The iron condor credit spread strategy is utilized by stock market traders when they believe that a share will probably trade sideways for a certain amount of time. Perhaps they expect small fluctuations up and down in the underlying stock price, however over the following 30 days price action will remain relatively unchanged. When this is actually the case, equity option trades can make the most of what is called time decay, or positive theta. What theta represents may be the decay in the value of an out-of-the-money option as its expiration date approaches. The iron condor setup is simply the combination of a bull put spread and a bear call spread.
This trade is set up by selling out-of-the-money options and purchasing further out-of-the-money-options. Once structured, the trade will receive a net credit since the sold options make an increased premium than the cost of the purchased options. As time decay continues to wear at the value of all options, the trade can potentially 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 risk versus reward setup will increase. Simply, the more risk you take on for the trade, the more credit you are able to potentially receive at expiration.
We shall now put up a good example of an iron condor trade and how to implement one. Let's suggest that Apple (AAPL) is trading at $620 per tell 41 days to go until expiration. We still find it 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. This provides us a net credit of $1.60. Next, we would complete the iron condor position by setting up 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 add up our total credits from each spread, which provides us $3.55. To calculate our risk for the trade, we would subtract the credit received from the sum total difference in strike prices. Within our example would subtract $3.55 from $10.00, which provides us a total of $6.45 of risk. Therefore, we can calculate this trade offers the potential to make $3.55 for each and every $6.45 we risk. Since one option contract represents 100 shares of the underlying stock, we've the ability 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 utilize in markets that are not experiencing plenty 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 a share when earnings will occur within the timeframe 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 organization you're considering opening this trade on. Also, make sure you identify clear quantities of support and resistance, as these may help identify high probability areas with which to set up your iron condor. Identifying the correct times to open this sort of trade allows a trade to profit when a share is trending sideways. Because this really is so usually the case with markets, being able to properly execute the iron condor strategy is crucial to being fully a successful options trader.