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02/02/2011

Iron Condor Options: Placing a Trade


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Profiting with Iron Condor Options Indexes are probably the best instruments to trade condors, and the SPX, RUT, and NDX are the best of this group. The two main reasons are liquidity and their use of European-style options. The greater the liquidity, the easier it is to execute the trade, and European-style options increase your safety by eliminating the risk of early exercise.

The buying and selling of contracts takes place through an auction process. The bid represents what the buyer wants to pay, and the ask is the price the seller is seeking. There is no right way or wrong way to approach the bid-ask spread, but how you negotiate the price will result in different outcomes in your trading.

In an electronic market the difference between the two can be negligible. Whereas the rest of the trading world has gone electronic, the indexes are traded the old-fashioned way, by open outcry. As in the old movies of the stock exchange, traders are yelling back and forth, frantically buying and selling with hand signals. One day these will also go the way of complete electronic trading, but until then the bid-ask spread you see on your screen will unfortunately not always be the price you can get. There is frequently a large discrepancy in the bid-ask on the computer screen and what is actually traded in the pit. The computer can show a spread that is dollars apart when the pit may be dimes apart. Therefore, the midpoint between the bid and ask is a good generalized reference for analyzing how trades work out. The midpoint, where the market is most likely to trade, is a pretty accurate and usable price.

There is no absolutely right or wrong way to decide which strikes to use, but remember, not all trades are equal. Going through the different strategies, you will decide how to approach the market.

TWO OUT OF THREE

Getting into a trade and getting out of a trade is what condors are all about. Everything that happens in between is just noise. Each trader has his own style. Your goal may be to trade as conservatively as possible. But trading condors is risky business. Even within a risky strategy, there are different degrees of risk taking.

The inevitable forward motion of time is a two-edged sword. On the one hand, the longer you stay in a condor, the greater your potential return. On the other hand, every day you are in the market is another day exposed to market risk. Everybody loves reward, but risk is frightful. An overly aggressive approach to trading just isn’t worth the sleepless nights.

There are numerous ways to trade condors. Be aware of all the important considerations before you make the trade. Condors are very slow-moving creatures. When you sell a condor, time decay occurs slowly at first. Don’t make any decision too hastily. Moving in and out of a trade too quickly is expensive simply from the bid-ask spread. If the bid-ask spread for a condor is $3.50–$4.00, then it sells, without negotiating, for $3.50 but is purchased for $4.00. So if you sold a condor and flipped it immediately, you would be out 0.50 a share. This can be a big loss for simply getting in and out of a trade. Patience really is a virtue when trading condors. You have to be patient each step of the way, whether you are getting into a trade or adjusting a trade. The only time you should be impatient is when taking a profit.

Many condor traders are in the market every single day of the year. This may not be the best approach but it is a legitimate strategy for some. You can make or lose money only if you are in the market. The strategy of staying in the market as little as possible and maximizing profits as much as possible is the most desirable.

Successful trading is all about having a plan. Without a plan you become victim to the two killers of all trading, greed and fear. Let the plan make the decisions instead of greed or fear making them. Trading plans may be prepared in advance not as a decision model but as a reaction model, which lets you take advantage of greed and fear in other traders. All aspects of the trade, entry, adjustment, and exit, are conscious tactical and strategic reactions to the market.

Trading works best when it is set up as a reaction to the market. As much as you want to, you will never be able to move the market one way or the other through sheer force of will or prediction. Confidence or worry will not have any effect on either the market or your success. If you keep this simple fact in mind, your experience will be a lot less stressful. Proper planning is simply making decisions in advance so that you can react appropriately when the time comes.

The only time in the trading process when you do not simply react to market conditions is when you enter the trade. Therefore you need to define your conditions for waiting for the right moment, entering a trade, and committing yourself. Because you choose the when and where of your point of entry, you have the leisure to make sure your trade fulfills all your predetermined conditions so that you don’t have to compromise on your goals.

When entering a condor, you hope that the market will stay range bound (1) within your wings long enough (2) to make the profit (3) you seek. Knowing what you want, “range bound,” “long enough,” and “profit,” defines the trade. There are three considerations when selling condors:

  1. Time
  2. Position
  3. Price

A perfect condor strategy is one in which the trader knows exactly how many days away from expiration he should put in his trade, exactly which strikes to sell in his vertical spreads, and the correct amount of credit he wants for the trade. Of course, this never happens because you can never purposely get every decision right in advance. To make a profit with condors, think of condor trading as the “Art of the Imperfect Trade.” You don’t have to be exactly right, just approximately right.

Unfortunately, these three conditions are frequently intertwined and it is difficult to consider one without the other two. Since volatility is the wildcard in options trading, you will not know whether your trade met all three conditions perfectly until after you are out of the trade. Staring at the choices in front of you prior to making a trade, you will frequently find that the best you can do is to compromise and choose two out of three of these considerations for your condor. The question is which two out of three?

–Michael Hanania Benklifa. Excerpted from Profiting with Iron Condor Options: Strategies from the Frontline for Trading in Up or Down Markets by (FT Press).


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