These are the rules we use when trading iron condors and any similar options spreads. Note that these are time-tested “rules of thumb”: they aren’t iron-clad commandments that can never be broken, but they are strategic pointers that have proven useful. If you ever see us breaking one of these rules, don’t hesitate to ask why - there’s probably a good reason!

1. Entry

• Always enter a position at least 4-10 weeks prior to expiration. If you’re wrong, the negative gamma risk outweighs positive theta risk at less than 4 weeks out.
• Look for a probability of success around 50-70%. Trades with higher probabilities of success also require higher levels of risk, so we usually avoid them.
• Never enter or exit a position the Wednesday, Thursday, or Friday of expiration week if possible. Market makers and even electronic servers are taught to tighten the bid/ask spreads during these times.
• Range-finding techniques: we use a “Condor Options”-branded secret sauce to determine the range of the spreads we work with. But we’ll give you a hint: the formula includes ingredients such as standard deviations, historical volatility, implied volatility, and the price of tea in China.

2. Exit

• Exit 4-10 calendar days (not trading days) before expiration, and not before then. In other words, exit by time function, not by price. If you or we get really nervous about a trade, there’s no harm in exiting half the position at 10 days before expiration and the rest at 4 days out.

3. The Rule of Thirds

• Let’s say you’re at the firing range, or if you’re as gun-shy but golf-loving as Travis is, you’re at the driving range. You’ve got a target you want to hit, and only three bullets or golf balls with which to hit it. Do you fire all at once in rapid succession, hoping that your aim is okay? No, you take a shot, check your aim, adjust, and try again. The same idea applies here: if you are only going to put on three condor positions in a given month, why jump in all at once? It’s much smarter to take an initial step, let the market do whatever it wants for a few days, and then initiate your second position. Wait a bit more, double check your aim, and then take on the third position. Commissions and slippage have been significantly reduced over the last several years, so while this rule would have been very expensive to follow 10 years ago, today it just makes sense.

4. Choose Your Weapon

• We don’t trade iron condors on non-index products, as you may have read on our FAQ. The biggest reason for this is that any individual stock will be subject to sudden price movement from events both expected (earnings, industry reports) and unexpected (management changes, big competitor success, etc.). The danger with these events is that they can easily create binary situations for our trades - if earnings are coming out on a volatile stock, either a good or bad report could push the price outside the range of our trade, leaving us with a loser overnight. Using index products instead dramatically (in fact, almost completely) removes this risk. The only analogous event risks to indexes are market-external events like economic reports, geopolitical events, etc., and of course these are also risk factors for individual stocks.
• So instead of looking to GOOG, AAPL, XOM, or GE for our underlying, we prefer the most liquid and actively traded indexes. Until recently, this meant things like SPX, RUT, and OEX. But the introduction and increasing use of ETF indexes has made those instruments increasingly attractive, not least because they often feature tighter bid/ask spreads and electronic execution. So now we usually look to SPY, IWM, DIA, QQQ, XLE, and similar underlying instruments. These weapons give us greater flexibility, reduce slippage, and faster execution.

5. The Condor Flock

*** This is a trade allocation strategy not taught by any other investing site. It entails putting on multiple iron condors with same expiration month but non-identical strike ranges and at different times. [DRAFT SECTION - more on this technique later.]

So what exactly is an iron condor and why do we focus on that particular kind of trade? This page will answer those questions.

What an iron condor is

An iron condor is a type of options spread trade that involves simultaneously buying and selling multiple contracts in order to capture a particular segment of future market movement. Before we get down to technicals, look at the following chart of price action in the S&P 500 over the year 2006.

Now, look at the range in which the index moved in August 2006. The SPX started off the month just above 1275, and went into September a bit above 1300. Now, what if the index hadn’t had such a good month, and had actually dropped to 1240? Anybody with a long position would have taken a serious loss. The unique and powerful ability of iron condors is that they enable you to make money no matter which way the market goes. Our strategy is a “non-directional” strategy because it works independently of market movement, meaning we don’t have to be right about whether the market will go up or down.

In our example, a properly constructed iron condor would have made money whether the S&P 500 ended August up at 1300 or down at 1250, because the idea behind this trade is to:

Sell rather than buy; and sell time rather than price.

Let’s explain what that means. If you’ve ever been to a casino or played a slot machine, you know that the games are mostly rigged in the casino’s favor. Sure, occasionally some lucky gambler will hit a big payout or find a hot streak, but the consistent profits that the house takes on a daily basis more than make up for the occasional lucky winner. The idea here is the same: by selling options rather than buying them, we take on the role of the casino rather than the individual gambler. And by selling time instead of selling price, we’re choosing the game that will put the odds most in our favor.

The trade itself is made up of four pieces:

• +1 put at the lowest strike in our range
• -1 put at the next lowest strike
• -1 call at the next highest strike
• +1 call at the highest strike in our range

Each leg of the trade is for the same underlying security or index, with the same expiration month. There should always be an even number of contracts traded, in multiples of four, so that the trade is always weighted equally with no downside or upside bias. That just means that for one Iron Condor, we’ll buy/sell 4 contracts, as shown above; to put on 2 Iron Condors, we’ll buy/sell 8 contracts, etc. Note: since not every member is trading with the same amount of capital or the same account size, you may want to adjust your trades accordingly. More on that later.