Options trading seems really challenging to novice traders. The array of jargons, tactics, and risk management complicates the entry for new traders. Most are of the opinion that options trading is reserved only for professionals, somehow seeming complicated, more especially in terms of the understanding and execution of the trade.
Options trading does not necessarily have to be confusing or stressful. With the right strategy, even first-timers can engage in it, quietly and fearlessly. One of the methods that has proven quite effective is the Iron Condor strategy—it is a simple, easy-to-implement technique used by many successful traders. It is also a low-risk, high-probability trade idea for new traders looking for consistent returns.
In this article, we shall introduce you to the easiest options trading strategy that most newcomers can initially attempt to trade. No, it’s not the Butterfly or the Condor, of which I will discuss presently. We shall outline the makeup of this trade, explain how it works, and observe how it can be used in your trading account so that you aren’t building complexity that scares away most newcomers.
What is an Iron Condor
An Iron Condor is the strategy that sells both the call option as well as the put option, simultaneously buying a higher call and a lower put for protection. Simplicity is characteristic of this trade and at the same time can potentially bring steady income.
What does an Iron Condor Strategy comprise?
- Sell a call: This will be selling call options that have a price higher than the currently prevailing price of the underlying asset.
- Sell a put: You sell a put option that is lower than the current price of the asset.
- Buy a call: You buy a call even higher than the sold call to protect against big moves on the price.
- Buy a put: You buy a put option lower than the sold put to limit your potential downside.
All of these should expire worthless, and you keep the initial premium you collected when selling those options.
Why is it Ideal for Beginners?
The Iron Condor is a delicious place for the beginning trader to be because it offers:
- Low stress: You are not constantly focusing on the trade. Once placed, you can leave it alone and sit back to watch it lapse.
- Controlled risk: The selling and buying options combination ensures having limited risk on both sides of the trade.
- Consistent income: This strategy is designed to create an era of steady profits over time with a high probability of success.
How It Works
Step 1: Iron Condor Set up
Let’s assume you want to trade the Russell 2000 Index, a very popular index of small-cap equities. On June 16, 2023, the index opens at 1898.54. You are going to use a two-month options chain with an expiration date of the third Friday of August.
The Iron Condor will set up as follows:
- Sell a 2100 call: This is above the market price, and there is a 10% possibility of expiring with value. You collect a premium of $6.15.
- Buy a 2150 call: This is 50 points higher and offers protection. You pay a premium of $3.35.
- Sell a 1690 put: This is below the market price, and there is a 10% possibility that it may expire in the money. You collect $10.40 in premium.
- Buy a 1640 put to sell at $7.35 as a hedge against a large potential drop. Total premium received after commission is $585.
Step 2: Getting a Feel for the Numbers
The concept of picking options with a 10 Delta is to take only those with a really low chance of expiring in the money—just 10%. A Delta number represents the probability an option will expire with value. In both calls and puts, the probability that the underlying instrument—the Russell 2000—is going to move at those prices is low.
This is a really nice thing since there’s an 80 percent chance that the option will expire worthless and you will lose nothing of the premium you paid, keeping it all as a profit.
Step 3: Trade Management
An ideal iron condor expiration comes about when the price of the index remains between both the sold call and sold put strikes all the way up to expiration. This means, as long as the Russell 2000 Index stays in a range between 1690 and 2100 by August, then all options expire worthless, and you get to keep the $585 premium.
You may also close the trade early before expiration if the options have lost value. For example, a month into the trade, you are on July 12th, where all four options should have plummeted considerably. You would close the trade, and you would have made a profit of $295, that is, over 50% collected premium.
Benefits of Iron Condor
- High Probability of Success: The primary positive of an Iron Condor is that it has a high probability of making profits. Since you are selling options that have a 10% chance of being exercised in the money, the probability of all options expiring worthless is at 80%.
- Time decay works in your favor: As time passes, the value of the options you sold will decline. There is a natural reduction in value called time decay, and it has proven to be one of the safest sources of profit in options trading.
- Limited risk: The protective calls and puts purchased limit your losses on both sides of the trade.
- Constant Income Potential: Since you can do the trade six times a year, you can do it once in two months, thus offering you constant potential income every year.
When to Close the Trade
Many traders close the Iron Condor trades at 50% of what the original premium collected is, for instance. So if you collected $585 in premium as an initial money, you’d want to get out and close the trade when you’d captured roughly $295 in profit. This is to avoid losses when the market swings dramatically in either direction.
Conclusion
The easy basis of the Iron Condor, with low risks and consistent opportunities for income, makes it the easiest options strategy to understand for a new trader. Selling these options that have a high probability of expiring worthless makes you collect premium income with your low risk. This makes the Iron Condor a great place to start off for those looking to get into the world of options trading without their heads in a twist or adding complications to their lives.
Start with an Iron Condor for those who are beginners and see how it really works for creating a consistent flow of income from your trades. It’s indeed one of the safest methods for beginners to initiate options trading with no experience whatsoever, given that it holds an 80% probability of success and limitations to the downside.