If you’re like most traders, you’ve been told that the “holy grail” doesn’t exist when it comes to trading. Not only do I not believe that, but I believe that you can find yours by the time you’ve finished reading this article.
New or inexperienced options traders typically buy options that are far out-of-the-money because they are attracted to the notion of limited risk and potentially unlimited returns. What they don’t realize is that these options are cheap for a reason — they rarely move enough to become profitable.
For instance, for a stock trading in the $20 range, the call option at the $25 strike might look attractive if it’s trading for just a few cents. But there’s a reason why it’s selling for practically a song, especially if that $20 stock hasn’t moved an inch in the past year.
What are the odds that this stock will move up five points during the lifespan of your options contract? If you’re looking at a stock that’s on the move and is well on its way to becoming the next Google (GOOG) or Apple (AAPL), then take the deal while you can get it. But if the answer is that the stock is probably not going to get up and go anywhere anytime soon, then you’re better off throwing your money into a wishing well.
Ninety percent of all contracts held to expiration expire worthless because folks don’t have a plan when they’re looking for option plays to add to their portfolios. Don’t be like “everyone else.”
There’s another way that offers an improved risk-to-reward scenario and improved odds of success. It’s called the Iron Condor, and I consider it to be the holy grail of options trading.
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3 REASONS IRON CONDORS GIVE YOU AN EDGE
An Iron Condor is non-directional. That means you aren’t dependent on the market moving up or down to profit. In fact, the market can go nowhere and you can still profit!
This makes it an extremely stable trade. It’s also one that doesn’t require a whole lot of attention once you initiate it, which makes it ideal for people who have better things to do all day than sit in front of a computer screen or who aren’t professional traders.
Second, an Iron Condor is an income spread. That means you get paid for taking the trade, which is in direct contrast to buying puts or calls where you have to fork over the moola to make it happen. As an added benefit, your broker will pay you interest the moment it hits your account. This is like getting a 2-for-1 deal at your favorite ice cream shop!
Third, an Iron Condor can give even a new, totally inexperienced trader a statistical edge that can’t be achieved by buying puts and calls alone. This dramatically increases your probability of profit and your returns at the same time. In fact, it’s not uncommon to regularly place trades with up to a 90% probability of profit and to achieve win rates upward of 70%-90% over long periods of time.
HOW TO TRADE AN IRON CONDOR
An Iron Condor, despite its fancy-pants name, is really a simple trade. Essentially, what you are doing is buying and selling a combination of options that “boxes in” the markets. As long as they close between the two edges of the “box” that you make, you profit.
Here’s an example.
The XYZ index is trading at $100. You sell one May 150 Call for $1 and buy one May 155 Call for 50 cents. At the same time you sell one May 50 Put for $1 and buy one May 45 Put for $50 cents.
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When you place this trade, you receive a credit of $100 ($1 credit spread multiplied by 100 = $100) in your account (50-cent credit for the call spread + 50-cent credit for the put spread = $1). As long as the XYZ index is trading between $50 and $150 at expiration, you get to keep the entire $100 credit to your account.
The maximum upside risk to this trade is the difference between the call strikes ($155 – $150, or $5) less the credit you received when you put the trade on. In this case, that’s $400 per contract — or, $5 – $1 = $4. The maximum downside risk is the same.
What’s more, since XYZ can’t finish in two places at once, half of every trade is going to win every time, which brings me to my next point.
If you pick your strike prices properly and each Iron Condor has at least an 80% probability of profit, you can reasonably expect to win 9.6 times out of every 12 trades. Assuming you’re initiating Iron Condor trades monthly, that’s roughly nine out of every 12 months. That’s a huge edge when it comes to trading of any kind, but especially options.
And that’s really the key to what makes the Iron Condor the “holy grail” in my book. Not only can you strictly limit risk with this trade, but you can do it in such a way that dramatically increases your chances of winning at the same time.
Keith Fitz-Gerald is the Investment Director for Money Morning/The Money Map Report. For more information on Keith, read his bio here.
