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A true trader never stops learning and understands that market wisdom comes from many voices. Even when putting on a complex options strategy, it always pays to look at the bigger picture.
The Russell 2000 Index (RUT) is a great trading index, and apart from two trading days in January 2008, has been range bound since January 2006. Different traders will have an opinion of what range bound means, but this is certainly a very wide range – 200 points approximately from the lows to the highs.
The Iron Condor is a popular strategy for Index trading particularly, as Indices are less likely to gap around as stocks can. This is because an index is always made up of a basket of stocks, so the ups and downs of different stocks are smoothed out. The Iron Condor makes its full profit by the stock or index staying within a certain range in (usually) a one month period. This large ‘bird’ with the extremely wide wing span is made up of selling an out-of-the-money (OTM) Call credit spread, and an OTM Put credit spread (encompassing support and resistance).
One thing we have had to constantly contend with in our trading over the past months is the Federal Reserve’s market management – cutting interest rates and injecting money into the economy. I have found it very useful, and in this instance critical, to look at the bigger picture before placing orders. A chart can look good from the technical perspective, but it’s important to understand how the markets are interlinked and react to each other. The Fed reacts to its own sources of information, however the bond market will always give insight into how much liquidity is in the financial system and whether or not more is expected. The bond markets have been covered in recent articles by John Jeffrey, and he has illustrated the relationship between government debt and interest rate direction. As expected, the bond yields moved lower (and actual bond prices higher), suggesting interest rates are falling across the yield curve.
As bond prices started to move lower in late January, it was an indication that the Fed may ease off in its interest rate reduction. In the context of this Iron Condor position, there was no expectation of any out of the ordinary Fed moves that could jeopardise or threaten the proposed trading range and integrity of the short put and call positions.
Manage your markets!
Matt Baker
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