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RUT Iron Condor trade for June

May 1, 2009

I’m not a very regular Iron Condor trader. There was a time when I spent a lot of time doing credit spreads and condors. There is overwhelming logic in using these time selling strategies as you are more likely to make money without having to be as spot on with your trades as with simple long or short directional trading. Simply put, you can make money when the market goes two directions and to some extent three of the three possible directions the market can go. Ultimately, though, I found that despite the logic behind trading from that angle, it doesn’t suit me very well. The very argument for using them, that the probabilities are in your favor and time decay makes things better as the days pass, was also what seemed to consistently confuse my better judgment. Rather than strictly heeding my observations about significant breaks in technical levels and such, I would tend to give a position the benefit of the doubt and watch it slowly but surely get worse and worse. Anyone who trades spreads, knows that there is a point beyond which the Greeks can suddenly start putting the squeeze on your very fast. In short, for me personally, the strategy seemed to make me a bit lazy and over-confident. As most of you know, the trick with credit spreads is that while your win/loss ration should be higher, the profit/loss ratio will not be nearly as high as the potential with directional trading. So taking just that one or few big losses can drastically affect any profits you may already have.
Of course, I learned a lot from the experience and the time at it, and I don’t entirely avoid selling strategies. I am just a lot more selective about using them and try to keep a mind of the much bigger picture. At the moment, one of the things that strikes me is that while volatility has come down significantly from the panic highs of the last 9 months, it is still quite high compared to recent history. As a result, option premiums are still relatively high compared to the days when I was having such frustration with spread trading. Because of the high volatility, we can put on trades that are further away from the money and still find decent premiums to sell.
Take a look at the VIX.  It seems to me the most likely next move on the VIX is a pop higher, but until that happens, it is where it is. The 40 line seems a significant resistance level, we are below all the major MAs and the indicators don’t give much reason to expect a reversal.

Here’s a long term look. Barring some reason for another major panic, I don’t see why this should go back toward 50.

SO, after that long winded into, I’m looking to do a nice, simple far out of the money iron condor for June. One of the reasons I don’t like credit spreads is that you just have to wait and let the time decay do its thing. I’m a little too jumpy while watching the day to day fluctuations of stocks for spread trading stocks. But doing smaller positions on way OTM spreads on the indexes is a nice way to pick up some “easy” money. (Famous last words!)
I tend to stick to options on the Russell 2000, RUT, because it trades electronically and you are not subject to the guess work and luck involved with getting fills in the SPX pit with the open out cry that goes on there. Of course, we can always trade the SPY, QQQQ, IWM, etc., but then you have to trade many more contracts to equal the same money at work with the actual index options and that means more commissions. I know there are reasons that the TOS guys prefer those products anyway….better fills, tighter spreads, whatever. But this is just me.
I’m no Iron Condor expert, but one quick an dirty rule of thumb I’ve learned for the far out of the money IC approach is to sell the short strikes with a delta of around .10 or lower. When and if the delta on those strikes gets to .25 defensive action is needed. Either close out, roll further away, or add something like a calendar spread to balance out your deltas to a more comfortable level.

Here’s what I’ve come up with for RUT June contracts.

As a $10 wide spread, the margin requirement is $1000 for the trade. For every lot, the profit potential is $147 and the max loss potential is $853, not including commissions. Of course, this is using the data after the close on Friday, so it will surely change a bit on Monday morning.

Here’s the Risk Profile using TOS’s snazzy analyze page.
The Green line shows the p/l potential for the trade at expiration in June. The white line shows the theoretical value of the trade at any given price at the current date. As time goes one, it inches toward the green line. I have set price slices at the current price in the center, plus and minus 15% from the current price, and the break-even prices for the position. By adding the probability numbers in red toward the top, we can see that the probability is a bit over 60% that the RUT will be within the range of plus or minus 15% from the current price at June expiration. There is only a 19% chance that the RUT will be on either side of our break even points at expiration. As long as it stays between those two levels, in that big window of just over 210 points, we make money.

High Probability of success, which comes with a lower profit/loss potential. Makes sense.

Now for a look at the chart. We’re right now between the down-trending 200 MA and the 50 day which is turning upward. The 20 MA is below us and firmly headed upward. Considering the action in this area back in the fall, I don’t expect us to surge through here very easily, particularly after the strong run we’re had. Some consolidation or a reasonable pullback would be healthy. The MACD and Stochastic show potential for a bit of a pullback, but also no overwhelming signal for such. I would expect a pullback to no further than the 50 MA, currently at around 425.

Pretty cool how the strikes found with delta around .10 put our spread just outside of the high and low ends of the range from the panic in the fall.
Looks like a pretty good trade. And if you’re really feeling randy, one might try to put on the call spread now and give the index a few days or a week or so to come down some to put on the low side a little further away just for extra safety. This is probably what I will do in actuality.
Next time, I’ll show what I did for May on the RUT using this same basic approach.
Ciao for now.

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