Iron Condors
Len Yates

When IV is high, it’s always a good idea to look for ways to sell options. In the years past, high commission costs prohibited many retail traders from using more sophisticated, multi-legged strategies like condors and butterflies. But with the advent of deep discount pricing from many options brokers, these strategies have become much more financially viable. So I would like to suggest how you might use those deep discounts to expand your strategy arsenal
 
I have written about credit spreads in the past. A vertical credit spread is formed when one option is sold short and another option of the same type (call or put) and expiration date is bought at a farther out-of-the-money strike. Traders use credit spreads more often to express their conviction of where the underlying price will not go, than where it will go. So credit spreads are usually opened out-of-the-money. 
 
For example, if the trader has identified a resistance level that he feels will not likely be penetrated, he may sell a call with a strike near that level and buy a farther out of the money call to cover his short call. Or perhaps the trader has recognized a support level he feels will not be penetrated. He may sell a put with a strike near that level and buy a farther out of the money put to cover the short put.
 
Building on that concept, I’d like to present one of the most popular ways of using credits spreads: a four-legged position called a condor. A condor consists of an out-of-the-money credit spread in calls plus an out-of-the-money (OTM) credit spread in puts. Initially, you try to receive approximately the same credit for each side. The initial position should be created so that the position is balanced, or delta-neutral. 
 
Traders who prefer to have time decay on their side are attracted to condors. Many condor traders have positions on continually, sometimes in more than one expiration month. Day by day, as the market chops its way sideways (which it does more than half the time), they watch their equity build as the credit spreads decay. When the market puts on a move, they simply adjust their positions to make them delta-neutral again.
 
Since a condor consists of credit spreads, its risk is absolutely limited. Even if the market were to open gap up or down 1,000 points, you wouldn’t be ruined. And you’re always going to win on one side. For instance, say you received a 2 point credit for the call spread, and the same credit for the put spread, with each spread having a 10-point strike difference. If the market takes a severe dive, the put credit spread will go to its maximum value of 10, generating an 8-point loss. That means you win on the call side, keeping the 2 point credit you received and reducing your net loss to only 6.
 
To trade condors, it is best to look at an index or high-priced stock. You need high-liquidity options and many different strike prices to work with. A lot of strikes are needed, at relatively small intervals, in order to give you the flexibility needed for putting credit spreads on “just the right distance” away from the money. Condor traders also tend to prefer indexes over individual stocks because indexes don’t have anywhere near as much of a tendency to make big price jumps.
 
The farther away from the money you can go, the greater the probability becomes of the spreads expiring worthless. So it is important to open the credit spreads far enough away from the money that they have a decent probability of expiring worthless. Going farther OTM also reduces the need to make any costly adjustments. However, the farther away options have lower premiums. In fact, beyond a certain point, those premiums fall off rapidly. That means you are sometimes pushed into using closer-to-the-money strikes than you really want to.
 
Let’s put together an example using a hypothetical stock, XYZ Corp, currently trading at $36 a share, and build a prospective condor in its options. The figure below shows the Matrix of available options. The ‘>’ marks to the left of the strike price indicate the at-the-money strikes – one among the calls and one among the puts. Out-of-the-money calls lie above that mark, and the out-of-the-money strikes in the puts lie beneath that mark.
 

Condor Position in Matrix

 
As this picture illustrates, you can be constrained as to how far away from the money you can go with a stock. The numbers in the Trade column show we are looking at 5 contracts of each of the four options in November, and this trade will generate a credit of $475. Let’s look at what the risk graph of this trade looks like:
 
The first thing we might be interested in is to calculate how far this stock could move within the 45 days time frame. The OptionVue 6 software comes with a probability calculator that can be used this way. Inputting the current price, volatility, and a time frame equal to the remaining life in the November options (the nearby’s were expiring in only a couple weeks, so we’re looking to the 2nd month this time), we find that a 1st standard deviation move for XYZ Corp could take it down to 32.53 or up to 40.31. 
 

Probability Calculator

 
 In other words, there is a 68% chance of XYZ Corp being between these two prices at the end of the projected time frame. We’d like to go even farther away from the money if possible, to get a better chance of success without adjustment. However, (referring to the Matrix again) we find that while we can sell the put at a strike price of 32.5, we need to sell the call at only 37.5 so that the option premiums still worth doing. Below is a graphic analysis of the condor that was entered in the Matrix
 

Condor Position Analyzed

 
The lines of progression show how this position develops profitability over time. Projected all the way to expiration, the analysis shows that this position has a 61% probability of success. Making adjustments over the time period to keep the position delta neutral can, and usually does, increase the probability of success (but reduces yield).
 
Condor traders are risk-averse traders. Besides the absolutely limited risk, a condor is also a very slow acting position. Even a relatively big one-day market move affects the condor very little, because one wing of the condor benefits while the other is hurt. Be careful, though, if your position has a close-to-the-money credit spread in the final days before expiration. You might want to consider closing that position early to avoid the possibility of being hurt by it.
 
Note that condors are only practical if your commissions are very low. That is because you’ll be trading a lot of options, especially when you consider the occasional adjustments. But for traders who enjoy actively managing a position in several options and seeing their account value grow almost daily, the limited-risk, slow-moving condor might be just the thing.