Anatomy Of An Iron Condor Option 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 trade generates a profit by selling both call options and put options, thereby taking in premium. Protection is provided by purchasing a slightly further out-of-the-money call and put to hedge your short options.

When the trade is opened, you will receive a cash credit in your account. That credit represents the maximum profit you can earn on the trade.

Trading In A Consolidating Stock Market

An iron condor is best suited for stagnant or 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.  Trading a large index like the SPX takes advantage of its tendency to move slowly, within defined ranges.

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. These indices tend to move more slowly than individual stocks, are less prone to large gaps 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.

The graphic above displays a "risk curve" for an iron condor. The dark black line outlines our "maximum 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.

Wide Profit Zone Increases Probability Of Success

By creating a wide profit zone on a slow moving index, we have developed a high probability approach that can generate consistent profits.

During a June 16, 2005, chat session we have constructed an iron condor position.  We did not try to predict where the market was going, but simply asked ourselves where the market was not likely to go. Market support for the S&P 500 had held at 1,200, without being breached. We identified likely resistance at 1,220, but provided ourselves even more room by selling the 1,245 call.

On the put side of the trade, we sold the 1,145 put option. So long as the SPX (S&P 500) stayed above 1,145 and below the 1,245 price level, we were poised to realize a maximum profit!

This trade was constructed with less than 30 days to the expiration date of the options being traded, for which we received a cash credit in our account of $175 for each spread we chose to sell.  That translated into a 13.2% return on risk over the 30 day period. That's better than 150% per year!

Don't Stop There! - Learn 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. The adjustment involves closing the side of the iron condor that is threatened, then open a further out-of-the-money spread. This will result in a debit. However, we will also move our profitable side closer to the money to further increase our credit on the trade. The intended result is to preserve a credit and profit potential.

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