What is the Iron Condor Strategy? | Options Trading Concepts

[Music] [Music] of and we're gonna break down some takeaways for you as well so let's get right into it and we'll break down the very first opening trade well show you how it's set up and how to calculate the P&L specifically the break-even the max profit and the max loss so we've got an iron Condor here and really all an iron Condor is is a four-legged trade where we're selling and out of the money put spread in addition to selling and out of the money call spread so we've got four legs here and we're collecting different values for each side so we're collecting a value for the put side and we're also collecting a value for the call side but we're gonna add those credits together to create our total credit value here and normally we look to stick around that 45 day till expiration range so we're gonna do the same thing with the iron Condor as well so if I'm collecting one dollar for this trade regardless of how much of that $1 is for the call side and how much of that $1 is on the put side I know that when I'm selling premium and specifically when I'm selling out of the money options my max profit is the credit that I received when we're looking at these standard strategies that's because the max profit is going to be realized if the options actually expire and stay out of the money so my max profit will be realized if the stock price which is currently at 55 stays anywhere within the range of 50 and 60 at expiration so we've got about 45 days to go it could come up a little bit it could come down a little bit but as long as it's in between these short strikes my put spread would be out of the money and expire worthless as well as my call spread which is also out of the money at this point in time so if I know that my max profit is simply the credit I received if I received one dollar for this trade my max profit would be $100 now to calculate max loss with iron condors we're looking at the width of our wings and we're taking our credit and basing it off of the value of those that width of the wings so if I look here and I see I'm selling a 60 call and I'm buying a 63 call that's a three-point wide spread and on the down side here I'm selling that 50 foot here in buying the 47 put to define my rib that's also a three point widespread we're not going to take three and three and add them together because of the fact that only one side can lose so the stock price can't both breach this strike and that strike at the same time so we're basically going to take that three point wide value since these are both the same we've got a three point wide spread here and a three point wide spread over here so we take those three points and we subtract one from that because I'm collecting $1 in credit I know that I can take my three point wide spread subtract my initial credit received of $1 and that gives me my max loss of $200 at any point in this trade the stock price can breach these strikes so it's important to remember that we are dealing with a defined risk scenario we don't have any naked options in this strategy because we're defining our risk on the upside by purchasing and out of the money call that's even further away from the stock price and then our short option and also on the downside we've got our out of the money put but we're purchasing a further out of the money put to define our risk now to calculate our breakeven it's pretty simple as well so instead of looking at these short options a lot of people might initially think that when we're looking at selling premium on our short strikes our breakeven is going to be right on those short strikes but when we take into consideration the credit we received originally which is one dollar we can use that one dollar to offset any losses we might see so if we're looking at these strikes here and I know that I'm selling my call on the 60 strike and I'm selling my put on the 50 strike if I collected $1.00 in premium I'm gonna be able to offset those losses on either side by one point so my breakeven to the upside would be 61 as you see here and my breakeven to the downside is going to be at 49 so let's talk about a little bit of how we came up with that value there so when we're looking at max loss our max loss is going to be if either of these strikes are completely breached at expiration if the stock price is at 65 for example my 47 and 50 puts are going to expire worthless but my call spread that I sold is going to be completely in the now as we know when we're dealing with options and options spreads our options are going to be trading for intrinsic value at expiration since I have a three-point wide spread here at expiration if the stock price is above these strikes here which would mean that these options are in the money I'm going to have to buy back the spread for around $3 so that's how I get that max loss of $200 if I know that I'm gonna have to buy this spread if it's completely in the money back for $3 at expiration or $300 but I collected $1 or $100 in real terms from the beginning of the trade I can use that $100 to offset the cost of me closing this side of the trade for $300 which is why my max loss is only $200 and now if we think about the break even if my stock price is at 61 this short call is going to be worth about $1 at expiration I'm gonna have to buy it back for about $1 if the stock price is at 61 my long call is still going to be out of the money because 63 is still higher than 61 so this call would be out of the money my puts would be out of the money so all I'd be really dealing with is that in the money call that would be in the money by a $1 if it's if the stock price was at 61 so if I collected $1 originally or $100 and I know I'm gonna have to buy back this short call to avoid exercise and assignment for $1 $100 then I can use that original credit I received to offset my losses completely which is why my breakeven to the upside would be at 61 conversely if we're looking at the downside it's the same exact thing so if the stock price is at 49 I know that both of these options are going to expire worthless because they're above the market price and when I'm looking at the stock price at 49 my put that I purchased at 47 to define my risk is also going to be out of the money and expire worthless so if I know that I have to buy back just this 50 option for about a dollar $100 and I collected that dollar originally I can completely offset my losses by that collection in the beginning so let's go on to the next slide and we'll talk about a few things to be aware of when we're looking at the benefits of this strategy so the very first benefit that I mentioned previously is that only one side can lose so if we have a stock price that's going down then of course my put side is going to be tested and when we're talking about sides being tested we're really just talking about where the stock price is going to if the stock price is going towards the put side then my put side would be considered tested and my call side would be considered untested if the call if the stock price went up my call side would be considered tested and my put side would be considered untested for that reason when we're dealing with situations and strategies where we're playing both sides of the coin where we're dealing with a short call spread that has a bearish assumption naturally and we're combining it with a put spread that has a bullish assumption naturally when we create that combination we create a profit zone right in the middle so because of that reason only one side can lose I know that if the stock price goes up through these strikes and totally breaches it I would be seeing the max loss because my call sides in the money but my put side would be trading for pretty probably nothing and I would be able to close that side if I wanted to and if the stock price went down let's say 245 my entire put spread would be in the money and I would be seeing my max loss because of that but my call sub call spread that I sold is going to be trading for probably nothing as well so another thing to consider is that when we're looking at both of these spreads and we're talking about the buying power reduction or the margin required for this trade we can get two spreads for the price of one so if we think about how it much is going to cost for us to place this trade in terms of the brokerage assessing the risk on the trade if I put on just this short put spread and let's say I collected 50 cents for just that short put spread and I collected 50 cents on the call spread which gave me that total credit of $1 if I were to just consider putting on this short put spread it's going to cost me it's going to take out more in terms of buying power reduction to place that trade because I'm only collecting 50 cents so if I have a short put spread that's three points wide as you see here and I collected 50 cents for that trade you're going to see the buying power reduction depending on the platform is going to show you either $300 because it's a three-point wide spread or maybe 250 dollars because it's taking into consideration that credit you received but the brokerage knows that only one side can lose as well so what I can do is if I'm going to place this put spread I can also throw on this call spread that has that same wing width I can collect even more which is going to increase my potential profit value and I can all I can do it all for the price of the buying power reduction of one spread it's not going to cost me another three hundred dollars or two hundred and fifty dollars in buying power reduction to place this spread as well as this spread because of the fact that the brokerage knows only one side can lose so if I can place this spread I can actually throw on this spread as well as long as these strikes are equidistant and when I say equidistant I'm talking about the wing width so if I have a three-point wide spread here and a three-point wide spread here I can put on this extra call spread collect a little bit more premium and I won't see a difference in the buying power reduction needed to place that trade another benefit of this strategy is that it's a delta-neutral trade so we talk all the time about staying delta-neutral and making sure our beta weighted deltas are neutral and really we're just looking to keep those neutral because at the end of the day nobody knows what's going to happen in the market we can have assumptions either bullish or bearish or neutral for that matter but if we keep our portfolio neutral most of the time then what we're going to do is we're going to help ourselves offset those directional moves if I'm extremely bullish and I have a very bullish portfolio and I actually see the market take a down move I'm going to see much larger losses then if I would have had a much more neutral portfolio because if I have a delta-neutral portfolio that theoretically at that point in time doesn't have too much directional risk per se then if I'm giving myself if I'm removing that exposure in terms of directional risk temporarily then that's going to give me the ability to maintain those losses at a low level as opposed to skewing completely bullish or skewing completely bearish so that's why we look to keep ourselves pretty delta-neutral and this is a great delta-neutral strategy to do so and I especially like this strategy because it's defined risk since I'm not dealing with naked options and I know that my max loss is capped on both of these sides regardless of whether the stock price blows to the downside or blows out to the upside I know that my max loss is capped at that value of $200 because both of these spreads are three points wide and I collected one dollar for the entire spread that I can use to offset any spread that I might have to buy back for intrinsic value at expiration so while there are plenty of benefits of the strategy there are a few things I want to point out on the next slide and some things to be aware of when trading this strategy so one really important thing to realize is that in order to deploy the strategy successfully with the same buying power reduction as if we were to look at one side of the spread we need to have the same wing width and in order to really understand our max loss we need to have the same wing width so as you can see here we've got three points wide on the upside and a three point wide spread on the downside but let's take an example and let's say that my upside risk was five points wide so let's say I moved this long call just a bit further out of the money to 65 now what would happen well number one my buying power reduction would increase because the brokerage knows that I'm taking more risk on one side now I would have a five-point wide spread