Welcome back to my series on Iron Condors. We’ve covered lots of theory, and now we’re cranking out some practice. Today I’ll show a hypothetical Iron Condor (IC) trade using options about 3mos from expiration. I wrote this on 10/20, and even though we’re using options with 3mos left, I’d only intend to hold the position for a month or so.
You can catch up on this series by skipping to “Iron Condors: A Quick Recap” section below. As you’ll recall, an iron condor consists of four legs:
• Buy a put, Strike A
• Sell a put, Strike B
• Sell a call, Strike C
• Buy a call, Strike D
Commission at TradeKing is $22.40 to establish the play, assuming one option contract per leg.
Usually the underlying is trading between strikes B and C when you initiate the trade. Its max potential profit is limited to the net credit received, while the max potential risk is limited to Strike B minus Strike A, minus the net credit received.
Iron condors are multiple-leg options strategies involving additional risks and multiple commissions and may result in complex tax treatments. Keep the risk of early assignment in mind when constructing your own trades. Consult with your tax advisor as to how taxes may affect the outcome of these strategies.
Now, an example: a 3mo RUT Iron Condor
As before in this series, we’ll be focusing on the Russell 2000 index (RUT). Below is a chart of the RUT:
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Over the last couple of months, the RUT has been more or less going sideways. It seems to be having a hard time creaking $620, so perhaps that’s a resistance level.
I have selected to sell the January 710 calls and the 520 puts and buy the 720 calls and the 510 puts. You can see the profit range plotted on the chart.
It’s good to get a longer view of things as well, since sometimes things look different. Below is a longer-term chart of the RUT:
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This makes things look a lot different. Instead of trending sideways, this chart makes the RUT look like it’s trending up. However, you also notice: the last time it was below $520 was in July, and the current trend seems to be moving away from this. The last time the RUT traded above $710 was a year ago in September.
TradeKing’s Probability Calculator indicates the probability of RUT finishing between 520 and 710 is 75.86% at the January expiration. That calculation is based on an At The Money (ATM) Implied Volatility of 27.07%. Remember: I said we’d consider exiting this IC in a month or so if things were to go well.
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Below is the P&L graph:
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The Bid indicates a $0.70 credit and the Ask is $3.20 credit with the mid-point at $1.95 credit. For this example, let’s assume we get the trade filled for a $1.80 credit, which is slightly below the midpoint. This was arrived at by taking slightly below the mid-point for each option bought or sold, giving us a more realistic entry.
If you look closely, you can see that the put spread netted $1.10 and the call spread netted $0.70. The IV on the put is much higher than for the calls, as we’d expect from the volatility smile. I also am a little closer on the put side on this example.
For this hypothetical example, let’s assume we’re trading 10 sets of options. So assuming we exit before expiration, TradeKing’s commission would be $45.80 entering and on exiting, for a total of $91.60.
The total credit would be $1,800 - $91.60 = $1,708.40 after commissions.
The total dollar amount that will be tied up in this trade is $10,000 - $1,708.40 = $8,291.60. That includes commissions.
The trade’s potential yield is $1,708.40/$8,200 = 20.8% at January expiration. Again I wouldn’t be intending to stay in the position that long. If this trade can be closed for a 5% or more gain after a month, we should be happy.
We’ll follow up on this example in a future post, to see how it really fared. If the RUT moves in the meantime, I’d consider an earlier exit or possibly an adjustment. If not we’ll make a judgment on when we’d theoretically exit, based on profit and time.
This will take a while to play out, so we’ll give ICs a breather and jump to one of my favorite “income trades”, calendar spreads, for my next post. I’ll keep updating you on this example as time goes by so you can see what my thinking would be as things develop. Stay tuned!
Iron Condors: A Quick Recap
In part 1, Credit Spreads on the Russell 2000 index (RUT), we revealed how credit spreads and iron condors are related trades, both used for income generation in sideways markets. Part 2 set up a theoretical RUT iron condor trade; we followed up on that trade in Part 3 to see how it fared.
I responded to two great reader comments, one exploring a related strategy, iron butterflies, the other on managing iron condors successfully once you’ve established the trade. Then we discussed how you can weigh the odds of an iron condor’s success, how to calculate expected returns and how to pick your expiration month – all before entering the trade. We also discussed Iron Condors and implied volatility as well as Iron Condors and the “volatility smile”. Last but not least, we followed up on an RUT October IC to see how it fared in reality.
As for commissions on iron condor trades, it will cost you $22.40 to enter a 1-contract IC at TradeKing. You can exit your IC in several ways, and commissions vary according to exit scenario. In a nutshell, commissions on a 1-contract IC range from zero to $14.90 for the following exits:
1. If you let all legs expires worthless: no additional commission
2. If you get assigned on one leg: flat $4.95, You may choose to close out the long leg, you’d pay an additional $4.95 plus 65 cents for that step.
3. If you get assigned AND you choose to exercise a leg to meet assignment, the assignment part costs $4.95 in commissions and the exercise $9.95, for a total of $14.90.
Until next time,
--Doc Maher
"Income Trader"
DocMaher Trading LLC
All-Star Commentator
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Jonathan F. Maher, PhD has a professional business relationship with TradeKing.
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