Unless you’re brand new to option trading you’ve likely heard of the Iron Condor trade. That’s a trade where you typically sell an OTM Call and Put Vertical credit spread as a way of initiating a non-directional position. I rarely utilize an Iron Condor but I often have it’s cousin, the Condor, in my portfolio. The Condor is a very similar structure but it consists of either all Calls or all Puts. That’s a difference but not that big of a difference. The real difference in the strategy as described in this post is that I buy the Condor instead of selling it and I use it directionally instead of non-directionally. I typically leg into Condor’s as part of a Delta Hedge strategy but this post is going to discuss utilizing the directional Condor as a way of initiating a medium to long-term position with very little directional (Delta) risk at trade entry. Let’s get to it!
One of the best times to initiate a directional Condor is on a breakout above or below a particular range. At that point, price may already be over-extended and due for some corrective action but the overall directional trend still seems clear. In those situations I typically allow for more counter-trend room before I potentially get stopped out. That requires a position with a relatively flat (closer to zero) Delta value. Below is the daily chart of QQQ. Price has seen a 10% rally over the last 4 sessions. It would be very reasonable to think price should see a 25% – 50% retracement of that move or, at the very least, a sideways consolidation for a few days to a week or more. So while this is a bullish chart and I want to be long QQQ at this point I don’t view this as an optimal entry point. Having said that, I’ve missed many a move in my day thinking price had to offer a better entry! Sometimes price just keeps on going. That’s where a directional Condor is a good choice.
Below is the risk profile of a Dec Condor in the QQQ. Initial directional risk is just 3.69 Deltas. If I do buy this Condor and price does retrace lower, the loss will be relatively minimal and I won’t be forced into closing the position due to the stop level being too close to my long entry. At first, the profits as well as the losses are relatively minor. However, while the losses remain reasonable through out the duration of the position, the profits have a much higher peak.
By the end of this month, some 23 days into the trade, the risk profile will be similar to the one shown below. The losses will have increased if price moves lower but I won’t be in this position by then if price hasn’t moved higher. That would mean the bullish price setup on the chart has failed so I will have stopped out well before this time. I will only still be holding this position if price has resumed it’s rally higher. The time bend as evidenced by the purple line (current profit/loss line as of the shown date) is starting to accelerate. That bend pulls the P/L line higher towards the position’s maximum profit line (blue).
The risk profile below is showing the current P/L line as of the morning of the position’s expiration. The time bend is mere hours from completing it’s journey. If price is anywhere within that maximum profit range then nothing needs to be done other than just waiting for time to carry the position to expiry.
After the close on Dec18, the risk profile will be complete. The maximum risk taken was $91 and the maximum profit was $409. That’s a reward/risk ratio of greater than 4:1.
Based on what I’ve described here you can imagine when a trade like this would be most profitable. As I’ve already said, I’d initiate this bullish Condor position on a breakout above a previous high because I’d want to participate in a further rally while minimizing the risk if a pullback occurred first. A rally that is often described as a melt-up fits perfectly within the directional Condor trade. The passage of time provides more of a benefit to this position than does the directional move.
Many of you have seen me leg into a Condor as an adjusting trade where I’m using a Delta hedging strategy and I already own a Call or Put Vertical Debit spread. That remains one of my favorite strategy’s however there are times when it makes even more sense to initiate the position with the purchase of the Condor.
4/30/2022 Update
Had a question regarding this post from over a year ago so I’m adding this update to show what happened after I posted this. BTW, while most posts in this blog are my actual trades this was not one of them! I am using ThinkBack in the TOS platform to demonstrate a strategy of narrowing a Butterfly or Condor to reduce/eliminate cost or, as you can see below, even lock in a profit.
The day following the post the QQQ gapped higher (#1) and then spent the rest of the day declining in a classic gap and crap. That is always a danger in buying a breakout and the exact reason I made this post in the first place. Buying an apparent breakout leaves you very vulnerable because it’s often terrible location for initiating a long position. The strategy of buying an OTM Condor or Butterfly helps to reduce that risk of bad trade location. Below is the ThinkBack chart of QQQ with the profit/loss line overlay (yellow line). I’ve highlighted the profit and loss at several points between 11/6/2020 and 12/18/2020. The day after the trade was initiated the position was already down by around 30%. 😖 Many a trader, including myself, could’ve easily said “I’m out” and exited the trade. That’s one outcome. Or perhaps, if I had done more than a 1-lot I would’ve sold half of the position and held the other half. The point of these posts is to have you think about what you would do so you are prepared for similar situations in the future!
Let’s say that I decided to keep the position instead of exiting. The max drawdown would have been around $60. Again, 😣! As you may have noticed above that holding the position would’ve resulted in a nice profit at several times prior to expiration. Holding that position however turned out to be a real roller coaster ride. Is there anything that could have be done to reduce that volatility? If I had sold the outside legs of the Condor and kept a narrower version of it when QQQ rallied up into 12/8/2020 then I could’ve locked in a minimum profit of $21 and either held the remaining position into 12/18/2020 when the narrower Condor would’ve expired worthless or I could’ve exited at any point along the way. Regardless, the $21 profit would have already been booked. I hope this update helps!
Comments or questions? Tweet at me @VegaOptions.
Thank you for giving these great case studies for learning. Questions on the details….. QQQ close on Dec 18 ’20 was 307.61 so the trade did not make it to profit but would have been max loss unless you had made some changes as alluded to. At the inception of the trade, entering on the close of Fri Nov 6 price was say 294.61. The next 10 days (calendar days or trading days do you use?) did not exceed that entry price till Nov 25. You said ” I won’t be in this position by then if price hasn’t moved higher. That would mean the bullish price setup on the chart has failed so I will have stopped out well before this time.”
However you did stay with it….. ? Also, as it neared expiry, price was not getting into the max profit area. Would there be a simple safe way to move the target down a bit?
Added an update at the end of the original post. Let me know if that answers your question or at least increases your understanding of the topic.