By Josip Causic, Online Trading Academy Options Instructor
After the publication of my previous article, I have received some emails from our readers asking for a specific example. Some even said that the article was incomplete without the example, for I have provided the readers only with a template for an I.C. I did have three links to three different examples yet not every reader clicked on the blue highlighted hyperlink which takes the readers straight to the various Iron Condor examples that I have covered previously. At any rate, I will oblige the readers' request, as I usually do, and present a current I.C. trade that I am in; however, the ticker of the actual underlying must be whited out, for we are neither broker-dealers nor financial advisors. The trade presented in this article is strictly for educational purposes only.
Hence, let us start by going through my checklist that our regular readers should already be familiar with from before.
Stage |
Action Involved |
Check Mark |
1 |
F. A. - Fundamental Analysis |
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2 |
T. A. - Technical Analysis |
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3 |
I.V. – Implied Volatility |
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4 |
Position Sizing (or Risk Management) |
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5 |
Planning the exit strategies |
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Figure 1
Planning Stage: Step 1 – Fundamental Analysis
I have selected an underlying that has shown decent strength over the last several months. Without getting too much into its specifics, let me just mention that there are no earnings releases, stock splits, or dividends on the horizon for the product that I am trading.
Step 2 – Technical Analysis
The chart below shows the weekly candles of the underlying that will remain unidentified. There are multiple trends acting on it, depending on the various time frames that could be looked at. On the yearly perspective we are in a downtrend, on the daily chart it appears that we are in a strong uptrend, whereas the weekly shows us that we are actually in a sideways mode. For those unable to see this from a single chart, I suggest changing the time frame to scrutinize the accuracy of my comments in greater extent.
For those wondering why I have selected the weekly, here is the answer. Due to the Iron Condor strategy, I am going to be in this position for several weeks; in fact, I will be sitting in it until the end of June, and I will explain this momentarily. Thus, if I am in the trade for several weeks, then the most relevant chart for me should be weekly. Due to my interpretation of the weekly charts, and also being aware of the fact that the markets tend to go sideways during the summer, my bias is towards a directionless stock market movement.
Figure 2 Having identified the sideways trend, let me move on to the support and resistance. There are two major levels that are marked up on the chart above. Support is at 83, and it could be easily verified by the fact that the previous five candles, excluding the current one, were obeying that zone of 83 religiously. The resistance at 93 that I observed isn't the immediate resistance, but the second major resistance in line. Additional studies could be thrown at the chart, such as Fib retracement which would point out that my area of resistance at 93 matches the 38.2% Fib line. The study of Fib retracements gives an additional confirmation and should not be taken as anything more than that – a confirming tool.
Step 3 – Implied Volatility
The third stage involves checking of the (I.V.) implied volatility. Currently the I.V. is at 23%, the highest it has been was 72%, while the low was 15%. These numbers mean that the I.V. is at its low-ER range. As the sellers of option premium, we should look for high I.V. or at least in the higher range. In the case of my underlying, the I.V. situation is exactly opposite; therefore, the question is raised, "Should we then pass on this play?" The answer to this question is not a black or white type of answer because we are dealing with options and there are always more choices available to us. So even though the I.V. is in the lower range, I did not pass on this play.
I noticed that this specific product had the Quarterly options listed on its option chain. Those are usually overpriced and in a previous article, Un-lubricated Quarterly Options (or) Squeaky Quarterly Options, I suggested to stay away from them, unless we are sellers. In my case I sold an I. C. and the overpriced quarterlies provided the artificial substitute for having a somewhat disadvantageous implied volatility. Hence, I have a passing checkmark for the I.V.
Step 4 – Risk Management
The fourth stage is Position Sizing. Once again, for novice option spread traders I suggest doing a single contract. For simplicity sake, I, too, have used a single contract. Besides, as option traders we could not possibly go any smaller size than a single contract, for each contract controls 100 shares of the underlying.
