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Jun 17, 2015

tastytrade's Best Iron Condor Segments

By:The tastytrade Research Team

We recently looked at two core concepts in the tastytrade repertoire that we value highly:

1) We do not buy premium.

2) We look for opportunities to sell strangles.

These are valuable lessons and concepts for all tastytraders; however, they leave some questions unanswered for the tastybite trader (with small account) and the newer trader just starting out.

Today, we tackle a huge barrier of that issue. We know we look to sell premium and we like to sell strangles, but what if your account cannot afford the margin of a strangle? That is where the Iron Condor swoops in to save the day!

To make a long story very short, an Iron Condor is a defined risk strangle. Meaning, we sell one call option above the current price, one put option below the current price, while buying a put and call further away on each side.

As an example, consider XYZ stock trading for 100. We may sell a 110 call and sell a 90 put, so that would make us short the 110/90 strangle. If we bought the 85 put and the 115 call at the same time as selling the strangle, we would now have sold a 5pt wide iron condor in XYZ stock.

When we sell an Iron Condor, we want the underlying stock to stay within our short strikes so that the options decay and we can buy the whole trade back for less than we sold it for (usually 50%). As with our strangle trades, we look to sell Iron Condors in underlyings with high implied volatility (IV), and more importantly high implied volatility rank (IVR).  While we want the underlying to stay within our short option strikes, we hope for a contraction in volatility so that we can manage the trade quickly for a win.

Let’s consider some classic tastytrade iron condor examples and what each one means:

1. 1/3 the width of the strikes

This is a classic, risk-2-to-make-1 scenario, something we realize we have to do to be profitable in the long run. When we sell an iron condor in this fashion we are looking to take in a credit of approximately 33% the width of the strikes used. For example, if we sold an iron condor in XYZ and our short put spread is 90/85, while the short call spread is 110/115, then we have a $5 wide iron condor.  Collecting 1/3 the width of the strikes would mean we would look to collect $1.66 on this XYZ iron condor.

Check out this segment on spread math and how this can be a winning trade with enough occurrences.

2. Chicken Iron Condors

What came first the chicken iron condor or the… I digress. The chicken iron condor is a tastytrade strategy where we look to tighten our strikes around the current price of the underlying to collect a larger credit, typically 45-50% the width of the strikes. On our $5 wide example from above, collecting 45-50% would be $2.25 - $2.50. Using a chicken Iron Condor gives us a risk-one-to-make-one scenario, however we know that volatility tends to over-state actual moves, meaning underlyings will stay within this range more than 50% of the time, giving us an edge.

Check out this classic tastybites segment to see how chicken iron condors worked out for earnings trades. 

3. Big Boy Iron Condors

Don’t let your mind wander to classic American diners; we are still talking option strategies! A Big Boy Iron Condor essentially replicates a strangle and may often be used by those traders with large accounts but cannot sell naked calls, like an IRA account. How do we replicate a strangle? We pick the strikes that we would use if we were trading a strangle and then buy very cheap “wings’, hopefully only paying only a nickel or dime for these long options, thus not lowering our credit by too much. Typically we will look to go 10 or 20 points out on our long options. Because these iron condors seek to replicate a strangle we may look to manage these trades like strangles. This means we may manage losing trades if we are incurring a large loss relative to the max profit, possibly 200%.

Check out this Market Measures segment on Big Boy Iron Condors 

4. Skewed, unbalanced, and ratio’d Iron Condors

These are three variations on iron condors that all serve a similar purpose, putting a slight, to relatively strong, directional component to our trades.

A skewed iron condor makes a directional component by placing strikes closer or further away from the current underlying price. For example if XYZ is trading at 100 and we sell a 85/90/105/110 iron condor, meaning we are short the 90 put and 105 call then we are skewed with more room to the downside, meaning we are likely more bearish on XYZ. Note here that the wings are still the same width, which brings us to the unbalanced Iron Condor.

An unbalanced iron condor has two different widths for the call and put spread, which can be implemented on either side. As an example, consider XYZ again trading at 100 and we sell the 80/90/105/110 iron condor, meaning that we are selling the 90 put, buying the 80 put, selling the 105 call and buying the 110 call. We are unbalanced on our put side and have more risk to the downside, indicating we are likely neutral to bullish on the underlying.

A ratio’d Iron Condor utilizes selling multiple contracts on either the call spread or the put spread. We may look to sell 2 put spreads to each call spread, or 3 call spreads to 1 put spread. It varies on the trade and our assumptions.

There you have it, Iron Condors every which way! Be sure to check out this segment on iron condor variations! 

Want to learn more about iron condors and other types of options trading strategies? Visit our learn page!

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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