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Three weeks ago, we started a new Real-World Trading series discussing the use of an iron condor (see Part I). At that time, we went over the makeup of the trade and what we are looking for in the underlying to best profit from this neutral strategy. This week we will take a closer look at this mock trade on the Russell 2000 ($RUT) to show how the movement, or lack thereof, has impacted the profit and loss in this trade.

In review, an iron condor is made up of four different options all expiring the same month. The two lower strike options would use puts with the two higher strike options as calls. In essence, we are entering a bull put spread and a bear call spread simultaneously. In our mock trade, we decided to use the RUT for several reasons. First, we felt that by using this index, the odds of a very large move would be small. At the same time, a daily chart of the RUT showed some solid support and resistance levels.

The idea behind an iron condor is to find a security that is expected to close between the middle strike prices. In our trade, we entered a 680-700-740-760 iron condor. On April 9 when we entered began to track the trade, the RUT closed at 698.38, which happened to be right above support at the indexes 50-day moving average. This is why we used the 700 strike as the bottom part of the body of our trade. Below is the data for when we entered the trade and how it sits as of the close April 30.

April 9
Russell 2000 ($RUT) @ 698.38
Buy 1 680 May Put @ 16.35 (IV=29.1)
Sell 1 700 May Put @ 24.10 (IV=26.8)
Sell 1 740 May Call @ 8.10 (IV=29.1)
Buy 1 760 May Call @ 3.80 (IV=29.1)
Net Credit (Max Profit) - $1205
Max Risk - $795
Downside Breakeven – 687.95
Upside Breakeven – 752.05

April 30
Russell 2000 ($RUT) @ 716.18
Buy 1 680 May Put @ 16.35 (IV=28.3)
Sell 1 700 May Put @ 24.10 (IV=26.3)
Sell 1 740 May Call @ 8.10 (IV=21.6)
Buy 1 760 May Call @ 3.80 (IV=21.4)
Net Credit (Max Profit) - $1205
Max Risk - $795
Current Profit - $370
Downside Breakeven – 687.95
Upside Breakeven – 752.05

When we started this mock trade, we expected the RUT to stay between 700 and 740, which would provide the max profit. When we entered the trade, our total delta was 2.46, which is basically delta neutral. This means that the delta of all the option contracts is close to zero. We would like this to continue, as it shows that the underlying is remaining in the range we planned. Another key “greek” we need to understand is theta, which is defined as the gain in a trade from each day of time decay. An option is a wasting asset, which means it eventually will have no time value left. All other things being equal, theta tells the dollar amount the trade will gain or lose, based on the passage of time, normally one day. Because an iron condor benefits from time decay, we normally will enter this type of trade with less than 45 days until expiration. Time decay accelerates the last month of an options contract, so we want to take advantage of this.

When we entered this mock trade, theta was at $6.27. This meant that after one day, the profit would increase by $6.27 due just to time decay. As of April 30, theta has increased to $25.96 and will continue to increase day to day as long as the stock remains in our profit range. This is because when the RUT is between 700 and 740, all the options in the iron condor are OTM and a trader wouldn’t have to do anything further.

There are only 15 days left for this mock trade, so the trade is in very good shape. In order for a profit not to be made, the RUT would have to drop nearly 4 percent or rise 3.35 percent. Though this could easily happen, support and resistance on the RUT is solid and should keep the index within its current range. It seems that some sort of strong news will be needed to push stocks through resistance and Wednesday’s FOMC meeting didn’t have much of an impact on stock prices.

Unlike a directional long trade, we are using a strategy that is best used the last month of the options’ lives. Though we do not have a time stop with an iron condor, we should also have a profit and loss stop. However, since the majority of the profits and losses occur the last few weeks of the trade, many iron condor traders will hold this trade until expiration. Nonetheless, traders might set a stop loss at half the profits. For this trade, that would mean getting out if the current loss ever equals $600, which is half the max profit.

We will continue to discuss this trade throughout the next few weeks. In the meantime, please feel free to ask questions or make comments on my forum. I would love to hear what readers would like to discuss further about this strategy.


Jody Osborne 
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site

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