- September 13, 2024
- Posted by: Jay Soloff
- Category: Trading Article
Iron Condors create amazing passive income, but knowing when to use them is critical!
There are dozens of options and strategies that you can use to generate cash.
Iron Condors or Condor Spreads are a versatile tool that creates cash flow while limiting your risk on the trade.
But to use this strategy effectively, you need to understand exactly when you should use a Condor Spread.
We’re going to look at the ideal market conditions for the use of condor spreads, and how it can be implemented to maximize returns while managing risk.
Understanding the Condor Spread
To understand how and when to use a Condor Spread, let’s first explore what the strategy involves.
The Condor Spread is designed for traders expecting minimal price movement in the underlying stock. The ideal situation is a range-bound market with low volatility.
The strategy itself is simple…
You use four different options: two calls and two puts, strategically placed at different strike prices.
First, you sell a lower strike put, which is typically placed closer to the current market price of the underlying stock.
This short put creates income for the trade but exposes you to downside risk.
To offset this risk, an even lower strike put is purchased. This provides a safety net in the event of significant downward movement in the stock price.
On the other side of the trade, a higher strike call is sold, typically positioned just above the current market price.
Similar to the short put, this call generates income but exposes you to risk if the stock price moves sharply upward.
To limit this risk, an even higher strike call is purchased, providing protection.
| Action | Type | Strike Price Position | Purpose | Risk Exposure |
|---|---|---|---|---|
| Sell a put | Short Put | Lower Strike | Generates income from the premium received. | Exposes to upside risk if the stock price rises sharply. |
| Buy a put | Long Put | Even Lower Strike | Provides a safety net against significant downward movement in stock price. | Limits potential losses from the short put. |
| Sell a call | Short Call | Higher Strike | Generates income from the premium received. | Exposes to upside risk if stock price rises sharply. |
| Buy a call | Long Call | Even Higher Strike | Provides protection against significant upward movement in stock price. | Limits potential losses from the short call. |
Those four options create an Iron Condor Spread.
How to Profit from Condor Spreads
A condor spread creates income from the net premium collected when placing the trade.
So if you sell the put and call options for $2.00 each (or $200 per contract), and spend $0.75 each (or $75 per contract) to buy your protective options, you pocket $2.50, or $250 per contract
=> $200 x 2 less $75 x 2 = $250
Not bad for a few minutes worth of work.
Like with any trade, there is risk. Check out our article: What Is an Iron Condor Spread?
We know what a condor spread is… we know how it’s profitable and what the risk looks like. Now the million-dollar question…
When to Use a Condor Spread
The number one thing to consider when trading condor spreads is volatility.
As I said earlier, this strategy is best in environments where we see low volatility and range-bound price movements.
In low-volatility environments, the Condor Spread thrives because the underlying asset is less likely to experience significant price swings.
A scenario where a stock has been steadily trading within a narrow range, and there are no major catalysts expected, would be ideal for this approach.
For example, if a stock consistently moves between $100 and $110 without breaking out, a Condor Spread can effectively capture profits from this predictable range.
Similarly, range-bound markets offer prime opportunities for the Condor Spread.
These markets are characterized by an asset repeatedly bouncing between support and resistance levels. As long as the asset stays within the middle strike prices, the strategy yields consistent profits.
I will caution you to look forward to potential news announcements that may swing the markets – and your underlying stock.
For example, often when the Federal Reserve meets and speaks – you’ll see large fluctuations in the prices.
Earnings Season
Another timeframe to be aware of is earnings season.
If you set up a condor spread trade on a stock, make sure to avoid periods around earnings. A surprise announcement – up or down – could push your trade into a loss situation.
That said, some traders look at earnings as an opportunity to capture increased premiums. They look at wider swings in the underlying stock, and the potential losses like the cost of doing business.
Consolidations
The condor spread shines during the consolidation phases of the market. Specifically, periods when the entire market is trading within a tight range. This often arrives after a significant move.
These phases, marked by falling volatility and sometimes decreasing volume, provide an excellent backdrop for Condor Spreads. For example, when a stock or ETF consolidates between $120 and $130, setting up a Condor Spread just outside this range can help lock in profits.
Volatility
A Condor Spread can also be highly effective when traders expect implied volatility to decline.
For example, If volatility is elevated due to a recent short-term news event, the narrowing price range that follows the news can make this strategy even more favorable. It’s a way to capitalize on the volatility decline while reducing exposure to dramatic price shifts.
If you want to diversify your income strategies from options, you may find the Condor Spread very useful.
=> It provides an additional stream of passive income
=> while keeping risk limited
For someone who already uses covered calls or cash-secured puts, adding a Condor Spread on a stable, range-bound stock can enhance portfolio returns without significantly increasing risk.
