Accredited Investing Education

Want a “Go to the Beach” Trade? How About a LEAP Iron Condor?

I have the privilege of working in the markets day in and day out as my full time enterprise. I am able to watch the markets tick-by-tick if I choose to at
any given time. This enables me to be a very active trader utilizing short duration – even weekly – option strategies. That being said, I also love to
entertain trades that require little to no maintenance, allowing me the opportunity to be away from the computer screen as long as I like. An iron condor
utilizing very long dated options is one of my favorite “go to the beach” trades. Let’s take a look at how this trade works as well as planning the
secondary exit if things don’t go as anticipated.

An iron condor is a trade placed with the expectation than an equity is going to remain within a trading range. It combines two different credit spreads –
a bull put and a bear call. The bull put side of the trades involves selling a put at a higher strike price and purchasing one at a lower strike. It
potentially obligates the seller to purchase shares of the underlying equity at the strike of the sold put. The risk is limited as the long put gives the
trader the right to sell shares at the strike of that option. The risk in the trade is the difference in strike prices between the short and long put (the
spread) minus the credit received for the trade. The bear call side of the trade involves selling a call at a lower strike than the call that is purchased.
The sold call carries the potential obligation to sell shares at its strike and the long call gives the right to buy shares at its strike. The risk in the
trade is the difference in strikes minus the credit received. Placing these two credit spreads together creates the iron condor which will be profitable as
long as the equity remains above the strike of the short put and below the strike of the short call though the expiration of these options. This trade
benefits greatly from theta decay. Theta is the option greek that defines how much premium an option will lose each and every day due to the passage of
time. The two short options in this trade profit from this erosion of premium due to time passing.

One of the benefits of utilizing very long dated options for this structure is the ability to place this trade at strikes significantly far away from where
the underlying equity is trading at the time of trade initiation. These options that are positioned well out-of-the-money actually have a faster rate of
theta decay than options that are much closer to the at-the-money position. In a truly stagnant or very slow moving trend, this enables these trades to
often be closed out for most of the potential profit long before their expiration date. They also provide ample room for adjustment in the case of a strong
trend developing that may threaten one of the short options. Let’s look at a quick example to illustrate this idea.

Let’s say you have the expectation that the S&P 500 will remain in a 15% range in 2014. Utilizing the SPY ETF as a proxy for the index and going out to
January 2014 options, you could create an iron condor that is 15% away from the current price of $182.93. For the bear call side, you could sell the 210
call and buy the 215 call for a credit of .52. On the bull put side, you could sell the 155 put and buy the 150 put for $.78. The total credit on this
trade would be $1.30 on $3.70 risk giving an annualized return of 33%.

Can the SPY fall or rise more than 15% in the next year? Absolutely which makes a secondary exit plan necessary for this trade. One potential adjustment is
to add additional long options in the direction of the trend that develops. So, if the bullish trend of 2013 continues stronger than what was anticipated,
the bull put side of the iron condor would work perfectly but the bear call might become threatened. A trader could add additional long calls to the trade,
enough to make the trade become a positive delta trade that would benefit from the bullish trend. If this is the plan, then sufficient capital for these
options needs to be set aside in the trading plan should one need to execute this adjustment. Does the SPY move 15% overnight? Not usually! The key here is
that a 15% up or down move in the SPY typically takes quite a while to occur giving the trader the ability to proactively adjust if necessary. In many
trading years, this sort of adjustment wouldn’t be necessary at all as markets remain within the 15% range. This trade needs to be managed – as all trades
do – but not on a daily basis. Only a strong trend in one direction or the other would cause the need for stronger attention and adjustment. These trades
are the backbone of my longer term trading plan. Back to the beach it is!

Karen Smith
OptionsANIMAL Instructor