Trade of the Week - Iron Condor (3/9/2010)

I'm putting this iron condor trade on as part of the video tutorial I'm doing. I released the introduction portion of this video on Saturday. Be watching for the trade setup and analysis as well.

iron condor on the SPY

Sell SPY 118/116/110/108 iron condor
1. Exit if I can lock in 60% of my initial credit (i.e. $.58)
2. Exit if I can close each spread for 20% of the credit ($.19)
3. Exit if within 4-7 days of expiration
Credit $.97

This is a $2 wide balanced condor with options in April where I received $.97 credit for the trade.

Why this strategy?

The market in general has run up pretty strongly over the past week or so and is approaching the high established back in early January. I suspect that the SPY will initially make a move up to test that resistance but may take some time to actually break through.

That makes a more neutral strategy like the iron condor a good choice. I chose the SPY because it represents a fairly broad segment of the market and also represents larger capitalization stocks. The Russell 2000 is currently showing unusual strength and may not be a good choice. Besides, I already have a trade going on that one.

Choosing the right strike prices

With volatility running a little lower, I'm having a little harder time finding desirable options in the near term month. March of course doesn't have enough time left to meet my 20 day minimum requirement. The March quarterlies have enough time but not enough value. That means I'm looking at April options.

As I usually do with this strategy (my 60% probability strategy), I look to sell strikes that have about a 60-65% probability of expiring worthless. On the Thinkorswim platform, that means looking for a strike with a probability of expiring of around 35% (35-40%. As of yesterday when I put the trade on, that was the $110 put and the $116 call.

Risk/Reward analysis

As would be expected with both a short put and call option, the range of profit is capped as the analysis below indicates.

Iron condor risk analysis

The nice thing about 60% iron condor strategy is that it usually results in a trade that has about a 1:1 reward/risk. As the chart above shows, the max profit is about $100/contract and the max loss is about the same.

In my initial analysis I can see this trade will give me about $.97 credit. The break even points are marked by the vertical dashed lines and are at $109.03 on the lower side and $116.97 on the upper side. That means my tolerable range of movement is about $7.94.

Position sizing

I've already established that the risk in this trade is about $100/contract. Actually, it's $103 per contract since the credit is only $.97.

As in every trade I take, I'm only going to be risking 2% of my portfolio on this trade. My portfolio currently stands at about $18,000 and 2% of that is $360. From here then it is simple math to determine how many contracts to sell. $360/$103 = 3 contracts and some fractional remainder.

Exit plan

The risk in this trade is likely to the up side. If the SPY breaks through the $115 level, then I doubt there is much to keep it from running up through $116, which is the short strike. I'll be watching this level very closely to see if it makes sense to simply close the trade. A lot will depend on how definitively the break is made (i.e how far and how much volume).

In the mean time, I have some standard exits defined for this iron condor strategy. I will exit under the following conditions.

  1. I will exit when I can lock in 60% of my initial credit. In this case, that is about $.39
  2. I will also exit when I can close each side for about 20% of my credit. That's about $.19 or so.
  3. I will exit when approximately 4-5 days of expiration

This strategy doesn't have any absolute exit for limiting loss but as I mentioned, I'll be watching the up side to see what happens.

Portfolio Impact

The iron condor strategy is initially a neutral strategy. That means it shouldn't add much in the way of either positive or negative delta. However, it will add theta.

iron condor portfolio impact

In this case, we can see that with the initial run up yesterday, the iron condor trade on the SPY had a negative delta. This will be the case if the SPY moves up strongly toward the short call. Notice that overall, this trade also adds a lot of negative vega. What does that mean?

Negative vega trades benefit from a drop in volatility and are hurt by a gain in volatility. With the VIX at the lower end of its range, there is a risk that volatility could jump accompanied by a drop in the SPY. That will have an impact on the iron condor trade in that it could hurt the put spread portion of the trade.

It wouldn't be a bad idea to put on a a trade that benefits from a rise in volatility and a drop in the market. Any suggestions? Watch for another trade that fits this profile in the next few days.

Update 3/16/2010

I just finally completed the trade video that goes through the steps covered in on this page.

A week into this iron condor trade, my call spread is seriously getting overrun. The good news is that I've closed the put spread for $.19. This leaves me with just the short call spread. With this recent push up over prior highs, I'm not quite so neutral as I was. What are some ways I could manage this trade?

  1. I could just close the position for a net debit of about $1.14 (counting the put spread). In that case, I'd have a small loss on the trade (about $.21).
  2. I could sell another put spread higher up to add to my credit and reduce my risk. I can sell a $114/113  for about $.40
  3. I could sell another iron condor higher up.

