The Iron Condor – Illustrated with Hewlett Packard

• Posted by Greg Harmon
• on December 2nd, 2011

There are many different strategies that I use with options and over the next few weeks I will continue to go through some of them to help explain the strategy and how it can be used to access the market with controlled risk. Today’s is the Iron Condor (links to the rest of the series are below).

Iron Condor

This strategy consists of buying one Put Spread and one Call Spread on either side of the stock price to create two ranges of profit. It can also be looked at as combining both a long and short Strangle hold around the stock. This trade is entered for one of 3 reasons. When there is no clear conviction on direction of a large expected move, a view that the stock will not move much or when Implied Volatility is abnormally high or low. The Strikes are chosen to maximize the potential gain depending on each circumstance. If the trade is to be able to win on a move in either direction then the inside strikes will be tight and they might possibly be a Straddle. The trader will buy this combination or be long the Iron Condor. The trader will sell the spread (or piece with value) that is against the ultimate move to recapture some premium and hold the spread in the direction of the move until their target. If the trade is for a limited move then the inside strikes will be further apart to protect against the move, with the outside strikes chosen to limit downside risk but maintain profit. The trader will sell the Iron Condor in this situation looking to pocket the premium or a large portion of it. Here the trader is looking for both sold options to expire worthless. The maximum gain on the sold Strangle is the premium taken in. If the trade is for a drop in volatility then the trader will sell the Iron Condor before an event looking to either buy it back at a lower price or to buy one of the pieces. Confusing? Lets look at an example from a trade we took recently on Hewlett Packard, $HPQ.

Hewlett Packard had run up to resistance at 28.50 going into earnings Monday November 21 but fell back as of noon that day as shown in the chart above. It had resistance higher at 29.80 and then 32. To the downside it had support at 26 and then 24.50, followed by 22 below. The Relative Strength Index (RSI) had been pounding on the mid line from above and the Moving Average Convergence Divergence (MACD) indicator was trying to roll lower on the daily chart. The weekly chart below showed that the RSI had been running sideways and remained in bearish territory. It had a MACD that was positive but stalling as the price hit the falling 20 week Simple Moving Average (SMA). I gave it a slight downside bias. But $HPQ was also interesting because it had weekly options. With just 4 days remaining and one of those a Holiday followed by Friday’s half day session. The activity Monday was biased to the downside with puts trading outnumbering calls by nearly 2:1. The at-the-money Straddle implied a move of 2.37 by Friday or 8.8% making a range of 24.50 to 29.27. Implied volatility was elevated at over 100% compared to historical at 38%.

Trade Idea: Sell the 24/27/27/30 Iron Condor

This starts by selling the 27 Straddle (selling both the Weekly 27 Strike Put and Call) but adds buying both a November 30 Call and a November 24 Put. Doing this limits your loss to $1 no matter which direction the stock moves. If it stays within a tight range then the ‘inside’ Straddle will be bought back and the ‘outside’ Strangle will be sold for whatever you can get.

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We sold the Iron Condor for $1.97. After reporting the stock did stay in a tight range but lower. The first move was to buy back the short 27 Calls for 13 cents on the move lower in the stock. Later in the day the lower half of the Condor was bought back for 1.11 as the stock recovered some. Net buyback cost was $1.24 for a 73 cent profit, leaving the long 30 Calls to Expire worthless.

The Strangle – Illustrated with Campbell Soup

The Ratio Put Spread – Illustrated with Salesforce.com

The Put Butterfly – Illustrated with Nordstrom

The Call Spread Risk Reversal – Illustrated with Leap Wireless

For more details on how I traded this name and for more ideas and deeper analysis, use the Get Premium button above. As always you can see details of individual charts and more on my StockTwits feed and on chartly.

If you like what you see above sign up for deeper analysis and trading strategy by using the Get Premium button above. As always you can see details of individual charts and more on my StockTwits page.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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