An iron condor is a strategy that involves holding four different options contracts with different strike prices, all of which are out-of-the-money. The idea behind an iron condor is to profit from an expectation prices will not move very much over the life of the options contracts.
Iron condors are usually used when traders believe that the market will be range-bound and not make large movements in either direction. They are ideal for use in markets where there is a lot of uncertainty or when volatility is relatively low.
The key to successful iron condor trading is to correctly identify these periods ahead of time so that you can enter into the trade with confidence.
Identify market conditions that are conducive to trading iron condors
Before you can start trading iron condors, you need first to identify market conditions that are conducive to this strategy. As we mentioned earlier, iron condors are best used when the market is range-bound and not expected to make large movements in either direction.
One way to identify these periods is to look at the volatility of the underlying asset. If the historical volatility is low, and you think this is likely to continue, this could contribute to an investment thesis of a range-bound market, allowing you to profit with a condor strategy.
Another way to identify periods where an iron condor trade would be successful is to look for times when there is a lot of uncertainty in the markets. It could be caused by political or economic events that are taking place.
Choose suitable options contracts
Once you have identified a period where trading an iron condor could be successful, the next step is to choose the proper options contract.
There are four different options contracts that you will need to hold to trade an iron condor: two calls and two puts.
The calls and puts need to have different strike prices and be out-of-the-money. Therefore, the underlying asset would need to move a significant amount before either of these options contracts will be triggered.
One way to choose suitable options contracts is to look at the historical volatility of the underlying asset. If the historical volatility is low, you will want to choose options contracts with strike prices close together. It will minimize the risk of the underlying asset making a significant move and one of your options contracts becoming in the money.
Another way to choose suitable options contracts is to look at the current price of the underlying asset and choose options contracts with strike prices far apart. It will give you more flexibility if the market does make a significant move in either direction.
Place your trade
Once you have chosen suitable options contracts, the next step is to place your trade.
You will need to use a broker that offers options trading to do this. Not all brokers offer this, so it is essential to check before signing up.
When you place your trade, you will need to specify the following:
- The type of options contracts (calls or puts)
- The strike price of the options contracts
- The expiration date of the options contracts
You will also need to specify whether you want to buy or sell the options contracts. If you buy the options contracts, this is known as a long position. If you are selling the options contracts, it is short. Selling a put and buying a call option both offer upside participation in the price of an asset, but come with differences in the contract and premium and so have slightly different functions.
Monitor your trade
Once your trade is placed, it is vital to monitor it closely because an iron condor depends on the asset price remaining within your preset range. There is always a likelihood that the market makes a significant move.
If the market does make a significant move, one of your options contracts could become in the money. If this happens, you will need to close out the position to avoid making a loss.
You will need to place an order for the opposite options contract to do this. For example, if you have long call options and the market starts to move up, you will need to place an order to buy put options.
Closeout your position
Once the options expire, you will need to close out your position. To do this, you will need to sell all four options contracts.
You can do this online through a broker or a trading platform.