Iron condors help your profits soar

CONDORS, tarantulas, butterflies. The world of options trading can sound more like the sort of thing that would attract David Attenborough than George Soros. Of all the animal-based tactics, one that is particularly popular in the current range-bound markets is the iron condor, which is a market neutral trade with limited risk. If you believe the FTSE 100 will stay around the current level, for example, then an iron condor could be the way forward.<br /><br />An iron condor spread consists of two call options &ndash; the right, but not the obligation to buy at an agreed price on a specified date and two put options &ndash; the right to sell, which have the same expiration day and are based on the same underlying instrument such as the FTSE 100 but differ in their strike prices. The call spread and the put spread should be of equal width although it does not matter how far apart the calls and puts are from each other.<br /><br />The option trader creates an iron condor by selling a lower strike out-of-the-money put (ie, it has no intrinsic value), buying an even lower strike out-of-the-money put, selling a higher strike out-of-the-money call and buying another even higher strike out-of-the-money call. Ideally, you would determine support and resistance levels for the index and then create the position such that the sold options are outside the predicted trading range. This creates a credit spread, which is essentially an option-selling strategy that allows traders to take advantage of the time premium and implied volatility that are inherent in options. You hope that the market remains tightly range-bound so that the options expire worthless, letting you retain the credit as profit.<br /><br />But, if the market doesn&rsquo;t remain within the range and breaks out strongly in one direction then you are best to sell that side of the credit spread and hold on to the other. With iron condors your maximum loss is limited but is greater than your potential profit and occurs when the price falls at or below the lower strike of the put purchased or rise above or equal to the higher strike of the call bought.<br /><br /><strong>LIMITED LOSS</strong><br />It is easy to see the attractions of iron condors &ndash; after all, who would not want to make a profit from markets that are barely moving while keeping the potential loss limited? But actually choosing which options to trade, how far out of the money to buy and the width of the call and put spreads are all issues that the options trader will need to consider before establishing the iron condor strategy.<br /><br />Selecting the underlying will be dependent on both your view and the availability of different strike prices. Indices are your best bet as these tend to be the most liquid and offer a wide range of strike prices at expiry dates that suit you. They also have enough implied volatility to make a tidy profit without having the potential to wipe you out. Typically, iron condor buyers select options with four to five weeks left before expiry as this reduces the chance that the underlying will move in to the money and leave you with no profit.<br /><br /><strong>SUMMER RALLY</strong><br />Naturally, you can also go short using an iron condor, which is also known as a reverse iron condor. This strategy is designed to earn a profit when the underlying stock price makes a sharp move in either direction, which might be useful for traders right now as equities are on the turn following their strong summer rally.<br /><br />The maximum gain for the reverse iron condor strategy is limited but is much higher than the maximum potential loss and is attained when the underlying stock price drops below the strike price of the short put or rises above or equal to the higher strike price of the short call.<br /><br />With markets so uncertain at the moment, strategies that offer limited loss are few and far between, but more consistent profits are ideal for the options trader looking to make the most of ranging markets. This could well be the year of the condor.