on the call side and still a three-point wide spread on the downside or the put side so when I'm looking at these spreads I would know that number one my buying power reduction would increase because I'm taking on more risk but so would my max loss because I know that if the stock price goes to the downside of course I would have to buy this put spread back for $300 at expiration because it would be trading for $300 of intrinsic value but if I have a five-point wide call spread on the upside and the stock price goes to 70 let's say now I've got a five point wide call spread that I'm gonna have to buy back for intrinsic value because both of these spreads they're both of these options I should say would be in the money so that three point wide widthh no longer applies because this is a five-point wide spread now so it's really important to realize that when we're dealing with keeping that buying power reduction the same and keeping that max lost the same on both sides we need to maintain the same wing with if we take on any more risk on either side while it is going to increase our credit most likely because if I move this 63 out to 65 I'm likely paying a little bit less to purchase that 65 option then I would be for the 63 option so my credit would probably be a little bit higher but I'm taking on $200 more of risk on the upside then if I have the equidistant wing widths or the same wing widths on either side here another thing to be considered considerate of is the probabilities of this trade so I mentioned taking on the one side originally and just that one side when I create that spread so let's say I just have a put spread on I have the ability to be profitable anywhere from 55 to 50 and even a little bit below 50 if it doesn't breach my breakeven point but what's really important is that the stock price can go to infinity to the upside if I just have that put spread on I don't have any barrier to the upside I'm not range-bound but when I create a defined risk neutral strategy like this where I'm creating a range I have to be really cognizant of the fact that I'm basically removing that infinity symbol to the upside because now although the stock price can move up it can't move up too much so when I'm looking at the probabilities of this trade I would likely see a lower probability on this iron Condor then I were to take just one side of the trade because I'm basically creating a range to the upside whereas if I just traded the put spread or if I had just traded the call spread I don't have a range on the opposite side so that's going to create a much higher probability of success because now the stock price can go anywhere in that range but in this particular situation the stock price has to stay within this range for us to be profitable and lastly to kind of piggyback onto that statement I'm always going to look for my call side credit amount when I'm looking at iron condors one thing that we've realized is that when we're trading in a normal market more likely than not will have a normal volume and to put that in simple terms it's basically just stating that the put side and we're looking at the put side and equidistant call values usually when there's a normal volatility skew the puts will be trading richer than the calls so in this example let's say maybe I would be getting 60 cents for this put spread and only 40 cents for the call spread or maybe a more extreme example maybe I'm getting 80 cents for this put spread and only 20 cents for that call spread so once once we get into those extreme situations that's when I would really consider whether I even want to put on that call spread or not because if I can only collect 20 cents on this side and I'm paying commissions of a dollar 50 here and a dollar 50 here for the dope commission rates which are fantastic rates and I'm collecting only 20 cents on this side and I'm creating a range that doesn't allow me to be profitable if the stock price goes to 70 or 80 or 90 I'm probably going to rethink that situation and I might just look to deploy just that put spread or even if I wanted to maybe move this out or take on more risk on this side whatever I can do to increase the credit on this side and something that I'm comfortable with is what I'm going to usually go for but I'm always going to look at that call side credit amount because a lot of times you'll see those extreme situations where we're collecting maybe 80 cents on that put side but only 20 cents on the call side which would make me reconsider so let's wrap all this together with some takeaways for you the very first takeaway we've got here is an iron Condor is a define drift strategy and it's a delta-neutral strategy for anyone that really does have a directional assumption but they want to take advantage of higher implied volatility which basically means the option prices are higher and it gives us a great opportunity to sell these strategies then this is a great one for beginners also we can place two spreads for the buying power of one given the sense that we have those same wing with so if I've got a three point wide spread on the call side and a three point wide spread on the put side it's not going to take out any additional buying power reduction to add on one of those spreads if I was just looking at the put side or just looking at the call side and also we seldom have to accept max loss so this goes to show why we look to adjust our strategies rather than just let them be so when we're looking at iron condors since I know that only one side can lose and only one side is going to be tested I can maneuver that other side the untested side and collect even more premium to reduce my max loss so if you haven't seen my three adjustments for the iron Condor segment definitely check that out it's in the previous archives of my Khanna's whiteboard so that's going to show you some considerations that would make when one side one of those sides is tested and what we can do to reduce our max loss and overall probability of success so thanks for tuning in hopefully you enjoyed this strategy overview if you've got any questions or feedback shoot me an email here or follow me at doe trader Mike on Twitter we've got Jim Schultz coming up those - stay tuned you

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Id: k7Q9BSaF7cY

Length: 19min 58sec (1198 seconds)

Published: Wed Sep 06 2017