On May 20, when the S&P 500 Index (SPX) was headed toward its May 6 “flash crash” lows, we initiated an iron condor strategy in the June SPY options for our OTA Premium trading portfolio. Here were the details of that trade: For our next Option Trading Alert, we are initiating an iron condor in the SPDR S&P 500 ETF (NYSE: SPY):

Trade Idea: SPY Iron Condor

• Sell to open 50 June 100 puts
• Buy to open 50 June 97 puts
• Sell to open 50 June 115 calls
• Buy to open 50 June 118 calls
• The limit price credit (i.e., when you execute your order, you should collect this amount) is $1.25 per share, or $125 per four-legged spread
• Note: All options should be traded simultaneously.

50 spreads = $6,250 premium income against $8,750 of risk 1 spread = $125 income vs. $175 of risk

The Sentiment

With the current sell-off and volatility spiking, now is a good time to sell some premium on the likely bet that the market will not continue to cascade lower. There are 29 days until June expiration and the S&P 500 Index (SPX) will probably trade between 1,025 and 1,125 during this time. This iron condor offers the opportunity to collect premium and earn up to a 71% return on capital at risk if we are right and the sovereign debt crisis in Europe is getting priced in sufficiently to this bull market. The SPY is priced as 1/10th of the SPX, and therefore, simply add or subtract a zero to convert the following levels and strikes. Differences in the way dividends and interest rates are calculated have the SPY trading at a slight premium that won’t affect our strategy to any significant degree. I have chosen short strikes about $9.00 (90 SPX points) away from the at-the-money 109 strike (SPX 1,090) on the downside, and $6.00 (60 SPX points) away on the upside. I’m confident that the market will be supported at $100.00 (SPX 1,000) and meet resistance at $115.00 (SPX 1,150) for the next few weeks. The June SPY 109 straddle is trading for about $8.95 and indicating that option professionals are currently making the bet that the SPX could indeed go to 1,000, but that it probably will not go through it. I think they are right now and will continue to be right for the next 29 days. With the CBOE Market Volatility Index (VIX) spiking above 40 today, at-the-money volatility in the SPY is around 35% and this is where many pros will be selling volatility. Here’s a note from the last SPY iron condor we did with December options that sums up the trade’s rationale: "Despite the emotional swings of this market—what else makes a good market but the constant tug of war between confident bulls and doubtful bears?—the bias is to the upside and probability favors another consolidation in a 100-point SPX range. Here are the consolidations of the past year when it paid to sell options around a wide range:" May to mid-July: SPX 875 to 955 July to mid-Sep: SPX 950 to 1,050 Sep to mid-Nov:SPX 1,020 to 1,100 The bias may be to the downside in the short-term, but the recent trading ranges tell the same story over time: Nov to mid-March: SPX 1,045 to 1,155

Trade Analysis

The SPY is currently trading around $109.25, down $2.50 so far today. The Upside: Maximum profit for this iron condor is the $1.25 collected upon entry (minus commissions), or $6,250 for this 50-lot. The max profit will be achieved if SPY shares are anywhere between $100 and $115 when the options expire on June 18. The Downside: Maximum risk is $1.75 per spread, or the difference between the call or put strikes, minus the credit received. This is $8,750 for this 50- lot. For maximum loss to occur, SPY would need to be trading below the long put strike ($97) or above the long call strike ($118) at June options expiration.

Click on image to enlarge!

Keeping in mind that we can’t lose on both ends of this trade, we will monitor the risk if a large move and spike in volatility occurs that could make the trade unprofitable if it threatens to go through our short strikes at either $100 or $115. The potential return on risk for this trade is roughly 71%. The margin requirement for this trade could be as high as $1.75 per spread , or $175 per lot ($8,750 for this 50-lot). Your broker should only margin one side of the trade. Breakeven: Breakevens here are (a) the strike price of the sold put ($100) minus the credit, or $98.75; (b) the strike price of the sold call ($115) plus the credit, or $116.25. Beyond these levels, the trade begins to lose money. SPY is currently about 6.7% below its upper breakeven and 9.4% above its lower breakeven.

Click on image to enlarge!

Based on the probability of today’s implied volatility, this strategy has a 57.14% chance of finishing between the breakeven prices and making some or all of the maximum profit. There is a 42.86% chance of losing money with this trade. This image was created using a free probability calculator, part of a virtual trading account.

Trade Management

Thursday, May 20:

We will closely monitor the price action over the next few weeks. If anything fundamentally alters our view of the market’s tone (i.e., fund managers reacting more strongly to global debt concerns and taking more risk off the table), we will likely exit the put spread.

Wednesday, June 2:

This strategy has worked perfectly so far with both implied and realized volatility coming in sufficiently in the past two weeks to make this trade quickly profitable. Instead of hanging on for the next 16 days until June options expiration while the market looks weak, we would rather take the profits now, and not worry about another spike in volatility. If and when we do get another good move, we will probably look to put another iron condor on. Buy to close this iron condor by trading the following options simultaneously:

• Buy to close 50 June 100 puts
• Sell to close 50 June 97 puts
• Buy to close 50 June 115 calls
• Sell to close 50 June 118 calls
• You should pay $0.55 or less to exit this iron condor

We were actually able to exit this spread for 51 cents with the S&P 500 up about 10 points on the day. For the 50-contract position we initiated in our OTA portfolio, this equaled a profit of $3,700. For a single contract, the profit would be $74. Exiting early guaranteed a certain amount of profit that justified our total risk. Yes, we left some money on the table. But, then again, an S&P slide toward the year’s lows and a spike in volatility would have had us paying more than 51 cents to exit and turned a healthy profit into a marginal one.

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