TESTIMONIALS . . .
Mike – There is not a day that goes by that we do not think of you and are thankful for the introduction to this world of non directional trading. I urge all traders to take your course and then begin to think and trade for themselves – and use the creative license you allowed us to receive. – Ron
Mike – You should be very proud of your performance, and I just wanted to thank you for teaching me your strategies. – Lee
Mike – I fully value and appreciate your candor, strategies and insight. You simplify what others try to complicate. I have gleaned a wealth (full pun intended) of information from both your newsletter and class. – Gene
The Iron Condor – Part II
IRON CONDOR REVIEW – PART II
By Mike Parnos
In my last column, I began the review of the Iron Condor. The Iron Condor is an integral part of our non-directional approach to trading. If you have questions, send them to me. It’s important that you grasp the concept. This kind of knowledge can set you free.
If you missed the previous column, go back and read it first. It provides the foundation for what is discussed in this column.
Iron Condor Maintenance Requirements
Your brokerage firm will want to hold $10,000 per spread in your account as collateral to cover catastrophic situations (each brokerage house calculates this somewhat differently, so check the rules where you are). A progressive options broker will require a total of $10,000 (for a 10 contract position) for the two spreads. A non-progressive broker will want to hold $10,000 in maintenance on each of the two credit spreads (totaling $20,000). The maintenance requirement can be in the form of cash or marginable securities. If you are using cash to handle the maintenance requirement, it should continue to earn money-market interest while it’s resting comfortably in your account. Again, check your brokerage to confirm their policy.
Our Exposure – Cash at Risk & Maximum Loss
The nice part about the Iron Condor is that you can’t be wrong in both directions. Technically it’s possible, but the likelihood of it happening is infinitesimal.
Our exposure is only the difference between the strike prices of the bull-put spread — 10 points. Now, remember that we’ve already taken in $1.70 in credit when we put on the Iron Condor. Therefore our actual out-or-pocket risk is only $8.30 ($10 – 1.70).
Break-even Points
We have break-even points (at expiration) of 1261.70 (1260 plus 1.70) on the upside and 1133.30 (1135 minus 1130) on the bottom side. These are break-even points — at expiration. Prior to expiration, there is time value to be considered. If you choose to close out the trade prior to expiration, you have to carefully calculate the prices prior to the trade to be accurate in assessing the cost of closing the trade and your profit or loss situation.
Adjustments
There are a few different ways to deal with a potential violation of a short strike price. In our SPX example, let’s assume that SPX is trading at 1140, just outside of the desired 1135/1125 range.
A) You can roll up and/or out. You can close out the bear call spread and roll it up and out — trading an increased number of contracts on the rollout to replenish what it cost to close out the original bear call spread.
B) You can wait and see what happens. As you know (hopefully), the market fluctuates. There’s still a reasonable chance that the market will come back down and finish comfortably below the short call strike. This is a judgment call, just remember that you are still at risk for the maximum loss here.
C) When a trend becomes apparent, you can close out the bull put spread and establish a bear call spread above the strike and trade a sufficient number of contracts so the credit taken in will replenish the cost to close out the original bear call spread.
D) You can buy back the short put of the bull put spread and, if you anticipate a continued upward move, ride the remaining long put (1125) down. If you’re right, and the stock moves to 1115, your long 1125 put will now have an intrinsic value of at least 10 points. But that’s IF YOU”RE RIGHT! If it’s early in the option cycle, and you believe the stock will continue, you can hold onto the long.
I wouldn’t necessarily close out the near worthless spread (i.e., the spread on the opposite end of the trading range) unless you need to close the spread to free up maintenance dollars for another purpose, or unless you can do it inexpensively — a nickel or dime. If SPX is threatening the lower bull put spread, bear call spread will likely expire worthless. Why spend the money on commissions if you don’t have to?
E) If, or when, a stock moves up (or down) through the short strike, we can simply buy (or short) 1,000 shares of the stock to cover the short position (if it’s a stock). When the returns back below the short strike, we simply sell the stock or cover our short shares. You may incur a few commissions and a little slippage, but it’s a good way to cover your positions. Notice that this possibility applies to Iron Condors placed on stocks. It does not apply to indexes.