This doesn't have to be a binary decision though. In other words, I don't have to pick one strategy. How about for this trade, I go with two of these strategies.

iron condor on SPY

I'm looking at the above chart and notice that there have been 13 positive closes in a row and today could be another one. This is showing a pretty strongly bullish outlook. However, with this many up days in a row, there's bound to be some down days as well.

What I'm going to do is close one contract of my call spread and sell a one contract put spread at $114/112.

This leaves me with a skewed iron condor at 118/116/114/112 with two contracts of the call spread and one contract of the put spread. The credit received from selling the one contract put spread ($.40) offsets the $.21 loss from closing one contract of the original iron condor.

There is still risk in the trade but it is now only about $200. In the best case scenario, I'll be able to close both sides for a profit and the entire trade will close for a small profit.

Update 3/24/2010

A week later, not much has changed. The SPY is still part way through the call spread portion of this iron condor trade.

Since I've already done some adjusting by closing one contract of the call spread and sold a one contract put spread to compensate, my risk is less than it was originally. The only thing to do is let this trade play out and look for an opportunity to close the various components of this trade.

As always, I'll look to my exit rules to determine if and when to close this trade.

Update 3/31/2010

This iron condor trade (or what's left of it) continues to linger on. Since last week, the market has pretty much gone nowhere.

There is a risk that this trade will continue to run up, or at least remain in the area it is. In that case, the call spread will lose some money. To offset the risk I've added a one contract call calendar right between the short and long call at $117. This is a May/April $117 call calendar put on for $1.41.

The effect of this can be seen in the above risk graph. It pushes my break even up about $.50 and softens the slope of loss if the SPY was to move up strongly into the $118-119 area. On the other hand, it shifts some additional risk to the down side. I'm not too worried about this at the moment since it doesn't look like the SPY will be selling off strongly any time soon.

It isn't my intent to over trade this position. However, I do want to take the opportunity to illustrate some of the trade management techniques that can be employed if a trade does go against me.

Update 4/8/2010

Not much has happened with this iron condor trade except that the SPY breakout followed through. At this point, we are even further ITM.

Remember, I bought a $117 May/Apr call calendar last week when the SPY was under $117. Now the SPY has broken $119 and currently sits above the call spread that is the remainder of the original iron condor. The ideal outcome would actually be for the SPY to sell off to around $116 or so in which case I could sell back the calendar spread and buy back the call spread.

I am still in the put spread I added even though there is only about $.08 left. I'll probably close that this week since next week is expiration week. I just didn't see any point in leaving credit on the table since the SPY was well above my calls.

I will be closing this trade no matter what early next week so the next update should be the final update on this trade come what may.

Also... I just finished an iron condor trade management video. Be sure to check it out.

Update 4/15/2010 (closing update)

Ok, I should have closed this trade out a few days ago but was on vacation and let it go a little longer. And wouldn't you know it, the market picked this time to go into hyper drive. I finally closed out the remaining adjustments to this iron condor trade. Let me recap what I've done recently, then I'll summarize the trade.

I bought back 2 contracts of the 118/116 call spread for $1.96. I also sold back the May/April $117 call calendar (1 contract) for $.95. I also bought back the 1 contract put spread for $.03

Here's the summary of the trade and all the adjustments in table form.

Trade Debit/Credit per contract Net debit/credit
Sold Iron condor (3 contracts) $.97 + $391
Bought back the $110/108 put spread $.19 - $57
Bought back 1 contract $118/116 call spread $1.05 -$105
Sold 1 contract $114/112 put spread $.39 +$39
Bought 1 contract May/Apr $117 call spread $1.40 -$140
Bought 1 contract $114/112 put spread (to close) $.03 -$3
Sold 1 contract May/Apr $117 call spread (to close) $.95 +$95
Bought 2 contracts $118/112 call spread $1.96 -$392

Net loss

-$.57 -$172

What would the trade have been had I simply let it go until expiration? Since I closed the calls for $1.96, it's safe to assume that all 3 of the original contracts would have closed for the same amount for a total net debit of $285 plus the initial debit of $57 to close the put spreads for a total debit of $645. That would have left a net loss of $254 or about $.84 per contract.

Perhaps the trade would have turned out a little better had I not put on the calendar spread, but I wanted to illustrate some different trade management techniques. The end result was that this trade only lost 55% on the initial risk and only .95% loss on the initial portfolio amount of $18,000.

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

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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