Basics of Iron Condor Options

10/19/2011 2:05 pm EST

Focus: OPTIONS

Kerry Given, PhD

Founder and Managing Director, Parkwood Capital LLC

The iron condor is a popular option trading strategy, but be sure to have solid risk management in place before executing any trades. Kerry Given examines the pros and cons of trading this option strategy.

I’m speaking with Kerry Given today, and we’re going to talk about the iron condor. Hi Kerry; nice to see you again. First, what is the iron condor?

The iron condor sounds like an odd strategy, but it’s fairly simple. It’s actually two spreads: If you put on a bull put spread down below the price of the stock or the index, and then also put on a bear call spread up above the price of the stock or index, you have an iron condor.

Is it suitable for beginning options traders?

Well, yes and no. I wouldn’t recommend it unless they’ve had proper training on how to control the risk, because one of the problems with the iron condor is that your (profit) potential is reasonably small; you can make maybe 10% to 15% on a typical trade, but you can lose a lot of money.

So, for example, let’s say that I’m trading 20 contracts on an iron condor, and I’m bringing in, say, $3000 in credit; that means that my maximum loss is $17,000. 

Therefore, you have to be very cautious about your risk management. If you have good risk management, it’s a very effective strategy.

And is that the crucial key to success in this strategy?

Absolutely, that’s the secret. You need to know not only how to control the risk, but also how to adjust it, if necessary, when the market moves against you.

Let’s talk about the adjustment first and then controlling it.

The way I adjusted when I traded, the way I think’s the best way—there’s certainly many different ways—is if the Delta of the short option on either side gets to be about 18, I will go out at that same strike price in the next month and buy long options.

So if it’s pressuring my call side, I’ll be buying long calls; or my puts, I’ll be buying long puts.

In any case, what that does for you is then you have some long options that are helping you as the market continues to move against you.

Any other things that I should be watching?

The other thing you should watch is, even if that moved against you and you had to make that first adjustment, I continue to watch the Delta of my short option, because if it gets to 30, I want to close those spreads entirely and just roll them down or roll them up, whichever side it’s on.

Do you use stops when you trade this?

Yes, I do. It’s very important that you have a stop. I always have what I call my “safety net,” if you will, in case of a market crash.

So, I always have a calculated number where I think the Delta of my short option would be about 35, and that would take me out entirely on that side.

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