Long Iron Condor
Description
The Long Iron condor is strategy for stocks that are rangebound.
A variation of the Long Iron Butterfly, it is in fact the Combination
of a Bull put Spread and Bear Call Spread/ The combination of
two income strategies also makes this an income strategy, Traders
often will leg into the Long Iron Condor, first trading a
Bull put Spread just belew Support and then as the stock rebounds
off resistance adding a Bear call Spread thereby creating the Long Iron Condor.
Ideally the stock will remain between the two middle strikes with
the maximum profit Occurring if the Options expire between these.
Ideally all these options will expire worthless and you get to keep the credit.
P/L Profile
Steps to Trading a Long Iron Condor
1. Buy one lower strike (OTM) put.
2. Sell one lower middle strike (OTM) put.
3. Sell one higher middle strike (OTM) call.
4. Buy one higher strike (OTM) call.
All options share the same expiration date for this strategy
For this strategy, you must use both calls and puts. A Long Iron Condor is
the combination of a Bull Put Spread and a Bear Call Spread.
The short put strike is lower than the short call strike.
Remember that there should be equal distance between each strike price.
while the stock price should generally he between the two middle strikes.
Steps In
Try to ensure that the trend is rangebound and identify clear areas of sup-
port and resistance.
Steps Out
Remember the Long Iron Condor is a combination of other strategies, so it
can he unraveled in two-leg chunks.
You can unraveL the position just before expiration
Outlook
With Long Iron Condor, your outlook is direction neutral. You expect little
movement in the stock price.
Net Position
This is a net credit Irade.
Your maximum risk is the difference between any two strikes less your net
credit. (Remember that the all the different strike prices are equidistant
to each other,) Your maximum reward is the net credit you receive.
Appropriate Time Period to Trade
Safest to trade with one or less month for expiration
Selecting the Stock
Choose the stocks with adequate liquidity, preferably over 500,000 Average
Daily Volume (ADV).
Try to ensure that the trend is rangebound and identify clear areas of support
and resistance,
Selecting the Options
Choose options with adequate liquidity; open interest should be at least 100,
preferably 500-
Lower (put) Strikes - Below the current stock price (or below where you think
the stock will be at expiration).
Higher (call) Strikes Above the current stock price (or above where you
think the stock will be at expiration).
Explration one month or less. Use the same expiration date for all legs.
Risk Profile
Maximum Risk [Difference in adjacent strikes - net credit]
Maximum Reward [Net credit received]
Breakeven Down (Middle short put strike - net credit!
Breakeven Up [Middle short call strike + net crediti
Advantages and Disadvantages
Advantages
Profit from a rangebound stock for no dost and low downside risk.
Capped and how risk compared with potential reward.
Comparatively high profit potential
Disadvantages
The higher profit potential comes with a narrower range between the wing
strikes.
the higher profit potential only comes nearer expiration
Bid/Ask Spread can adversely affect the quality of the trade.
Exiting the Position
With this Strategy, you can simply unravel the spread by buying back the
options you sold and selling the options you bought in the first place.
Advanced traders may leg up and down or only partially unravel the spread
as the underlying asset fluctuates up and down. In this way, the trader will he
taking smaller incremental profits before the expiration of the trade.
Example
XYZ is trading at $27.50 on April 12. 2004.
Buy the May 2004 20 strike put for $0.25.
Sell the May 2004 25 Strike put for $1.25
Sell the May 2004 30 strike call for $1.30
Buy the May 2004 35 strike call for $0.35
Net Credit Premiums sold - premiums bought= 1.95
Max Risk Difference in adjacent strike ? net credit
5.00 - 1.95 = 3.05
Max Reward = Net credit 1.95
Break Even Down = Lower middle strike - net credit = 25- 1.95 = 23.05
Break Even Up = Upper Middle Strike + net credit = 30 +1.95 = 31.95
|