Iron Condor: Pre-Trade Considerations

Iron Condor Trading

Iron Condor
Condor. Google Images

Question from a reader: How can I discover the type of iron condor that is suitable for my personal comfort zone?

Reply: There are several items to consider when using this strategy.You will discover that there is no blueprint for an exact, rule-based position that suits your needs. You can afford to be flexible when trading the iron condor.

Underlying
Diversification is important for any investor, and especially when selling premium (i.e., collecting cash for an option spread).

If you prefer to trade individual stocks, I suggest owning four or five simultaneous positions.  

I prefer to trade index options because that eliminates the risk of trading individual stocks which are always susceptible  to an unexpected news release.  Another benefit is that trading a single iron condor on an index makes it much easier to manage risk (i.e., adjust positions) -- if and when the market is undergoing a significant price change.

Spread width  
One of the fallacies that iron condor traders tend to believe is that trading a 20-point wide iron condors is very different from trading a 10-point spread. [NOTE: The spread width refers to the width of the call and put spreads and has nothing to do with the distance between the call and put options.] The only important difference is that position size must be reduced by 50% in order to maintain a safe level of risk.

If you trade 20-point spreads, there is one thing that must be understood.

  A 20-point spread is exactly the same as trading two consecutive 10-point spreads.  Translation:

Let's look at the call portion of the iron condor: Selling the 480/500 call spread is exactly the same as selling:

The 480/490 call spread and selling the 490/500 call spread.

And that is why selling one 20-pointer carries the same ultimate risk as selling two 10-pointers.

 There is nothing 'special' about the 20-point spread. I choose the wider spread only when I want to sell both the 480/490 and the 490/500 spreads. By choosing the 480/500, I get to sell a position that is equivalent to selling an equal quantity of each of the more narrow spreads. 

One major point is obvious, but must be made: NEVER sell the 480/490 and then immediately sell the 490/500. Doing so requires spending twice as much on commissions and increases slippage (the cash lost when trading, due to the fact that we must deal with bid/ask spreads). Just trade the 480/500 spread with a single order.

However, if you already sold the 480/490 call spread, there is no reason why you cannot trade the 490/500 call spread (probably as an adjustment) at a later time.

Lot size and margin
Always consider how much margin money to have tied up in each trade. Always maintain some margin availability for future adjustments, if needed. If you don't have that extra room, then you will not be able to adjust positions and will be forced to exit if you run into trouble. It is wise to avoid ever getting squeezed due to lack of margin.

Premium (price) and strikes
Each trader has a preferred method. Some prefer to trade options with strike prices that are a specific number of points (or a specific percentage of the underlying price) out of the money.

Others prefer to collect a specific premium. Still, others sell options with a specific Delta.

None of these methods is better than another. I urge you to adopt each method of choosing your iron condor at least once. and you will know which is most comfortable -- because one will feel more natural or one will be far easier to understand. 

When implied volatility is low, rather than high, the available premium for initiating the iron condor is less. The same is true for the Deltas of the out of the money options (because the chances that the options will be ITM when expiration arrives is reduced).

Expiration months
You may feel most comfortable trading the Weeklys (options that expire in one week, or less). At other times, you may prefer options with longer lifetimes. For iron condor trading, I suggest not owning options with an expiration date that is more than 13-weeks in the future.

There is a wide choice of iron condor types, and I know that one (or two) will be more comfortable for you than another. But choosing is not too difficult. When you think about a potential investment in an IC, look at the plot of potential profit and loss; think about how long you want to own the position; look at how far out of the money the options that you sell are -- and you will know whether owning that position feels right, or is just too risky. Then make the most important risk-management decision: choose a comfortable position size.