When you learn how to successfully trade options, one benefit that you soon discover is the ability to generate reliable monthly income. You don’t have to be correct on the direction of a particular stock or the market, you can profit based on option decay. You essentially build a trade that throws off cash when stocks stay in a channel. An attractive trade for monthly income is an iron condor.
An iron condor is comprised of four separate options. First, you apply a put credit spread well below the stock price. This means you sell a put at one strike and buy a put just below it. Second, you apply a call credit spread well above the stock price. You would sell a call at one strike and then buy a call just above it. These four options form a channel. If the stock stays within the channel until expiration, you get to keep all of the credit received.
One problem with the iron condor is that stocks can jump around. Remember, you want the stock to be boring and stay in the channel. What if the CEO announces accounting irregularities or a big product recall? The stock could gap down and produce a maximum loss before you can do anything about it. In order to mitigate the headline risk of a single stock, it is possible to trade iron condors on indexes or ETFs. That way, a problem with a single stock won’t cause too much damage.
There are two common ways to select where to place your options. You want the channel to be as wide as possible, but narrow enough to make money. The first way is to place the short strike beyond support or resistance. The second way is to pick the short strike that has a delta value near .10. In the chart below, you can see that I was able to place the short put at 147, below support. I placed the short call at 160 because that had a delta closest to .10. I placed the long options 3 points further away. The result is that I can target 16% return in 26 days.
In most cases, I would close the trade well before expiration. My typical rule is to close the trade when I have gotten 8% return on my risk, or on Monday of expiration week, whichever comes sooner. And if things go badly, I will close the trade at a loss equal to the target return of 16%. With a trade structured like this, I can get my 8% per month pretty regularly and only rarely will I have a bad month and lose at most 16%. The iron condor is a great way to trade the channel and make a reliable monthly income.
Submitted By John Marsland
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