Long
Iron Condor
Description
The
Long Iron condor is a 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 below 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.
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 be
between the two middle strikes.
Market
Opinion
Neutral.
You expect little movement in the stock.
P/L
When
To Use
Use
this strategy when you believe the stock will have low volatility, and you are
looking to enhance income.
Example
XXXX
is trading at $27.50 on April 11, 2011.
Buy
May 2011 20 strike put for $0.25.
Sell
May 2011 25 strike put for $1.25.
Sell
May 2011 30 strike call for $1.30.
Buy
May 2011 35 strike call for $0.35.
Net
credit from premiums sold-premiums bought = $1.95
Benefit
The
benefit is that, for low cost, you can profit from a rangebound stock with
capped downside risk.
Risk
vs. Reward
The
risk is the difference between any two strikes minus your net credit. The
reward is the net credit you receive.
Net
Upside
Net
credit received.
Net
Downside
The
difference between adjacent strikes minus net credit.
Break
Even Point
Break
even up: middle short call strike plus net credit.
Break
even down: middle short put strike minus net credit.
Effect
Of Volatility
Increased
volatility would have a negative effect on this position.
Effect
Of Time Decay
Positive
when the position is profitable, and negative when it is not profitable. The
stock is profitable when you buy it, so from then on time decay erodes the
value of the position.
Alternatives
Before Expiration
You
can close out this position just before expiration by unraveling in two-leg
segments.
Alternatives
After Expiration
Close
out the trade by buying back the options you sold and selling the options you
bought.