In Understanding Iron Condors Part I, I discussed the basic properties of an iron condor. This time let’s take a look at some of the decisions that must be made before you select which specific iron condor to trade. There are many details to consider.
If you are a trader who believes that he/she knows when the stock market, or a specific stock, is going to move higher or lower, then don’t open an iron condor when you believe the stock is likely to undergo a substantial price change. That’s the wrong time for an iron condor – a strategy that earns profits when the stock or index trades within a range – the more narrow that range, the better.
If you believe the stock will move in one specific direction, then you may prefer to open an iron condor position with a market bias. You can build a position with a bias by choosing appropriate strike prices for the spreads. Iron condors are usually initiated as market neutral plays, but if you have an opinion that you want to incorporate into your position:
- Sell call options that are further out of the money than the puts
- Sell fewer call spreads than put spreads
- Sell put spreads that are further out of the money than the calls
- Sell fewer put spreads than call spreads
If you know that you cannot predict the future, it’s a good idea to own iron condors that are market neutral when opened. They move away from neutrality as the price of the underlying changes.
Choosing the Underlying asset
It’s generally safer to trade iron condors on indexes because you are trading a diversified portfolio and never have to worry about one or two stocks delivering a market surprise that results in a price gap of 20% or more. True, gaps occur with an index when there is major news – but that occurs far less often, and the gaps are smaller.
Most indexes in the U.S. are European style options and not American style. That means the options cannot be exercised before expiration. That’s to your advantage. The differences between these option ‘styles’ have already been covered. Please do not assume that the differences are minor. They are very important and advantageous to iron condor traders.
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