Iron Condor Risk Graph

Anatomy Of An Iron Condor Option Trade

Anatomy Of An Iron Condor Options Trade

Using an Iron Condor to Trade the SPX (S&P 500) Index, Allows You to Generate Profits on a Large Slow Moving Index.

An iron condor trade is a combination of two vertical credit spread trades. This option trading strategy generates a profit by selling both call options and put options, thereby taking in a cash premium. Protection is provided by purchasing a slightly further out-of-the-money call and put option to hedge the short options.

When the trade is opened, you will receive a cash credit in your account. The credit received represents the maximum profit you can earn on the trade. Because the long options limit the potential loss, the combined position is a defined risk trade.  As such, from the outset the iron condor trader knows precisely the maximum risk and the maximum reward of the position.

Trading in a Consolidating Market

An iron condor is best suited for sideways markets. So long as the market stays flat, or within an identified range, all of the options will expire worthless allowing you to keep the credit generated when the position was originally opened. Of course, the trade can be closed prior to expiration if the market appears poised to trade outside of the anticipated range or to simply capture accrued profits prior to the expiration date.

Trading the SPX and Other Large Index Products

It is possible to trade iron condors on individual stocks. However, we prefer to trade the position on large stock indexes such as the S&P 500 or the Russell 2000. These indexes tend to move a bit more predictably and slowly than individual stocks. These broad market indexes are less prone to gapping up or down as compared to individual stocks, and carry highly liquid option chains.

Our goal is to construct an opening position that provides a wide profit zone, giving the index ample room to move over the life of the trade.  These high probability positions tend to produce profits the vast majority of the time, which leads to a consistency of profitability that many traders appreciate.

SPX Iron Condor Option Strategy

Iron Condor Risk Graph

Click to Enlarge the Iron Condor Risk Graph

The graphic above displays a "risk curve" for an iron condor. The price of the S&P 500 index runs horizontally across the bottom, from left to right.  The blue line outlines the trade's "profit zone." So long as the S&P 500 stays within that wide profit zone, a maximum return is realized by the end of each month.

By creating a wide profit zone on a slow moving index, we have developed a high probability approach that can generate consistent profits.  It is only when the index threatens to trade higher or lower than the boundaries of our position that we need to be concerned.

To minimize the number of times the market will threaten our iron condor position, we identify price levels within the market that are unlikely to be reached during the life of the trade. This serves to enhance our overall probability of success.

We have also developed both hedging techniques to protect or "defend" our trades as well as advanced adjustment techniques to modify our trades so as to adapt to changing market conditions.

Learning to Manage the Iron Condor

Even though the S&P 500, and other large indices, are "slow moving monsters," we have gone even further to protect against losses by refining the basic option trading strategy, incorporating conservative trade management principles. Those trade management guidelines are designed to keep you, and your money, safe!

Our trade management principles allow you to "adjust" your position in the market to preserve profits or limit losses when the market makes an unexpected move. We want to adjust our position before our short options are in the money. There are several potential adjustments that we can make depending upon our perception of the market activity.

Generally, the intended result is to preserve the original credit and profit potential while mitigating against the risk of capital loss. To learn more about the Iron Condor option strategy, how our subscribers trade the position, and more about other effective option strategies, considering joining us in the Trading Room.

About The Author

Christopher Smith