Matt Baker
Matt Baker

I would like to continue this month with my new series on Iron Condor (IC) trading and share some of the insights I gained in trading Iron Condors on the Russell 2000 Index (RUT). I traded the RUT for most of 2008 and am certainly back in the saddle in 2009.

At the time of writing we are experiencing a sideways to slightly bullish market – perfect for this strategy! There is a lot more to take from this article than just ways to trade the IC because really it is just 2 short spreads (or credit spreads), sold far OTM with the view that they will erode in value and be able to be bought back cheaper than they were sold.

Given that credit spreads are part of other strategies we know (condors, butterflies or just single credit spreads), the trader should be able to incorporate some ideas from this article into other areas of their trading. Let’s revisit the period from December 2007 to September 2008, when the RUT was trading in a range.

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Let’s assume we are legging into the trade and are therefore placing our spread orders separately.

When we sell a spread, our broker will give us a quote (a bid/ask) on the actual spread. Single options have their own bid/ask spread, but strategies (spreads, butterflies, calendars etc) also have their own bid/ask spread. For example if we wanted to sell the 810/820 call spread on the RUT, and we pulled up this spread on the order screen, there would be a bid/ask quote for the spread. For example the bid may be 50 cents and the ask 60 cents and would look like 0.5 / 0.6. This means at the worst, we could sell this spread for 50 cents and at best we could get 60 cents.

We know that we are never going to get the best price otherwise there would be nothing in it for the market maker. But there is a way we could still get the 60 cents - or even more, which I will discuss later. But commonly on the RUT I am filled at the midpoint, which means the price right down the middle of the bid/ask. In this case that would be 55 cents. On some broker platforms when you bring up a quote for the spread, they default in quoting the mid-price for you. If I need to get out of a trade quickly, or I want to sell a spread quickly, I will take 5 cents off the price to increase my chances of getting filled. If the market is moving fast or volatility is very high (making bid/ask spreads wider), I may have to take 10 cents off the price.

Either way, I always try to get more for selling my spreads than just the mid-price. It doesn’t take much market movement for the option prices to move around and if the RUT moves enough intra-day then my spread price will move as well. So commonly in the example above, I will actually place a limit order to sell the spread for 60 cents. I won’t get filled straight away but if the market moves a little in the direction of the spread then that 60 cents may now become the mid-price of the spread, meaning I have a fair chance of being filled.

The catch here is that if the market moves in the other direction for the entire day, then I will never get filled and will probably wish I had taken the mid-price originally. Regardless of this, I think the strategy is worthwhile. 5 cents may not seem much, but that’s $5, and if you had 5 contracts, and then the same for the put side that’s $50 in total. Doing this at the exit of the spreads would mean another $50 in your pocket, or in this case, $100 so far. Now if you sold and bought back your spreads twice in the month, potentially that’s an additional $200 that you’re better off. Now we all know it’s not as black and white as that, but it’s amazing to see how fast those 5 cent’s all add up.

I hope that has given a new way to think about placing orders and getting filled. Happy trading, but please remember trading this strategy carries a great deal of risk, relative to the reward you can make. Please don’t go out and trade these if you don’t understand the strategy, risks, rewards, breakevens and both winning and losing adjustments like the back of your hand.

Manage your risk!

Matt Baker