Finally, I am at the point of discussing the Iron Condor specifics. At the time of my entry the underlying was trading at 87.25. As the chart above has indicated, I observed the 93 level being resistance. The 87.25 price was 5.75 away from the 93 zone. On the south side, I noticed the 83 zone as the area of support; hence, the price was away 4.25 points from it. In other words, I have given room of ten points for the price to fluctuate, for I honestly do not know exactly where the price might be at expiry. All that I am forecasting here is where the price will not be, which I find somewhat easier. Anyhow, the actual Iron Condor was made up of these two sides.
Bear Call side
BTO + 1 (Higher Call Strike that is deeper OTM) June5 94 call
STO – 1 (Lower Call Strike that is deep OTM) June5 93 call
Bull Put side
STO – 1 (Lower Put Strike price that is deep OTM) June5 83 put
BTO + 1 (Even Lower Put Strike price that is deeper OTM) June5 82 put
The Combined Max Profit involves the addition of both maximum profits from the bull and bear side.
Max Risk = strike spread width minus the combined Max Profit
Max IC Profit = $29
Max IC Risk = $ 71 which comes from either strike price width, Bear Call or Bull Put, both are the same; so one point spread minus the credit of 29 cents equal 71 cents. Each contract controls 100 shares of the underlying so 71 cents needs to get multiplied by 100, equaling $71.
The action I performed involved selling of an Iron Condor for (Quarterlies) June5 2009 with these strike prices: 93/94 calls and 83/82 puts. My maximum profit is only $29 while $71 is at risk. Consequently, there are two breakeven points; on the upside, the BEP is 93.29 for I have sold the call with the strike price of 93, whereas on the down side, the BEP is 82.71 because the 83 put strike price that was sold. It is from the credit that the brokers are going to pay themselves. Figure 3 below shows the exact trade sitting in my account with the specific premiums for each of four legs.
Figure 3 Step 5 – Planning the Exits
The last and most important stage involves planning the exits. Now, let me get to the specifics: There are three possible scenarios presented in Figure 4 below. The reason why there are three is because the price can close at 3 different places at the expiry: Above my sold 93 call, below my sold 83 put, and in between 93 and 83. Let me go through each of the 3 outcomes, one by one. Once again, I have sold the 93 call and 83 put.
Scenarios |
Price of underlying at the expiry |
Premium at the expiry |
Outcome 1 |
94 |
Max loss |
Outcome 2 |
82 |
Max loss |
Outcome 3 |
In between 83.01 & 92.99 |
Maximum profit |
Figure 4
Scenario 1: The stock closes above 94 and the maximum loss is achieved because the 93 call was sold and the 94 call was bought. The price closing at 94 means that there will be no premium left in the 94 call.
Scenario 2: If the price closes at the expiry below 82 then once again the Max L is achieved.
Scenario 3: The price closing within the two sold strike prices, 93 call and 83 put. This outcome is both the best and most desired one because in such case I keep the maximum profit.
I have already mentioned the two possible breakeven points, yet I would not allow my trade to come to either of two breakeven points. I had already set two alerts to get my attention, at the following levels: Upside 92.70 and down side 83.30. My alerts are set at the amount of the reverse of BEP. When those alerts go off, there is no time for hesitation and action must be taken. Depending exactly where the price is, I might end up with a slight loss or a thin profit, because there are other components involved in this play besides just the price action. They are volatility and time decay. However, whenever these alerts get hit, the unwinding of one of the sides will protect me from achieving the maximum loss. In a future article, I will come back to this trade and present the facts as to how the trade unfolded.
In conclusion, I have given another example of an Iron Condor with the sole intention of illustrating that it is somewhat easier to forecast where the price will not go rather than to forecast where it will go. An I.C. is a great strategy for a sideways market but it is not a Holy Grail. Be aware of all possible outcomes before entering into any I.C. position. Once again, plan your trade exits beforehand, and trade your plan. Have a good trading experience.
- Josip Causic
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