Best Iron Condor Strategy
Best Iron Condor Strategy for Income Investors
A well-crafted Iron Condor strategy represents not only a conservative income-producing version of credit spread income investing, it is a credit spread technique that is operating on steroids in the monthly income production department.
Compared to a regular credit spread, the Iron Condor can greatly increase (often double!) your rate of return on margin deployed, but does so with no increase in risk when based on a sound Iron Condor screening strategy. In this white paper we will contrast the Iron Condor credit spread pair with the plain vanilla credit spread.
Then we’ll review a powerful Iron Condor strategy for screening for what we consider the best Iron Condor option spread candidates among stock-, ETF-, and Index-underlyings.
Although credit spreads carry risk as well as reward potential, they are among the most conservative option investment strategies. That’s why Iron Condor and regular credit spread investing for income is an approved use for options in retirement accounts.
Conservative investors seeking monthly income, such as those using “The Monthly Income Machine,” understand the recurring income producing power of plain option credit spreads.
But too often, even regular users of option credit spreads leave a lot of money on the table because they fail to take full advantage of a specific Iron Condor selection strategy.
The Basic Option Credit Spreads vs. the Iron Condor
The basic option credit spread is a short option strike price and a long option strike price more distant from the underlying in the same underlying stock, ETF, or Index, with the two options having the same expiration date. It may be a bull Put credit spread or a bear Call credit spread.
The Iron Condor is simply two option credit spreads – one bull Put spread and one bear Call spread – that meet the specific definition of an Iron Condor. Specifically, both credit spreads must: (1) have the same underlying stock, ETF, or Index, (2) be the same expiration date, and (3) the interval between the long and short strike price of each spread must be the same.
As noted earlier, the Iron Condor pair of credit spreads offers a mega-increase in income potential at no increase in risk if the Iron Condor strategy employed is correct.
Example #1- The Basic Credit Spread
If we have a basic credit spread with XYZ trading at $100, it might look like this:
Sold Short XYZ June 85 put at $1.10 Bought Long XYZ June 80 put at $0.41 Net spread premium collected = $0.69 = $69.00/credit spread potential profit
Total Margin (cash in account) required to support credit spread: $500
The Example #1 credit spread is a “bull” Put credit spread. The investor doesn’t care which way XYZ moves so long as it stays above 85 (the strike price of the short option) at expiration. If it does stay above 85, both options will expire worthless and the investor will keep the $69.00 (the net premium) credited to his account when he established the credit spread.
Example #2 The Iron Condor Credit Spread
If we have an Iron Condor credit spread position, with XYZ underlying stock trading as before at $100, in addition to the bull Put credit spread, we also have a bear Call spread. The Iron Condor trade might look like this:
Sold Short XYZ June 85 Put at $1.10 Bought Long XYZ June 80 Put at $0.41 Net spread premium collected = $0.69 = $69.00/credit spread
Sold Short XYZ June 120 Call at $0.88 Bought Long XYZ June 125 Call at $0.21 Net spread premium collected = $$0.67 = $67.00/credit spread
Total Margin (cash in account) required to support BOTH spreads: $500!
Result of making the single credit spread into an Iron Condor
Recall in Example #1 that our desire is for the underlying XYZ stock to be above 85 at expiration in which case the bull Put spread will expire worthless as we wish.
In Example #2 we have a bear Call spread in addition to the bull Put credit spread described in Example #1. The bear Call spread will prosper (expire worthless) so long as XYZ stock is below 120 at expiration.
In other words, if XYZ stock currently trading at $100 is anywhere between 85 and 120 at option expiration, BOTH credit spreads provide us with income to the tune of $69.00 + $67.00 = $136.00.
What makes the Iron Condor a powerhouse is that a single $500 margin supports both the Put credit spread and the Call credit spread, rather than $500 being required margin for each of the two spreads.
This is the case because when the options expire, XYZ obviously cannot be both above 120 and below 85 at expiration. Therefore, having both spreads does not increase the risk compared to having just one of the spreads, so only a single margin is required that covers both spreads (at an options-friendly brokerage firm). Consequently, our profit potential is doubled as is our rate of return… again, with no increase in risk.
Iron Condor Screening Strategy for Best Credit Spread and Iron Condor Candidates
There are literally thousands of potential credit spread candidates. The investor, of course, needs to identify those spread contenders that offer the best mix of success probability, profit potential, and risk acceptability based on his personal profit objectives and risk tolerance, i.e. the best reward/risk ratio. (See also white paper: Credit Spread Screening – How to Identify the Best Credit Spreads.)
In short, the investor should have an objective method that quantifies the criteria to be considered in selecting the best credit spreads for him to use. Whether employing the specific “The Monthly Income Machine” criteria and the values for these trade entry criteria, or the investor’s own choice of criteria values, there are trade selection criteria that all credit spread investors should objectively consider when screening for best credit spread/Iron Condor candidates.
The nine “The Monthly Income Machine” trade entry criteria are:
- No earnings report (if a stock-underlying spread) prior to option expiration day
- Maximum Trading days until option expiration
- Minimum average daily trading volume of underlying stock, ETF, or Index
- Minimum distance of underlying stock, ETF, or Index from short strike price of credit spread
- Maximum delta value of short strike price option of credit spread
- Minimum net premium received when credit spread is established
- Maximum interval between long and short strike prices of credit spread
- Minimum open interest of option
- Predetermined Stop Loss point for exiting or adjusting a position if a major adverse move takes place
Iron Condor Strategy – Summary and Conclusion
One of the most attractive investment vehicles for the conservative investor seeking recurring monthly income is the option credit spread and the related Iron Condor credit spread pair.
Objective criteria (at least the nine discussed here!) can and should be employed to screen for credit spread and Iron Condor candidates that offer the most attractive reward (premium income) for the least amount of risk.
Investor can add criteria to those listed above, but at a minimum, specific values for all of the nine enumerated should be employed in the screening process.
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I trade vertical spreads regularly for the past few years now and have read many lessons about vertical spreads from many sources, books, etc. but I could not find any method which I can really rely on, until I found Lee’s “The Monthly Income Machine”.
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P.S. Other “white paper” articles by Lee concerning selection of best reward/risk ratio credit spread and Iron Condor income candidates: