OPTIONS

A Neutral Options Strategy

The Iron Condor

by Jesse Chen

Being neutral on the market is different from being unsure. Here's a strategy to take advantage of your view.
Neutral options are a sound strategy in options trading. They combine a balanced risk and reward ratio with a high probability of profit and wide profit zone. Neutral options come in three main flavors: short strangles and straddles; butterflies; and iron condors.

These positions are appropriate to use when you expect the market to go nowhere or, if the market does go in some direction, the strategy will be able to take advantage of the movement. I'm going to describe the former situation. Below are the six option spreads that people use for neutral options strategies. I've included abbreviations for the positions:

  • Short straddle = Sell at-the-money call (sac) + Sell at-the-money put (sap)
  • Short strangle = Sell out-of-the-money call (soc) + Sell out-of-the-money put (sop)
  • Butterfly call = Buy out-of-the money call (boc) + Sell 2 at-the-money calls (2sac) + buy in-the-money call (bic)
  • Butterfly put = Buy out-of-the money put (bop) + Sell 2 at-the-money puts (2sap) + buy in-the-money put (bip)
  • Iron condor (flat) = Buy further out-of-the money call (bOc) + sell out-of-the-money call (soc) + sell out-of-the-money put (sop) + buy further out-of-the-money put (bOp)
  • Iron condor (pointed) = Buy out-of-the-money call (boc) + sell at-the-money call (sac) + sell at-the-money put (sap) + buy out-of-the-money put (bop)
    • Short strangles/straddles usually require large account margins but provide the highest probability of profit and have unlimited risk. Butterflies are four-option spreads using all calls or all puts. Iron condors are four-option spreads that combine both calls and puts.

    FLAT IRON CONDORS

    Iron condors have a wide profit zone but a balanced reward-to-risk ratio. As an example, I'll use Oex options on the Standard & Poor's 100 index, options that are heavily traded and very liquid. From the six-month price history of the Oex in Figure 2, we see that the Oex has dropped from its high in September 2000 and has settled into a narrow trading range. This may be an appropriate time to try a neutral option strategy. I want to construct a neutral position around the Oex's price on December 14, 2000: 710.67.

    Figure 1: Summary. Use this table to find the neutral spread that best fits your needs.

    Figure 2: OEX. As the OEX reaches the middle of a range, a neutral strategy seemed apt.


    ...Continued in the August 2001 issue of Technical Analysis of STOCKS & COMMODITIES

    Jesse Chen publishes OptionStar through Star Research. He can be reached at optionstar.com.

    Excerpted from an article originally published in the August 2001 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2001, Technical Analysis, Inc.


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