Taming grizzly risk with iron condors
In a split second, the quaint nature moment turned into a life or death situation. The Kodiak bear caught sight of the hikers and decided to stand on his hind legs for a better look. All ten feet and 1,500 pounds of him didn’t like what he saw.
You can’t outrun them. You sure as hell can’t fight them. You can only hope to stand still and hope they go away. Such is the predicament most options traders find themselves in when price has turned on them and risk is now unlimited.
Why tempt the grizzly bear of risk when you can generate options income from a place of relative safety? Adding iron condors and credit spreads to your arsenal can go a long way in helping you do this.
Fortunately, there’s a way to trade these momentous events with confidence – and for profit.
Why most traders poke the bear and lose.
When the bear was finished they needed hair samples and a DNA test to identify the remains. Such was the fate of a Yellowstone hiker from Billings, Montana. The grizzly? Apparently a hungry mama bear who saw an easy target for lunch.
Bear attacks are a common reminder of the deadly risk that rounds every corner of a picturesque walk in the woods if you’re not comfortable. All of Yellowstone is considered bear country – and tourists are constantly warned. Yet something always seems to happen.
Take one look at an options chain for any stock or index and you can bet that an ugly mauling is underway. Some trader somewhere is running for dear life from huge losses – or is barely hanging on. It’s not an exaggeration.
Why? Many options traders simply take on too much risk with a single trade. Amazingly enough, they do this with the belief that they’re ‘playing it safe’. Long calls and naked puts are usually the biggest culprits. The thought of an out-of-the-money score is simply too much to resist.
The very second these positions are taken. The bear is officially poked, fate is tempted and the path to losses is secured.
A trade that gives price a wide berth.
Bear mace, a walking stick with a bell and travel companion who’s not nearly as fast as you are. If you’re looking to limit your risk when hiking in bear country – those are good places to start. Apparently bears don’t care to be spooked.
When heading into the market, you can trade with the equivalent – simply by using an iron condor. Just as the name suggests, an iron condor is the combination of a bullish and bearish set of spread trades positioned above and below the current price range.
The space between the two spreads is the condor and is essentially the range that price needs to stay between for you to generate a profit. Check out the SPX below. As price trends and grinds as it usually does with an index, a condor with a wide enough wingspan allows you to generate income if it stays in the range.
The key to the condor: Knowing how to set it up and how to manage it.
Generate income that you can forecast.
When a grizzly bear comes your way, conventional wisdom says that you should play dead. The logic being that the bear with pick, prod and eventually lose interest. The last thing you should do? Run. (Even if your buddy is slower than you are). Probably good just to give bears a wide berth if you can help it.
The same is true with an iron condor. Like any trade, there are aggressive positions you can take, with lower probability. If you’re interested in a trade you can use to pay the bills – a wide iron condor that gives price a wide berth is your best position.
Scan the options chain for a delta of around 25 and take your position as far away as possible from price with at least a month to spare before expiration. Set it up in Thinkorswim and confirm that the range is wide enough with the risk analyzer.
In the case of this SPY trade (using the SPX as a reference point) – this iron condor is set to generate $360 if price stays within the range before expiration on 11/18/2017.
Given that the trade has a 250+ point spread – not a bad place to be at this stage in the game. And for one contract! If price starts to move in one direction or the other aggressively – you can add a butterfly on either end to give yourself more breathing room.
Poke the bear on another trade. Use the iron condor to trade for consistent profits.
Let everyone else get mauled while you pay bills.
You read about them all the time and it’s always the same story. Some tour guide gets mauled on a trail they know very well by some bear they’ve seen a million times before. They’re airlifted out and there’s always a horrible account of the encounter. Sometimes a grizzly bear has just had enough.
Don’t tempt the grizzly bears of risk. Take a longer view of your options trading and put probabilities in your favor. Adding an iron condor to your options portfolio will allow you to pursue your bias – bull or bear – without having to be entirely right or wrong.
Make sure you’ve given price a wide berth with a spread wide enough to handle proven fluctuation and enough time to manage the trade. If you’re feeling the heat on either side – add a butterfly to give your position more breathing room. Take the income that’s generated and leave the encounters for everyone else.