Friday, November 2, 2012

Iron Condor: The wimpy option trade!

I have been trading options for a few years now and have logged over 4,000 trades.  In that time I have become quite familiar with the risks associated with trading naked options.  I will say that I love trading naked options.  Writing naked calls when a stock is overbought and writing naked puts when a stock is getting unfairly beat up is a great way to trade.

The risks associated with these naked positions require nerves of steel and careful risk management.  The problem is that these 'risky' options often offer enticing rewards for those that can stomach the risk.  In the last few years I have often looked at the cost to protect these options only to decide to sit the round out and wait for a better set-up.  Market dynamics in the last few months has caused somewhat of a change in the market.  Protecting these naked positions with long options has become quite reasonable.

For example: using options on Apple's stock ($AAPL), right now a trader can execute a trade to write puts 6 percent below the market price and simultaneously buy puts and the next lowest strike price and keep a net $1.00 in premium per contract.  At the same time you write calls 8 percent above the market price and simultaneously buy calls at the next highest strike price and keep another net $1.00 per contract.  This gives the trader a net $2.00 in premium and limits the total risk to $3.00 per trade.  As long as Apple stays within your 14 percent range for the next 45 days (Dec '12 Expiration), you keep your $2.00.

Of course there is a fairly good chance $AAPL will have more volatility than that for the next 45 days.  However, there is always a degree of risk in this market and a reward over risk ratio of 0.67 looks pretty attractive.  So, if you're too wimpy, like me, to accept the unlimited risk of trading naked options, an iron condor just might be the ticket.