Investors often consider the maximum potential return for an iron condor stock options position to be capped or limited, however, potential returns for iron condors can be increased after initial entry through rolling.
An iron condor is a neutral strategy and is a combination of two other popular stock options strategies, the bull-put credit spreads and the bear call credit spreads. An iron condor performs best when the underlying does not move significantly up or down after entry.
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A bull-put credit spreads consists of selling an out-of-the-money put option in addition to purchasing a put option at a lower strike price. The bull-put stock options strategy is a neutral to bullish strategy. If the price of the underlying is equal to or greater than the strike price of the short put option at expiration, the position will retain the initial net credit and will be fully profitable.
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The margin requirement for a bull-put credit spreads position can be calculated as:
| Margin Requirement for Bull-put credit spreads =
[(Short Put Option Strike – Long Put Option Strike) – Bull-Put Credit] * # of contracts * 100 shares/contract |
The potential return for a bull-put credit spreads position can be calculated as:
| Bull-Put Potential Return =
initial net credit/share * 100 shares/contract * # contracts ————————————————————————— margin requirement |
A bear call credit spreads position involves selling an out-of-the-money call option in addition to purchasing a call option at a higher strike price. The bear call stock options strategy is a neutral to bearish strategy. If the price of the underlying is equal to or less than the strike price of the short call option at expiration, the position will retain the initial net credit and will be fully profitable.
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The margin requirement for a bear call credit spreads can be calculated as:
| Margin Requirement for Bear Call Credit Spreads
= [(Long Call Opt. Strike – Short Call Opt. Strike) – Bear Call Credit)] * # contracts * 100 shares/contract |
The potential return for the bear call credit spreads is the same as for the bull-put credit spreads illustrated earlier.
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The margin requirement for an iron condor can be either the cumulative margin requirement for the bull-put credit spreads and for the bear call credit spreads or for only one credit spreads position. The latter margin requirement is a special margin condition which generally applies if the spreads between the bull-put credit spreads and the bear call credit spreads are equal and all the options expire at the same time. Special margin allows investors to essentially double their returns when applicable.
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The return calculation for the iron condor is the same as illustrated earlier for the bull-put credit spreads strategy.
As an illustration of rolling a position from PowerOptionsApplied Chromium TradeFolioTM will be analyzed.
On 3/24/2009, the following iron condor position was entered by PowerOptionsApplied Chromium service for the NDX index:
| Buy To Open Put | Sell To Open Put | Sell To Open Call | Buy To Open Call | |
| NDKPE (APR 925) |
NDKPS (APR 950) |
NDTDT (APR 1475) |
NDVDJ (APR 1500) |
|
| Fill Price | $1.84 | $2.32 | $0.87 | $0.60 |
The position qualified for special margin, as the difference between the spreads was equal and all of the options expired at the same time. The position was entered at a net credit of $0.75 which represented a potential return of 3.1%.
The price at entry of the underlying index NEX was $1238. Contingent orders were entered with stop-loss points set at 2% of the short option strike prices. The contingent orders were set to close the short options if the predetermined stop-loss point was transgressed. The lower stop-loss was set for $969 and the upper stop-loss was set for $1446. With the stop-losses, the price of NDX could fall -21% or rise 16% and the position would remain fully profitable.
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On 4/6/2009, NDX had risen in price since entry to $1313 and the price of the short put option NDKPS(APR 950) had decreased by at least 80% and the bull-put credit spreads was a candidate to be rolled. The following position was decided to be rolled to:
| Buy To Open Put | Sell To Open Put | |
| NDUPI (APR 1075) | NDUPL (APR 1100) | |
| Fill Price | $1.56 | $2.15 |
The initial long put option NDKPE(APR 925) was sold to close for $0.35 and the initial short put option NDKPS(APR 950) was bought to close for $0.44. The total net credit for rolling the bull-put credit spreads was $0.50 calculated as: $2.15-$1.56 + ($0.44-$0.35).
A new lower contingent order was entered for closing the short put option with a stop-loss price of 1122 which represented 2% of the short put option strike price. The new lower stop-loss allowed the NDX to drop in price -14% and still remain fully profitable.
At expiration on 4/17/2009 the position had not hit a stop-loss and the price of $NDX was at $1354 which was higher than the short put option strike price of $1100 and below the short call option strike price of $1475.
As a result, the position was fully profitable with all options expiring worthless. The initial net credit of $0.75 and also the incremental net credit from rolling of $0.50 was retained for a total profit of $1.25 per share of underlying or $125 per contract. The total net credit represented a return of 5.2%, almost double the initial return at entry of 3.1%.
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PowerOptions’ sister company PowerOptionsApplied provides expert stock option trading recommendations. PowerOptionsApplied specializes in covered calls, naked puts and iron condor stock options strategy recommendations. PowerOptionsApplied provides a 30-day risk free trial of its service.
[tags] margin requirement, potential return, strike price [/tags]