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Trade of the Week - Iron Condor (10/06/2009)

Ok so this iron condor trade is a little bit different than most of the ones I've traded before and certainly different than the standard strategy I've covered here.

Iron Condor trade setup

Sell IWM 63/62/56/55 spread
1. Exit if I can lock in 60% of my initial credit (i.e. $.30)
2. Exit the puts if I can do so for about $.20
3. Exit the calls if I can do so for about $.10
4. Exit if within 4-7 days of expiration
Credit $.76

This particular trade has a $2 wide vertical put spread and a $1 wide vertical call spread. If that seems a little odd, hang on and I'll explain it further.

Why this strategy?

I was looking at the market today and contemplating what trade I might put on for November. Is this pullback actually over? I'm only 1/2 convinced. So, I wanted a trade that was semi-neutral and yet gave me less risk to the up side. And... I hit on it... a skewed Iron Condor. If you're having trouble grasping what this risk profile might look like, have a look.

Iron Condor analysis

What this shows is that my risk to the up side (i.e. anything above $62.75) is capped at about  $.24, which is the $1 strike minus my credit of $.76. The downside risk is $1.24 because it is a $2 wide strike on the put side.

I chose the IWM because, like many ETFs, it is highly liquid and it represents a pretty broad segment of the market. In other words, this ETF will follow the broad market direction, which is what I'm looking for. 

What makes this trade so nice is that it fits the broad requirements of any trade I take. It is a defined risk trade and it is positive time decay. That means IWM could move around quite a lot and I still make money.

Choosing the right strike prices

As usual, I try to choose short strikes that have roughly a 65-70% probability of success (i.e. expiring worthless). On the thinkorswim platform, that means using the 'probability of expiring' column to find something with a 30-35% probability of expiring in the money.

Iron Condor choosing strikes

With that criteria, I'm left with a short 56 put and a short 62 call. Because I've decided to skew this iron condor, the long strikes are then a given (54 put and 63 call)

For me, the choice of November options is a given. October only has 10 days left and December is too far out. November is just about the perfect time frame with 45 days left.

Position sizing

The beauty of this kind of a trade is that my risk is defined. The credit I can receive on this trade is $.76. Using the widest side of my spread, my risk is $2 less the $.76 credit leaves me with a risk amount of $1.24. 

Iron Condor trade entry

Any followers of my previous trade of the week posts probably know where I'm going next...

With a defined maximum loss of $1.24 (or $124 per contract), how many contracts can I sell? I can sell 3 contracts, which will result in a risk of $372 with a potential gain of $228.

Exit plan

The exit plan for this trade is going to be a little different. My overall rule to exit when I can lock in 60% of my initial credit. In this case, that would be around $.30. Because I have a skewed Iron Condor and my risk is different on each side, I'm also going to skew the individual (per side) exit rules. I'll set the exit to close the put spread if I can do so for $.20 and the call spread if I can do so for $.10.

Here then are my basic exit rules for this trade.

  1. I will exit when I can lock in 60% of my initial credit. That would be about $.30.
  2. I will exit the put spread when I can buy it back for $.20
  3. I will exit the call spread when I can buy it back for $.10
  4. I will exit when approximately 4-5 days of expiration

Finally, I want to talk about the impact of this trade on my overall portfolio. This skewed iron condor is a slightly bullish trade. However, with the move up yesterday my portolio is currently showing a slightly negative delta (SPY weighted). On the other hand this trade adds to my current positive theta. Remember, positive theta means that every day that goes by will cause my positions to gain in value. 

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

Update 10/14/2009

Just over a week into this skewed iron condor trade, I just closed the put spread. On the other hand, my calls are being over run.

Let's look on the bright side though. My greatest  risk was to the down side with a $2 wide spread covered by only $.76 in credit. Let's take a look at how closing the put spread affected the overall position.

I received $.76 in credit for the trade but paid back $.20 to close the put spread. That leaves my net credit in this posion $.56. I have a $1 wide spread on the call side so my remaining risk is $.44 (times 3 contracts) or $132 total. If I follow my exit rule for closing the calls (assuming IWM ever sells of to any degree), then my actual gain in this trade will be $.34 - a projected ROI of 27% (using the initial max risk amount).

Given that this trade closed so early, there are some different possibilities available to me as adjustments or modifications to this trade.

  1. I could sell another put spread closer in - this has some risk to it though
  2. I could wait for a pullback and then sell a put spread - this would be preferable
  3. I could buy a small calendar spread - this would protect my up side movement but would cost me a lot of my current credit AND adds risk to the downside 

I'm not ready to make any adjustments just yet. This week is too wacky being options expiration week and the beginning of major earnings announcements. However... with the large push up recently, the odds favor a pause or even another pullback.

Update 10/22/09

I'm still hanging in with this iron condor (or what's left of it) and it's not doing too badly. In fact, if I were to close the call spread today, I could do it for about $.35. That plus the $.20 I paid to exit the put side would leave me with a total debit of $.55 and a profit of $.22. Not great but certainly not bad either.

I'm going to be watching this trade a little more closely as I'd like to make sure this trade at least breaks even. I wouldn't be surprised to see a little more weakness in the broader market, which will certainly help the trade out.

At this point, I'll stick to my rules, but I want to be prepared to adapt if the market turns around. One strategy I might consider is selling another put spread (maybe only $1 wide). There's still plenty of time to do this and anything more than $.46 in credit means I have no  risk. If I were to make the put spread a $2 wide spread, I'd still have some downside risk but probably would get a better credit. Either way, I'd end up with some kind of iron condor again.


And... I'm out. Last week, all I had left of this skewed iron condor trade was the $1 wide call spread. I had decided to wait out the move down and I'm glad I did. Today, I closed the remainder of the position for $.10.

I took in $.76 credit initially and gave back $.30 to close the position leaving a net profit of $.46. With an ititial risk of $1.24, that's an ROI of 37%. WIth 3 contracts, that's a profit of $138 or a return of .6% on the portfolio.

This trade couldn't have gone any better and really illustrates the life of a trade. In fact, in a recent video I recorded, I talked about exactly this scenario as a reason why I trade premium selling strategies primarily.

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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