Why I Won't Trade Iron Condors

Don't let their cool sounding name deceive you - iron condors can be merciless birds who devour large chunks of your capital!

They get their name from what they look like - to some people - when their profit/loss profile is graphed out.

Apologies in advance for the quality of my homemade graph here - and yes, I know that's the face of an owl, not a condor.

(I briefly considered adding a Copyright to the image, but I'm not sure I actually want to take public credit for it!)

I included the graph here because you can immediately see the pros and cons of the trade.

If the stock remains within a certain trading range during the holding period, you can generate very high ROIs based on the capital you place at risk.

And that's another advantage to some - because these trades don't require a lot of capital to set up.

But you can also see what happens if you're wrong - your "limited capital" can very quickly get decimated.

Dissecting the Dangers of Iron Condors

To understand the danger and risks of iron condors, you need to understand how they're constructed, and that's from a pair of corresponding credit spreads.

To illustrate:

Imagine a stock is trading right at $50/share as with our iron condor (or rabid owl) graph above.

To set up the strategy you might sell a put at the $45 strike for one price and then buy an offsetting put at the $40 strike for a lower price.

This would generate a net credit while capping your losses.

Since you receive more for selling the $45 put than you pay for buying the $40 put, as long as the stock doesn't end at expiration below $45/share, that net credit represents your full profit potential.

And since the capital required is essentially the maximum loss on the trade (i.e. the difference between the two strike prices less the net premium received), you can see why the potential ROIs on these trades can be so high.

To complete the construction of the trade, you simply do the same thing on the other side (i.e. to the upside) using calls - e.g. you sell a call at the $55 strike and then buy an offsetting call at the $60 strike to create another net credit.

And then you hope and pray the stock remains trading within that $45-$55 price range.

No Straw Men (or In Defense of Iron Condors)

Now, I'm not trying to oversimplify things and create straw man arguments because a veteran iron condor trader (if you can find one) would argue that there are things you can do to avoid those maximum losses.

And, because a stock can't simultaneously trade in two different places at the same time (e.g. below $45/share and above $55/share), you can only achieve a "maximum loss" on one side of your trade.

I understand the argument, but to me the trade is still too much like being in a slug fest with Mr. Market where I'm trying to land as many punches against him before he lands a much heavier body blow against me.

Mr. Market's body blows aren't easily absorbed.

Your best (only?) hope is to try to move out of the way at the last minute (i.e. cut your losses short) and pray his body blow turns into a glancing blow.

This is more than mere opinion on my part - I hear iron condor and credit spread horror stories all the time from new members of The Leveraged Investing Club.

I call them "credit spread refuges" and they join because they've learned the hard way what can happen (or will happen, if you just give it enough time) happen when the strategies you employ have no "structural advantages" built into them.

Structurally Advantaged Option Trading

A structurally advantaged trade is what I call a strategy that gives you a good chance of repairing it when it goes the wrong way on you.

(And don't kid yourself - trades go the "wrong way" all the time.)

But with a "structurally advantaged" trade, the idea is that you're not only able to avoid a loss, but that you can still walk away with decent returns.

Or a strategy where you know the "worst case scenario" ahead of time and that outcome still represents an attractive investing opportunity in and of itself.

No joke - it really is possible to trade options this way.

The customized put writing strategy I teach (to credit spread refugees and non refugees alike) in the self-paced Sleep at Night High Yield Option Income Course is one such "structurally advantaged" trade.

No guarantees, of course, but I've often been wrong on what a stock will do - or at least what I want it to do - but when I sell or write puts in very specific ways and under very specific conditions, I've never gotten into serious trouble with a trade.

In fact, the trade history of the model Warren Buffett Zero Cost Basis Portfolio inside The Leveraged Investing Club demonstrates and documents the principle of being able to make great returns when I'm "right" and still decent to good returns when I'm "wrong."

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