OAP 136: How To Calculate Break Even Prices On Iron Condors & Iron Butterflies

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Are you new to options trading? Do you have a small account and want to start trading iron condors and iron butterflies? Today's podcast will be very important as we help you understand how to calculate breakeven prices on iron condors and other risk defined strategies the correct way. Plus, we'll walk through a multi-month adjustment to an existing IWM iron butterfly in which we nearly doubled the credit received by rolling contracts to the next expiration period.

Key Points from Today's Show:

Iron Condor

  • A simple options strategy where by you are selling a spread on either side of the market
  • If the stock is trading at $100, you might sell the $105 call option and buy the $106 call option
  • This creates a $1-wide call spread above the market. 
  • If the stock is trading at $100, you might sell the 95 strike put option and buy the 94 strike put option
  • This creates a $1-wide spread below the market. 
  • The combination of two spreads on either side of the market creates the iron condor payoff diagram.
  • You generally want to see the stock move between your short strike prices. 
  • If the stock moves between your strike prices and ends between your prices, then you take in all the credit possible at the expiration

What happens if the stock moves just a little bit beyond those strike prices?

  • You don't lose automatically. 
  • This is where break-even prices come into play.

Example:

Sold the call spread 25 cents (the 105-106 call spread). Then also sold the put spread for 25 cents. Together this gives you a collective credit of 50 cents. This collective credit now moves your break-even point out 50 cents on either end from your short strikes. That means the true break-even points are now 105.50 on the call side and 94.50 on the put side, which is 50 cents wider than your short strike prices. 

*The credit is always based off of the addition and subtraction of the credit from the strike prices of the short strikes. 

  • Generally, the markets are pretty fair and efficient when it comes to pricing in these credits and break-evens. 
  • If you have a wider spread on either end of your Iron Condor, then that means you generally are going to take in a bigger net credit, which means that your break-even points are going to be a little bit wider. 
  • Therefore you will potentially have a wider profitable range to catch the stock in. 
  • In order for you to get the benefit of that wider range and potentially higher win-rate, you will have to take on a little bit more risk (in the form of a wider spread).

Iron Butterflies

  • The same concept as with Iron Condors is true, except now we're dealing with a much larger credit. 
  • With an Iron Butterfly, you are selling premium at the money on both the short call and the short put.

Example:

If a stock is trading at $100, to create an Iron Butterfly strategy you would sell the $100 strike put and the $100 strike call. Then you would buy the same, 106 call and 94 strike put. 

This will generally have a very similar overall potential probability of profit.

Assume that you take in a net credit for the inside legs of $5.25. That $5.25 that you take in as a net credit for selling the at the money strikes moves your break-even point out $5.25 on either end. You effectively get a very similar payoff diagram as far as break-even points, it's just the distribution of your profits are a little bit different. 

  • With an Iron Butterfly, you are taking in all of your credit right now. 
  • Now you are taking in a much higher credit so that if the stock lands closer to where the stock is trading now (meaning it moves more sideways), you make a lot more money on an Iron Butterfly.

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Free Options Trading Courses:

  • Options Basics [20 Videos]: Whether you're a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
  • Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an "edge" in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
  • Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We'll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
  • Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You'll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
  • Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we'll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
  • Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can't seem to get answered, then this section will help you.
  • Portfolio Management [16 Videos]: When I say "portfolio management" some people automatically assume you need a Masters from MIT to understand the concept and strategies - that is NOT the case. And in this module, you'll see why managing your risk trading options is actually quite simple.
  • Trade Adjustments/Hedges [15 Videos]: In this popular module, we'll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we'll help you create an alert system to save time and make it more automatic.
  • Professional Trading [14 Videos]: Honestly, this module isn't just for professional traders; it's for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.

Option Trader Q&A w/ Massimo

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today's question comes from Massimo, who asks:

In regards to money management, is the percentage that I have to take into account related to the maximum risk? Or is there another number that I have to check in order to evaluate my capital at risk?

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

PDF Guides & Checklists:

  • The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
  • Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
  • Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
  • Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
  • When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we'll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
  • 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.

Real-Money, LIVE Trading:

  • EWZ Iron Butterfly (Closing Trade): After nearly pinning the stock at our short strikes, and thanks to the volatility drop, we netted a $600 profit on this iron butterfly trade.
  • VXX Short Call (Closing Trade): One of the most consistent and profitable options trades we can make is shorting pure volatility with VXX and today we closed this naked short call in VXX after a couple days for a $420 profit.
  • DIA Iron Condor (Adjusting Trade): This neutral iron condor in DIA is need of a quick adjustment early this week as the market continues to rally. In this video, we'll discuss why I'm adding an additional put credit spread while also choosing NOT to close out of our current put credit spread due to pricing reasons.
  • COP Short Put (Closing Trade): These single short puts in COP acted as a great hedge for our other bearish bets in oil this month and helped smooth out our returns after we closed them for a nice big profit.
  • TSLA Put Debit Spread (Closing Trade): Although many people thought we were crazy for getting bearish in TSLA this pre-earnings put debit spread trade made us $200 today. After the huge run up from $140 to $260 and getting some technical sell signals, we were pretty sure this stock would pull back.
  • MON Iron Condor (Closing Trade): Following a huge drop in implied volatility we worked hard to close this MON iron condor trade adjusting the order multiple times to fill before the end of the day.
  • IBB Call Debit Spread (Opening Trade): We'll show you how I started searching for a new bullish trade and eventually found a low volatility trade in IBB looking for a move higher to hedge our portfolio.
  • TLT Iron Butterfly (Closing Trade): Following the Brexit vote TLT and bonds traded in a nearly $8 range really quickly - even still the drop in implied volatility helped generate a $330 profit for us.
  • XBI Call Debit Spread (Closing Trade): Got lucky picking the exact bottom for our entry in this call debit spread for the XBI biotech ETF which ultimately was closed for a profit of $165 today on the rally higher.
  • COH Iron Butterfly (Earnings Trade): Shortly after the market open we close out of our COH earnings trade for about a $160 profit, leaving just 1 leg on to expire worthless.
  • EWW Debit Spread (Closing Trade): Using some of the technical analysis signals we discovered in our backtesting research, we were able to make a quick $130 profit on this bearish EWW debit spread trade.
  • IBM Iron Condor (Earnings Trade): Shortly after the market opened you'll follow along with me as we watch volatility drop and liquidity come into the market before closing out the position for $250 profit.
  • SLV Short Straddle (Opening Trade): Using our watch list software we decided to continue to add to our existing SLV short straddle position with a new set of strike prices reflective of the move lower in the ETF recently.

Thank You for Listening!

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About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.