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 is essential as we help you understand how to calculate break-even prices the correct way on iron condors and other risk defined strategies. 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.
Iron Condors
- Iron condors are a simple options strategy where you sell 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 also sell the $95 strike put option and buy the $94 strike put option creating a $1-wide spread below the market.
- The combination of two spreads on either side of the market creates the iron condor payoff diagram.
- Generally, you want to see the stock stay between your two short strike prices.
- If the stock stays between your strike prices and ends between your prices at expiration, then you keep 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:
Using the same iron condor example, assume we sold the call spread for 25 cents (the $105-106 call spread) and sold the put spread for 25 cents. This gives you a total 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 on the addition (call side) and subtraction (put side) 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, you are generally going to take in a larger net credit, which means your break-even points will be a little wider.
- Therefore, you will potentially have a wider profitability range for the position.
- For you to benefit from that wider range and, potentially, higher win-rate, you will have to take on a little more risk (in the form of the wider spread).
Iron Butterflies
- The same concept is true for Iron Butterflies as with Iron Condors, 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:
To create an Iron Butterfly strategy, if a stock is trading at $100, you would sell the $100 strike put and the $100 strike call. Then you would buy the same, $106 strike call and $94 strike put.
This will generally have a very similar probability of profit. Assume that you took in a net credit for the inside legs of the iron butterfly 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 ($100 + $5.25 = $105.25 upper break-even point and $100 - $5.25 = $94.75 lower break-even point). You 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 a much higher credit so that if the stock lands closer to where the stock is trading now (meaning it moves sideways), you make a lot more money than with an Iron Condor.
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