A High-Probability Iron Condor Trade in the S&P 500 (SPY)

A High-Probability Iron Condor Trade in the S&P 500 (SPY)

Inverse ETFs are one of the few ways to combat this bear market.

SPY Iron Condor

Back on January 24 I traded an iron condor in the Dow Jones (DIA).

At the time, as posted, we sold the iron condor for $0.80. Now the spread is worth roughly, $0.12, for a 15.7% return. Not bad, especially when you consider our probability of success on the trade was over 85% at order entry.

Now we are faced with another opportunity for an iron condor, this time in the S&P 500 (SPY).

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Volatility remains fairly high across the board. And as volatility increases (or at least remains above normal levels), trading opportunities increase, which opens up the options playbook significantly.

Iron condors, among other credit spreads (bear call, bull put, etc.) using highly liquid ETFs, are one of my favorite defined risk, non-directional options strategies in a high implied volatility environment.

The strategy consists of a short call vertical spread (bear call spread) and short put vertical spread (bull put spread).

Sample Trade: Iron Condor (SPY)

The IV rank and IV percentile in SPY are hitting extremes not seen in years. As a result, now is the perfect time to start selling some premium in SPY, and most of the highly liquid ETFs like DIA, IWM and numerous others.

SPY-IV-rank

Let’s say we decide to place a trade in the highly liquid S&P 500 (SPY) going out roughly 30 days until expiration.

The expected move, also known as the expected range, is from roughly 421 to 466 for the March 18, 2022 expiration cycle.

In most cases, my goal is to place the short strikes of my iron condor outside of the expected move. Moreover, I prefer to have my probability OTM, or probability of success around 75%, if not higher, on both the call and put side.

Choosing Expiration Cycle and Strike Prices

Since I know the expected range for the March 18, 2022 expiration cycle is from 421 to 466, I can then begin the process of choosing my strike prices.

Put Side of the Iron Condor:

SPY-bull-put-spread-iron-condor

The low side of the range is, again, 421 for the March 18, 2022 expiration cycle, so I want to sell my short put strike just below the 421 strike, possibly lower.

As you can see above, the 400 strike with an 85.01% probability of success fits the bill. In fact, it is a very conservative approach to the trade, which is almost always my preference.

Now, once I’ve chosen my short put strike, in this case the 400 put strike, I then begin the process of choosing my long put strike. Remember, buying the long put strike defines my risk on the downside. For this example, I am going with a 5-strike-wide iron condor, so I’m going to buy the 395 strike.

Again, it’s all about the probabilities when using options selling strategies. The higher the probability of success, the less premium you should expect to bring in. But as long as I can bring in a reasonable amount of premium, I always side with the higher probability of success, as opposed to taking on more risk for a greater return.

So, with SPY trading for 443.35, the underlying ETF can move lower roughly 9.8% over the next 30 days before the trade is in jeopardy of taking a loss.

Call Side of the Iron Condor:

SPY-bear-call-spread-iron-condor

The high side of the expected range is, again, 466 for the March 18, 2022 expiration cycle, so I want to sell the short call strike just above the 470 strike, possibly higher.

As you can see above, the 470 strike with a 90.12% probability of success, fits the bill. Once I’ve chosen my short call strike, I then begin the process of choosing my long call strike. Remember, buying the long strike defines my risk on the upside of my iron condor. For this example, I am going with a 5-strike-wide iron condor, so I’m going to buy the 475 strike.

As a result, I am going to sell the 470/475 bear call spread for roughly $0.85. But, before I place the trade I want to choose the bull put portion of my iron condor.

SPY-credit-iron-condor

Again, it’s all about the probabilities when using options selling strategies. The higher the probability of success, the less premium you should expect to bring in. But as long as I can bring in a reasonable amount of premium, I always side with the higher probability of success, as opposed to taking on more risk for a greater return.

So, with a range of $70 (400-470) and SPY trading for roughly 443.35, the underlying ETF can move higher by 6.0% or lower by 9.8% over the next 30 days before the trade is in jeopardy of taking a loss.

Here is the theoretical trade:

Simultaneously…

  • Sell to open SPY March 18, 2022 470 calls
  • Buy to open SPY March 18, 2022 475 calls
  • Sell to open SPY March 18, 2022 400 puts
  • Buy to open SPY March 18, 2022 395 puts

We can sell this SPY iron condor for roughly $0.85. This means our max potential profit sits at approximately 20.5%.

Again, I wanted to choose an iron condor that was outside of the expected move and has a high probability of success. This is why I sold the 470 calls and the 400 puts.

Remember, when approaching the market from a purely quantitative approach, it’s all about the probabilities. The higher the probability of success on the trade, the less premium I’m able to bring in, but again, the tradeoff is a higher win rate. And when I couple a consistent and disciplined high probability approach on each and every trade I place, I allow the law of large numbers to take over. Ultimately, that is the true path to long-term success. I’m not trying to hit home runs. I understand the true, consistent opportunities, particularly when seeking income, come with using high probability options strategies coupled with a disciplined approach to risk management—the latter being the most important.

Managing the Trade

I typically close out my trade for a profit when I can lock in 50% to 75% of the original premium sold. So, if I sold an iron condor for $0.85, I would look to buy it back when the spread reaches roughly $0.40 to $0.20. However, since we are so close to expiration, I might ride the trade out until it expires worthless, thereby reaping a full profit. As always, the market will dictate my actions.

If the underlying moves against my position I typically adjust the untested side. Most roll the tested side, but all research states that rolling the untested side higher/lower allows me to bring in more premium and thereby decrease my overall risk on the trade. Moreover, I look to get out of the trade when it reaches 1 to 2 times my original premium. So, in our case, when the iron condor hits $1.70 to $2.55.

Of course, the aforementioned numbers will change drastically if I’m able to sell a bear call spread over the next several days. Stay tuned!

Ultimately, position size is the best way to truly manage a trade. We know prior to placing a trade what we stand to make and lose on the trade, therefore we can adjust our position size to fit our own personal guidelines. Iron condors are risk-defined, so it’s important to take advantage of their risk-defined nature by staying consistent with your position size for each and every trade you place. Remember, it’s all about the law of large numbers.

As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.

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