One of my favorite strategies is a two-part play: Legging into iron condors.
I was talking with one of my mentoring students before the end of year about this strategy. The student was fairly neutral on a particular stock, but felt it might have a little more room to the upside in the short term. The stock was in a very mild uptrend, just starting to lose steam. Also, we did a volatility analysis as explained in my webinar series on volatility at MarketTaker.com, and found implied volatility to be high.
This scenario can be a perfect set up for this two-part option play. First, with the stock around $24.85, the student sold the July 21-23 put spread at $0.55. Then he waited for the next opportunity to materialize. The next step was to sell the call side of the iron condor. Low and behold, the stock had a few mildly-strong bullish days and he pounced on the next leg of the trade. With the stock now around $26.25, he sold the Feb 28-30 call spread at 0.60.
Why wait? Why didn’t he just sell the call spread at the same time as the put spread?
Two reasons: Bigger premium and a “wider net”.
With the stock priced down near $24.85, the 28-30 call spread was only bid $0.25. It’s hard to justify selling a two-dollar-spread for a quarter. Make $0.25 or lose $1.75? Not worth it. But with a little richer premium the trade becomes a bit more attractive.
And, the beauty of the iron condor, is that you can only lose on one of the two credit spreads. If the stock rallies too much and makes the call spread a loser, the put spread is a winner. If the stock falls too much and the put spread becomes a loser, the call spread is a winner. So, really, the trader is kind of “doubling up”. He takes in a total premium of $1.15 (that’s the $0.55 on the put spread and the $0.60 on the call spread). The most he can make then is $1.15, and the most he can lose now is $0.85.
But even though the trader can only lose on one spread while the other ends up a winner, he has risk in either direction: if the stock moves too high or too low he can lose. So, really, it is kind of like having double exposure.
Cast the widest net possible. That is, try and get the strikes as far apart as possible so that the trade has a big area (in terms of where the stock can be trading) to produce a winner at expiration.
Certainly, my student couldn’t sell the 28-30 call spread for $0.25. If he wanted a reasonable premium he’d have to have sold the 27-29 spread. At the time the put spread was initiated, he could have gotten $0.45—a better premium, but a tighter range for the stock.
Legging into the iron condor after the stock rallies allows for the best of both worlds. A high enough premium to make the trade worthwhile and a big enough area for the trade to have a reasonable chance for profit.
Of course, the risk is that after selling the put spread, the stock falls and the opportunity to sell the call spread never materializes. This will happen time to time.
Rule: You have to like the first leg, on its own, in order to think about trading this set up.
You can’t count on the market always playing out how you hope. But if you like each individual credit spread as a stand-alone play, then you’ll really love legging into the iron condor.
Dan Passarelli is with www.markettaker.com.