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Twitter First, a disclaimer of sorts. If you don’t understand the terminology, don’t be discouraged. Focus on the concept. Pay attention to the numbers; you’ll learn the terms with repetition.
An iron condor strategy is a non-directional options strategy that profits when the option on the underlying stock of your choice expires within your chosen range at expiration.
It’s a strategy, when used correctly, that has led to incredible returns around earnings announcements. Our recent trades have witnessed 9.3% in WFC, 15.2% in IBM and 18.3% in AXP . . . and we’ve only just begun. I expect to see at least 20 to 40 more trading opportunities during this earnings cycle. If you are interested . . .
Here is Our Approach
In our case, since we are trading earnings, we want to choose strikes that are outside the expected move.
Again, the basic premise of the iron condor strategy is easy. You choose the range of the trade. Increasing the range will decrease your potential profits, but will increase your likelihood of success.
The first requirement when trading iron condors is to make sure you are using a highly liquid security, like one of the Dow stocks. Highly liquid, in the options world, just means that the bid-ask spread is tight, say within $0.01 to $0.10, at least in most of the stocks I trade.
For instance, take the heavily traded American Express (AXP). The company reported earnings after the close last Thursday.
The stock was trading for $100.26.
And as you can see below, AXP had an IV rank of 66.5% . . . a notably high level of implied volatility. As soon as earnings passed, IV was crushed, as usual, which allowed us to lock in accelerated gains.
An above-average to extremely high IV rank means we can sell options for above fair-to-highly-inflated prices. And as anyone who sells anything for a living, your preference is to always sell your product(s) for inflated prices. Options are no different.
So, assuming AXP’s implied volatility is at least slightly above average, we can proceed to the next step.
Our next step is to find out what the expected move is to our chosen expiration cycle for the trade. In most cases, we use the expiration cycle that is one to nine days after the earnings announcement. We chose the expiration with nine days left for our AXP trade.
As you can see in the highlighted area below, the expected move was roughly $7.50, from $96.50 to $104.
Because we knew the expected move, we had had the ability to choose some appropriate strikes.
First, I looked at the call side of the iron condor, also known as a bear call spread. I wanted to find the short strike with around an 80% probability of success.
The January 105 calls fit the bill, with a delta of .17 for a probability of success around 83.56%.
Next, I look at the put side with the same goal in mind: a probability of success of around 80% or higher.
The January 105 puts work with a probability of success around 82.66%.
So, my starting range was $95.50 and $105. Obviously, I could have altered it, but this is the typical starting point for my iron condor trades around earnings.
What’s the Return?
By selling the 105/107 bear call spread and the 95.5/93.5 bull put spread simultaneously – thereby forming an iron condor – we could make roughly $0.43, or 27.4%, if AXP traded between our chosen strikes immediately following earnings. Because we are using $2 wide strikes, our risk was $1.57 per iron condor sold (width of spread strikes minus amount of premium received or $2 – $0.43).
With AXP trading at $100.26, the underlying price in AXP had to breach the breakeven levels of $105.43 or $95.07 by January expiration in nine days before the trade began to take a loss.
Best of all, the probability of success on the trade is a staggering 80% on both the upside and downside.
I like those odds.
On Friday morning we took off the spread for a 18.3% return to add to our 9.3% gains in WFC and 15.2% in IBM. Next week brings an abundance of trades. Don’t miss out on the opportunity to learn a viable options strategy around earnings. As I said before, I will be making 20-40 trades, if not more, during the next six to eight weeks.
Risk Management – Don’t Overlook the Importance of Position-Size
Because we are making short-term trades based purely on binary events, risk management as seen through strict position-size is essential for long-term success. In fact, since the trades have little to no duration, there is rarely time to adjust a trade, therefore again, position-size is key.
We know through extensive research that roughly 80% of the expected move around earnings is larger than the actual movement of the stock.
Remember, we are trading math here. It’s all about allowing the probabilities to work themselves out amidst the iron condor strategy, knowing that if the statistics play out, our wins should far outweigh our losses.