The Iron Condor

The Iron Condor

The iron condor is a defined risk market neutral strategy. It is composed of a bull put spread and a bear call spread put on for a net credit. The risk is defined as the distance between one of the spreads minus the credit received. The investor hopes that the underlying market will stay between the two short strikes and the net credit will be collected as profit. This can be a good income strategy. It can have a high probability of success depending on the width of the condor or how far the short strikes are from the underlying. It can also have a poor risk reward ratio depending on the distance between the short and long strikes on the call and put spreads.  The closer the strike prices are together, the less risk there is, but you’ll also receive less credit for the overall position.

Let’s look at an actual example as of the time of this writing. The SPY closed at 137.57. If you had the  market opinion that the SPY would not rise by more than $4.43 or fall by more than $5.57 by expiration, you could consider selling an iron condor that would consist of 1 short SPY 132 put, 1 short 142 SPY call, 1 long SPY 145 call and 1 long SPY 129 put. The net credit using the current bid/ask prices and by going out 41 days in time would be $88 for each condor. The risk would be defined as the distance between a spread and the net credit or $212. Volatility is low now so the option prices are not real high. You can get more credit by widening the distance between the spreads, but then there is also more risk. For example is you decided to use a 4 point spread, it would be for a net credit of $104, but now the risk would be $296.

Using the standard deviation is a good way to determine where to place the spread, it can be calculated so that there is a low probability that the underlying will move far enough against you, but you’ll also have the long positions there for the absolute risk control.

The iron condor can be applied when you think that volatility is high and you believe it will fall. If the implied volatility is high in the current month and lower in the farther out months, a calendar spread might make more sense.

SPY Iron Condor

SPY Iron Condor


About sellacalloption

Author, Radio Show Host and Portfolio manager and chief option strategist for IWC Asset Management.

Posted on March 11, 2012, in Neutral Income Strategies and tagged , , . Bookmark the permalink. Leave a comment.

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