Josip Causic

Flying High With Iron Condors

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The strike prices that I intended to sell were 71 strike price for the put side of the trade, and 75 strike price for the call side. On the put side, the IWM had to close above 71 at the time of expiration, whereas on the call side the IWM had to close below 75.

The room that this trade had for fluctuation was only four points wide -- so on June 3, 2008, I did have a choice of selecting the June expiration, or going even further out to July or even August, but I ended up selecting the June expiry.

From June 3, 2008, to June 20, 2008, which was the third Friday in June, there were only 17 calendar days left. At that time, I was teaching an option class and we needed an iron condor example, so for educational purposes I placed the iron condor on the IWM with a single contract. Most of the time, I would like to go into an iron condor five to seven weeks prior to expiration. The reason for taking on this trade was that the time decay (theta) is the greatest during the last two weeks of the option lifespan.

How I Got Out

When I sold an iron condor on the IWM, I had a net positive theta (theta measures the rate of decay in the time value of options), and at the same time, a neutral to negative delta. A net positive theta means that time was on my side, as the Rolling Stones would say. For every passing day while the price was going sideways, I was profiting.

A neutral-to-negative delta came from the fact that I had traded the options that were out of the money. I had sold approximately the delta of 10 on each leg (71 put and 75 call). Inside of delta is also the probability of expiring.

Thus, if I sold a delta of 10, then I have a 90% of chance of seeing my sold strike price (71 put and 75 call) expiring worthless, which is exactly what we want. However, keep in mind that holding on to an iron condor to expiration is equal to taking on a higher risk. In my case, the iron condor had to close below 75 and above 71.

As you can observe from the chart below, the IWM's closing price was $72.55, thus no action was required and all four options expired worthless. I was able to keep the maximum profit.

(Click here to see a larger version of this chart.)

In conclusion, an iron condor is a short bear call and a short Bull Put traded at the same time on the very same underlying stock. So, an iron condor involves a net premium selling. And in this case, the iron condor worked as well as any textbook example.

Josip Cusic is an instructor with the Online Trading Academy. To learn more about him, read his bio here

This article originally appeared on The Options Insider Web site.