This blend of steady premium collection and defined risk makes the Condor Spread a flexible and powerful strategy in various market conditions.
Advantages of Using a Condor Spread
There are many advantages to using a Condor Spread:
- Limited Risk with clearly defined maximum losses
- The ability to generate income in flat markets
- Profit from declining or flat volatility
- Works on Big or Small accounts
- Options Time Decay works in your favor
- Ability to use short or long-term options
- Easy to adjust strategy based on market movements
- Reasonable Margin Requirements
- Capital Efficient when used in a broader portfolio
Disadvantages of Using a Condor Spread
There are some disadvantages to the Condor Spread strategy:
- Limited Profit potential
- It can be complex to “roll” the options strategy
- Time decay can be impacted by price movement
- You may not always be able to close a trade early.
- Changes in implied volatility can impact options values
- Risk of early assignment
A Real-World Example of When to Use a Condor Spread
To further illustrate when to use a Condor Spread, let’s explore a real-world scenario that demonstrates how this strategy can be applied effectively.
Example: Using a Condor Spread in a Stable Utility Stock
Let’s consider a practical example of using a Condor Spread in a stable utility stock. As you know, utility stocks are often low volatility and frequently hold a consistent trading range.
Consider The Southern Company (Ticker: SO)
The stock price is around $90 as I write this.
Let’s take a look at the chart and determine an appropriate strike price and time frame.
Source: Stockcharts.com
Consider this trade.
First, we’ll work with options that expire in about 6 weeks. You’ll want to SELL a $87.50 put and BUY a $85 put, establishing the lower end of the Condor Spread.
=> This spread trade creates a credit of $.40 ($40 per contract) with a risk of $2.50 ($250 per contract).
Then you’ll sell a $92.50 call and buy a $95 call… with the same expiration dates.
=> This spread trade creates a credit of $0.60 ($60 per contract) with a risk of $2.50 ($2.50 per contract).
If the stock stays between 87.50 and 92.50 – you’ll make money ($100), with the options expiring worthless!
If the stock closes between $92.50 and $95 or between $87.50 and $85 you’ll see anywhere between a small profit and a maximum loss of $150.
If the stock randomly jumps- or falls – $20 not to fear, you’ll be locked in at a maximum loss of $150.
Think of it in these terms, you’re risking $150 to make $100. (Not a bad risk-to-reward ratio- in my opinion!)
| Action | Type | Strike Price | Credit | Risk | Outcome |
|---|---|---|---|---|---|
| Sell a put | Short Put | $87.50 | $0.40 ($40/contract) | $2.50 ($250/contract) | Profit if stock stays between $87.50 and $92.50, options expire worthless. |
| Buy a put | Long Put | $85.00 | – | – | Provides protection against significant downward movement. |
| Sell a call | Short Call | $92.50 | $0.60 ($60/contract) | $2.50 ($250/contract) | Profit if stock stays between $87.50 and $92.50, options expire worthless. |
| Buy a call | Long Call | $95.00 | – | – | Provides protection against significant upward movement. |
Profit and Loss Scenarios
| Stock Price Range | Outcome |
|---|---|
| Between $87.50 and $92.50 | Profit of $100 (options expire worthless) |
| Between $92.50 and $95 | Small profit to a maximum loss of $150 |
| Between $85 and $87.50 | Small profit to maximum loss of $150 |
| Jumps or falls by $20 | Maximum loss of $150 |
With the utility sector which is known for its stability… more than likely, you’d see consistent profits with a Condor Spread.
Conclusion: Mastering the Condor Spread Strategy
The Condor Spread is a versatile and strategic options trading tool that can be used in different market conditions.
The key is understanding when to use a Condor Spread, to maximize profits, and limit risk.
Make sure you focus on low volatility environments, and range-bound markets, and avoid specific events like earnings announcements… and you’ll be able to generate consistent income with defined risk.
This isn’t a “set-it-and-forget-it” type of trade. Remember to select the right underlying stock, determine appropriate strike prices, and be prepared to adjust your positions as needed.
Include this strategy in a broader portfolio of trades, and you’ll see consistent gains!
How to Learn More About Iron Condors?
There are millions of nuances to trading Iron condors.
For example, reviewing the underlying stock, and developing a solid projection of its volatility can be critical.
Get this right, and you print money… get this wrong and you’ll see loss after loss.
I want to give you a leg up on Iron Condor trades. I’ve assembled a list of my 10 favorite stocks to trade Iron condors. It’s a great place to start if you’re looking for consistent income with limited risk.
Click here to get “The Top 10 Stocks for Iron Condor Trades” – Free
