technical analysis, fundamental analysis, volatility analysis, feel, and
subjectivity.
A Safe Landing for an Iron Condor
Although traders can’t control what the market does, they can control how
they react to the market. Assume a trader has done due diligence in studying
a stock and feels it is a qualified candidate for a neutral strategy. With the
stock at $90, a 16.5 percent implied volatility, and 41 days until expiration,
the standard deviation is about 5. The trader sells the following iron condor:
With the stock at $90, directly between the two short strikes, the trade is
direction neutral. The maximum profit is equal to the total premium taken
in, which in this case is $800. The maximum loss is $4,200. There is about
a two-thirds chance of retaining the $800 at expiration.
After one week, the overall market begins trending higher on unexpected
bullish economic news. This stock follows suit and is now trading at $93,
and concern is mounting that the rally will continue. The value of the spread
now is about 1.10 per contract (we ignore slippage from trading on the bid-
ask spreads of the four legs of the spread). This means the trade has lost
$300 because it would cost $1,100 to buy back what the trader sold for a
total of $800.
One strategy for managing this trade looking forward is inaction. The
philosophy is that sometimes these trades just don’t work out and you take
your lumps. The philosophy is that the winners should outweigh the losers
over the long term. For some of the more talented and successful traders
with a proven track record, this may be a viable strategy, but there are more
active options as well. A trader can either close the spread or adjust it.
The two sets of data that must be considered in this decision are the prices
of the individual options and the greeks for the trade. Exhibit 10.8 shows
the new data with the stock at $93.
EXHIBIT 10.8 Greeks for iron condor with stock at $93.