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The Hidden Dangers Of Iron Condors

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by Gavin in Blog
February 1, 2021 0 comments

Contents

Iron condors are a popular option strategy used by professional money managers and individual investors alike.

I’ll begin by briefly outlining the concept of Iron Condors and then expose the hidden dangers that lie within them.

Iron Condor – What Is That? 

An Iron Condor is an options strategy that consists of four differing contracts.

The strategy invites investors to purchase four options, two puts (one long and one short) and two calls (one long and one short), as well as four strike prices, all containing the same expiry date.

The aim is to profit from low volatility in the underlying asset.

Put simply, an Iron Condor generates the maximum profit when the underlying asset closes between the middle strike prices at expiry.

Iron Condors are a combination of a Bull Put Spread and a Bear Call Spread.

Iron Condors – How Do They Make/Lose Money? 

When you have an open position in an Iron Condor, you desire that the underlying stock or  index maintains a comparatively small trading range from the commencement of the position until the options expiry.

When the expiration date comes, if all your options are out of the money, they will expire worthless and you get to keep every dollar you received when opening the Iron Condor.

This is the ideal situation, however, there are hidden risks and the ideal situation will not always occur.

An investor will preferably sacrifice the last few cents of potential profit to close the position prior to the expiration.

The advantage of this is that the trader can secure a good profit, eliminate the risks and free up the capital for the next trade.

Risk management is key for investors and this strategy requires a whole lot of it.

As long as the market does not go too far in either direction, you are a winner!

Hidden Risks 

An essay could be written on each of the hidden risks, but I will briefly outline them and delve into risk management strategies to ensure you are properly equipped to be a profitable Iron Condors investor.

  1. To fully immerse your portfolio in the high profitability potential of an Iron Condor you will often risk 8 to 9 times as much as your peak profit – this is a high level of risk that will require close attention.
  2. To mitigate the potential risk outlined above, options traders will most often implement a stop loss, however, a stop loss can reduce the likelihood of winning to below 50% in some cases – as little as 1 in 3 investors will walk away with high profitability and it will most likely not be you.
  3. The traditional Iron Condor can lose money extremely quickly when the market experiences a strong trend.

It is because of this that Iron Condors are increasingly risky in bullish markets, even more so than market sell-offs.

Most traders I speak to have more issues on the call side of their iron condors compared to the put side.

That’s why it’s worth considering trades like the Rhino Trade.

Risk Management 

Although on the surface Iron Condors may seem like a limited-risk strategy, excluding the hidden risks, it is important to understand how to reduce your risk in order to maintain your portfolio balance.

A highly practical risk management technique to practice with Iron Condor trading is to simply be patient.

Understand what the minimum amount of credit is required to cover yourself for the capital you have at risk.

Locate a strike price at which you are happy to sell at, place limit order at the position and allow the market maker to take one of your trades when the desired credit has been accumulated.

Longer-term Iron Condors will move a lot slower than short-term trades and for this reason I always avoid weekly Iron Condors.

An investor should always know the precise point at which they should try to repair a position if it is vulnerable.

If the index comes to that point or makes one of your sold strike points vulnerable, there are other alternatives than unloading the position for a loss.

Understand and research these alternatives to protect yourself and your portfolio!

In conclusion, Iron Condors have the potential to have extremely high profits – however, the investor must understand the risks and know how to mitigate them before risking significant amounts of capital on this strategy.

Trade safe!

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.

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Options Trading 101 - The Ultimate Beginners Guide To Options

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