TOOLS OF THE TRADE

THE IRON CONDOR

The Iron Condor is a very popular non-directional trade.  It optimizes a stagnant range bound stock or index.  It is comprised of four option instruments.  The name itself can be quite intimidating, but you will learn that even seemingly complex multi-leg trades are really nothing more than a composite of previously known and understood positions.  That is so in this case.  The Iron condor is just a 1) Bull Put credit spread and a 2) Bear Call credit spread.  When combined together, the trade can be a very powerful and profitable position as long as the underlying security remains between the short call and put options and stays there until expiration.

The trade is best implemented on stocks and indexes that have established a definitive trading range.  I personally prefer placing the trade on indexes like the SPX.  My preference is for several reasons.  1) Indexes provide instant diversification 2) they are broad based and cash settled and as such, may qualify for IRC 1256 and more favorable tax treatment on gains (consult your tax advisor) and 3) indexes usually are not prone to frequent and severe gaps which is not what you want to see when trading this strategy.  One other aside, your broker should apply SPAN margin rules in this trade which means that they will only hold margin on one side of the trade which will increase your ROI.  The reason they should only hold margin on one side is that the stock or index can only be trading at one place at time so therefore the broker cannot be at risk on both sides at once.

Study the risk graph and you should begin to understand the risk/reward of the trade.  Best, Robin

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