the $111 level
  4. I will exit when approximately 4-5 days of expiration

Portfolio Impact

Since I didn't have any trades on prior to entering this iron condor trade, I'd expect that the result would be a fairly neutral position. However, with the strong buying early in the morning, the trade the delta is already showing a bearish bias - meaning the trade would benefit from the SPY selling off a little. 

iron condor portfolio impact

What I like though is that I have positive theta. I'm not surprised to see a bearish bias since I expect some chopping around (up and then down again). No matter what though, time passes and these options will continue to lose value and make me money.

Update 2/2/2010

I'm already out of the put side of this iron condor trade. That doesn't bode too well for this trade overall, but it still remains to be seen whether this is more than a relief bounce.

I closed the put spread for $.17 mid day on Tuesday. While that does close out the put side of the trade and eliminates any down side risk, it does slightly increase my up side risk by $.17. So, my new total risk (to the up side only) is $1.16 or $348 for my three contracts. That's till within the maximum amount I can risk on a trade.

Over the next few weeks, I'll be looking for a pullback that will allow me to exit the call spread as well. Right now, the SPY is bumping against the under side of the level I mentioned should act as a resistance area. If we see another strong buying day that pushes the SPY over $111, I may consider closing the trade early. I'm really looking to see if a lower high will be established since that will either confirm or cancel the current short term bearishness.

Update 2/8/2010

Since closing the put spread last week, the SPY changed directions and started selling off heavily.

This is the ideal case for an iron condor trade. I had put the trade on with the expectation that there would be some churn over the next month and the trade has done well for that reason.

Iron condor trade management

There is a bit of a mental or psychological game that comes into play, particularly when the underlying is threatening to go against you. 

How do I manage the fear that rises up? 

  • By sizing my position so that the loss of the trade doesn't threaten to wipe my account out. 
  • By having a clear plan for my exits. 
  • By having a plan in mind for handling the case when the trade goes against me. Some trades I will manage and others I will simply exit. 
Having these things as part of my trading plan makes trading a lot more fun!

At this point, the call spread remains open and stands at $.30 to close. My target price is $.20 with two weeks to go until expiration. I will be looking for a chance to close the trade this week if possible.

Update 2/9/2010

I should have waited another day before writing the update I guess.

Near the end of the day, the sell-off was enough to deflate the spread to the point where my trarget exit was reached.

Just to recap the trade... I put the iron condor on for a credit of $1.01 and closed for a total debit of $.40. That leaves a net profit of $.61 and a total ROI on the trade 61%.

For the record, this was a textbook trade. As those who have followed some of my other trade tutorials know, the trade usualy takes longer to develop and they often involve many more twists and turns. It's nice to get these every so often.

Rule # 1 - Don't lose money.
Rule # 2 - Never forget Rule #1  (Warren Buffet)

Stay tuned for further updates as the trade progresses...

Note: This trade discussion is for educational purposes only. I am NOT making any recommendations on the trade or the underlying stock or ETF. If you decide to follow this trade, please do so in a paper trading account. Trading options involves risk and some options strategies can result in losing more than the original amount invested.

thinkorswim, Division of TD Ameritrade, Inc. and Success With Options are separate, unaffiliated companies and are not responsible for each other's services and products.

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