9 Weeks to Better Options Trading: Iron Condors
Veteran options trader Steve Smith breaks down iron condors.
For the first article in the series, click here.
If you are a novice options trader, we suggest you start with Steve Smith's 6-Week Options Trading Kickstarter series.
Options traders often want to make bets on volatility. However, doing so can entail taking on inordinate downside risk. To limit this downside risk, we can use combinations of spreads, the most common of which is the iron condor.
While iron condors can be bought or sold, they are typically sold for a credit to take advantage of a stock or index that is in a trading range. They benefits from both time decay and a decline in implied volatility. Selling an iron condor is a bet that the underlying shares will remain in a limited range and have an accompanying low or decrease in volatility. If you were buy an iron condor, you are banking on a break outside the range that is defined by the condor's outer strikes, or “wings.”
- the April $140 call for $1.40
- the April $140 put for $0.70
- sell 1 April $142 at $1.50 a contract
- buy 1 April $144 at $0.50 a contract
- sell 1 April $139 put at $0.80 a contract
- buy 1 April 137 put at $0.42 a contract
An iron condor is a time and volatility play. In selling premium, we benefit from time decay or theta and a decline in implied volatility that would accompany a range-bound stock price. On the other side, I see no reason to use condors as a long volatility play. To bet on a rise in volatility, straddles or strangles makes more sense. In particular, when it comes to the broader markets, buying a straddle or strangle on the SPY is far more effective than playing with something like (TVIX), which as we've seen, isn't particularly good at fulfilling its mandate. But if I think a certain stock or sector is range-bound, then selling a pair of out of-the-money spreads, a.k.a. our friend the iron condor, makes sense.
For complete access to Steve Smith's trades in real-time, check out the OptionSmith portfolio, which returned 28% in 2011. Click here for more details.
Here is a complete schedule for "9 Weeks to Better Options Trading":
Week 1: 5 Rookie Mistakes Options Traders Make
Week 2: Option Pricing Basics: Understanding Implied Volatility and Time Decay
Week 3: Trading Strategy: The Power of Calendar Spreads
Week 4: Trading Strategy: Butterfly Spreads
Week 5: Trading Strategy: Iron Condors
Week 6: Trading Strategy: Risk/Reversal
Week 7: Trading Strategy: Back Spreads
Week 8: Managing Risk
Week 9: Special Situations: Earnings Reports, Takeovers, and Extreme Market Moves
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