The Dark Side of Iron Condors

One of the many strategies which intrigue novice options traders is the Iron Condor. The term itself sounds exotic, and begs you to research the strategy a bit more. I must admit that upon hearing this term used for the first time, I was more than a bit curious.

On the surface, the strategy is very sound: Taking a neutral position on the security, earning premium upfront, and allowing the time decay to make you money! However, there is a dark side to this trading strategy that most practitioners usually do not speak about, but can be disastrous to novice and experienced traders alike...

First, for the 2 option traders on the planet who have no clue as to what an Iron Condor is, let me try to shock some life into you:

An Iron Condor is a very simple options trading strategy! It may actually be one of the simplest strategies, because the premise is so logical!

You are simply taking a neutral position by placing two credit spreads in both directions on a security which you do not believe will move in either direction with much conviction. So you initiate a position where you will sell two positions (a call and a put) which are outside of your estimated range of movement for that particular security. Then you will protect yourself from unlimited losses, by buying two positions which are even further out of your predicted range, as a hedge.

These are all done simultaneously, and the entire position is given its name because of the resemblance to the large prehistoric bird. Once the position is initiated, you are relying on the market price of the underlying security to remain within your predicted range for this strategy to be profitable.

The advantages of this strategy stems from the fact that you have earned a net credit for positions facing both directions, so by expiration date, logically, only one of them can possibly lose. And again, this loss would only occur if the price of the security broke out of your predicted range by MORE than the credit that you earned.

There is also the advantage that this strategy possesses in terms of leverage! See, because you can only lose on one leg of the position, most options brokers will only require enough margin in your account to cover the maximum risk from just one leg of the entire position, thereby giving you a much better return than if you simply initiated one credit spread!

Sounds great, right? Well not so fast... The problem comes if and when the price of the security moves outside of the predicted range, and greater than the credit you have been paid! Remember, your downside risk is only capped, not eliminated! So you can still lose money! That's why the focus in this article is to help the novice trader understand the untold risk that they maybe subjecting their portfolios to, when using this strategy...

See, while Iron Condor Strategies can usually offer astonishing, 80-90 percent probabilities of winning and can provide yields of over ten percent monthly, what isn't being talked about is the risk to reward ratio of these trades - which can be as high as 10 to 1.

In layman's terms, this means that in order to achieve those 80 to 90 percent probability trades - you need to risk ten dollars to make just one - or to be more realistic - you need to put at risk $10,000.00 for the chance to make just $1,000.00.

Now, these types of risk/reward ratios are common, and I have no problem initiating this type of trade, with this in mind! That's because I know what must be done if these positions go awry! The problem comes from those so-called experts who teach how to 'adjust' these trades, to turn a losing trade into a winner again!

In my opinion, an Iron Condor position which has turned into a loser, cannot be adjusted up or down, or rolled over for a profit! Think about it... To roll up, down, or out of the position, you would need to close your losing position and open a new one further away from the original, in the direction of the losing position, with the following month's expiration.

However, once you have closed your position, you have effectively booked a loss! Then, you have another month to wait for your new adjusted position to expire, with the hopes that it will expire worthless! Otherwise you lose again!

Usually, investors are elated when they first start trading this strategy, because they find themselves making great returns month after month! But then reality hits when they wind up giving back most of those returns during the 1 or 2 bad months that can occur throughout a normal year! See, this strategy should come with a warning, so that investors understand that all it takes is just one or two problem months to come along and cause you to book losses that will completely obliterate the 8 to 9 wins you've managed to rack up, and devastate your entire account!

But it's not all doom and gloom...
As I said before, I have no problem with putting on this type of trade, and it is actually the preferred type of opening position trades that we initiate! But that's because we know exactly how to 'massage' these trades in order to virtually eliminating losses!

So that's my DISCLAIMER: Every investor considering this type of trade needs to fully understand the risks involved, and not rely on simply the positive aspects of this strategy to pull them through to a profit! Because the problem months will inevitably come along, and turn your whole portfolio upside down if you do not take the proper precautions!

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