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I’d like to use the opportunity to share some of the insights I gained in my Iron Condor trading on the Russell 2000 Index (RUT). I traded the RUT every month of 2008 except for November and December expirations. The RUT, traded between 640 and 860 from January 2006 until September 2008, but kept confined to the 640 – 800 range for most of 2008. This made the Index a great range bound vehicle to trade a sideways strategy with. Let’s have a look at a chart of the RUT from January to September 2008.
Chart 1
click to enlarge
So why choose the Iron Condor, what is the Iron Condor, and what are its risks?
Firstly please let me emphasize that this article is for traders who already trade the Iron Condor to perhaps pick up some insightful information, and for new traders to be exposed to some of the thought processes of an Index trader, that they may be able to implement themselves someday.
The Iron Condor is simply the sale of two OTM (out of the money) spreads – one call spread and one put spread. By using the support and resistance lines in the chart above as a guide (640 and 800), then as an example, the trader could sell the 820 / 830 call spread and sell the 620 / 610 put spread. Please note this is not taking into account entry criteria or where the Index actually is when placing the Iron Condor. This is merely an example of selling OTM call and put spreads, outside of support and resistance. Please also bear in mind that the Iron Condor carries much more risk than most strategies. For example, to make $100 you may have to take $900 of risk!
The first insight I’d like to go into is whether to place the trade as a complete Iron Condor (i.e. sell the call and put spreads at the same time) or whether to leg into the trade (have separate orders for the call spread sale and put spread sale, knowing you may only be filled on one side), or perhaps just only place one side first.
If the Index is starting to trend down and coming off resistance, this may be a good time to sell the call spread, if you are confident the market has seen its highs. In this case although the overall index is still range bound, I am suggesting it’s at the top end of its range. If the index keeps heading down, the call spread will lose value which is great for you as a seller. As well, you may not have received much premium for the put spread if you sold whilst the market was up, so you may decide to wait until the market comes off a fair bit.
If in the same example the Index started to move down quite suddenly, perhaps with longer than usually bearish bars or even gaps (and perhaps bad news in the media as well), then I still may hesitate selling the put spread, as the market is showing signs of breaking down and in these cases (like late September 2008), it may not be clear as to whether support is going to hold. You don’t want to be short a put spread if the market is coming down fast!
The last reason I may decide to leg in would be if I wasn’t collecting enough premium for the spread on that side. For example we could bring up an order for the complete Iron Condor (selling both the call spread and put spread) for $1.60 total. This may look great, but if we then went and checked the prices for the spreads individually and they were $1.25 for the put spread and $0.35 for the call spread (totaling $1.60) then the trader possibly wouldn’t place the Iron Condor as a package. All else being equal, you may decide it’s not worth selling the call side for 35cents, especially if you would normally have an order in to buy it back at 20cents. The little you are setting out to make minus commissions too may not be worth the risk you're taking. Perhaps you could wait until the Index trended up a little and sell the call spread then (assuming this still went in accordance to your trade plan).
I hope this has given you a couple of ideas in managing credit spreads on Indexes. Remember, this style of trading carries a great deal of risk, relative to the reward you can make. Please don’t go out and trade these if you don’t understand the strategy, risks, rewards, breakevens and both winning and losing adjustments like the back of your hand.
Manage your risk!
Matt Baker
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