The iron condor credit spread strategy is employed by stock market traders if they believe that an investment is going to trade sideways for a quantity of time. Perhaps they expect small fluctuations up and down in the underlying stock price, however over another 30 days price action will remain relatively unchanged. When this is actually the case, equity option trades can take advantage of what is called time decay, or positive theta. What theta represents could be the decay in the value of an out-of-the-money option as its expiration date approaches. The iron condor setup is just the combination of a bull put spread and a bear call spread.iron condor
This trade is established by selling out-of-the-money options and purchasing further out-of-the-money-options. Once structured, the trade will get a net credit because the sold options generate a greater premium than the expense of the purchased options. As time decay continues to wear at the value of options, the trade could become profitable. However, sharp moves by the underlying stock to the upside or downside will cause the positioning to become a loss. The further from the money the purchased choices are, the more the chance versus reward setup will increase. Simply, the more risk you accept for the trade, the more credit you are able to potentially receive at expiration.options trading
We will now setup a good example of an iron condor trade and how exactly to implement one. Let's claim that Apple (AAPL) is trading at $620 per give 41 days to go until expiration. We believe it is highly probable that the stock will be trading between $580 and $640 at expiration. If we start with the bull put spread, we would want to purchase the 580 put strike selection for $4.40 and sell the 590 put strike selection for $6.00. Thus giving us a net credit of $1.60. Next, we would complete the iron condor position by establishing a bear call spread. To do this, we would choose the 660 call strike selection for $4.25 and sell the 650 call strike selection for $6.20. This will give us a net credit of $1.95.
To calculate our overall risk and reward, we would simply mount up our total credits from each spread, which gives us $3.55. To calculate our risk for the trade, we would subtract the credit received from the total difference in strike prices. In our example would subtract $3.55 from $10.00, which gives us an overall total of $6.45 of risk. Therefore, we are able to calculate this trade provides the potential to create $3.55 for every $6.45 we risk. Since one option contract represents 100 shares of the underlying stock, we have the capacity to profit $355 at expiration while risking $645. Therefore, if Apple stock is trading between $590 and $650 per share at expiration this trade will be fully profitable.
The condor strategies are great to work with in markets that are not experiencing lots of volatility and neither the bulls nor the bears have a dominant stranglehold on the market. It is highly suggested never to execute an iron condor on an investment when earnings will occur within the time period of the trade being open. Earnings are one of many single biggest drivers of stock price movements. Always make sure you check for upcoming earnings on the business you're considering opening this trade on. Also, make sure you identify clear degrees of support and resistance, as these may help identify high probability areas with which to create your iron condor. Identifying the correct times to open this sort of trade allows a trade to profit when an investment is trending sideways. Because this really is so the case with markets, to be able to properly execute the iron condor strategy is vital to being fully a successful options trader.