According to Schaeffer’s Investment Research, Trading options isn’t easy as there are so many things that can happen to a stock’s price during the course of a trading day. There are stocks that are so volatile, the prices could swing $5 or $10 on a given day. Then there are other stocks that trade as flat as Kansas with no swings in either direction. What can a trader do to make money on stocks that seemingly have no movement from day to day? This is where the Iron Condor strategy comes into play.
An Iron Condor is essentially both a Call Credit Spread and a Put Credit Spread with the same expiry date. To those that don’t know or for those that need a refresher, a Call Credit Spread is when you purchase a call option at a higher strike price and sell a call option at a lower strike price. A Put Credit Spread is similar as you purchase a put option at a lower strike price and sell a put option at a higher strike price.
An iron Condor combines both of these strategies and the name of the game is for the stock to stay flat. You will end up with a surplus in premiums paid out to you when you execute all four of these legs to start the Iron Condor. You want to keep these premiums in your account and the stock needs to stay within certain parameters for this to happen, says Schaeffer’s Investment Research. We’ll look at good and bad examples below that reflect these outcomes
Jerry likes ABC stock and sees that it’s been trading pretty flat for the past few months. The current stock price of ABC is at $17 a share. Jerry executes a Call Credit Spread by purchasing a call with a strike price of $20 and sells a call for $19 a share. The purchased call has a premium of $10 and the sold call has a premium of $25, so Jerry has $15 in premiums in his account as a surplus.
Jerry then executes a Put Credit Spread by purchasing a put option for a strike price of $14 and sells a put option for $15. The purchased put option has a premium of $25 and the sold put option has a premium of $40. Jerry now has $30 in premiums in his account due to the added $15 of premiums collected in the Put Credit Spread surplus.
The expiry date arrives 30 days later and ABC stock is currently selling for $16 a share. All four legs of Jerry’s Iron Condor expire worthless and Jerry keeps the $30 in premiums that he’s collected. ABC stock needed to stay below the $19 sold call and the $15 sold out.
Let’s use the same parameters above for ABC stock and Jerry’s Iron Condor is still the same with the same strike prices and expiry. The expiry date arrives and ABC stock is now selling at $25 a share. Jerry’s two put legs would expire worthless as the stock price finished above the two put strike prices. Jerry’s purchased call would sell at the $25 strike price and Jerry would make $500 on that leg, but Jerry’s sold call would cost Jerry $600. Therefore, Jerry would lose a total of $70 when the premiums paid out are factored in.
Executing an Iron Condor is a very shrewd strategy when dealing with stocks that have historically traded flat. Always pick out two legs that give you a large enough swing to stay in-between. If you would like to know more about Iron Condors and other trading strategies, please contact Schaeffer’s Investment Research Review today.