This article is from Dan Passarelli, options trader and educator and author of the Market Taker Edge newsletter.
One recent option trading idea in the Market Taker Edge newsletter is an iron condor on Rambus Inc. (NASDAQ: RMBS), a technology licensing firm. This trade has one of the best risk-rewards I’ve seen in a while. It’s an excellent candidate for an income play, such as the iron condor. Iron condors are for range-bound stocks and this stock has been stuck in a range for months.
Iron Condors
Iron condors are four-legged strategies that might appear complex to the novice trader, but are actually rather straightforward. In an iron condor a trader sells an out-of-the-money put and buys a further out-of-the-money put for protection (i.e., a put credit spread); at the same time the trader sells an out-of-the-money call and buys a further out-of-the-money call for protection to the upside (i.e., a call credit spread). The gist is that the trader wants the underlying to remain between the two short strikes through expiration, hoping for all the options to expire worthless, and thus keep the premium. The maximum profit, therefore, is the initial premium received. The maximum loss is the higher call strike, minus the lower call strike minus the premium. Let’s examine this week’s RMBS iron condor play.
RMBS Trade
Sell the RMBS March 17-18-23-24 iron condor to garner a total of .35 or better (That’s $35 for one option contract, which covers 100 shares of stock.)
Specifically, buy the RMBS Mar 17 Puts, sell the RMBS Mar18 Puts, sell the RMBS Mar 23 Calls and buy the RMBS Mar 24 Calls all as one trade. If RMBS is between $18 and $23 a share at March expiration the trader keeps the credit received as profit. If RMBS is below $18 or above $23, the trade may end up a loser, with the max loss being .65 (that’s 24 minus 23, minus .35). The break-even points are $17.65 and $23.35.
Check the option chains for the latest RMBS March option prices.
Rationale
This wide range (between $18 and $23) that RMBS needs to stay between to reap the maximum profit offers a very high probability of success. RMBS hasn’t been outside of this range since August of 2010.
Option prices, in part, are based on the volatility component of their premium (the implied volatility). The implied volatility (IV) for RMBS options is very overpriced. That means that the options are overpriced. The .35 premium compared to the unlikely chance that this stock moves outside the range is a fantastic risk-reward. This is one of the best iron condor plays I’ve seen in a long, long time.
Dan Passarelli has more than 17 years’ experience in the options industry. He began his trading career as a market maker on the Chicago Board Options Exchange (CBOE), taught at the Options Institute and is the author of “Trading Option Greeks.” Follow Dan on Twitter.
