Many aspiring traders are drawn to the world of options due to its potential for significant profits. However, the complexity of predicting market movements can feel overwhelming, leading many to quit before they ever really get started. For beginners, the idea of picking whether a stock or index will rise or fall seems daunting.
Fortunately, options trading offers much more than just ‘betting’ on market direction. There are high-probability options trading strategies; actually, one carries an amazing 90% success rate, and that is what many call the Iron Condor. It’s in the arsenal of proprietary trading companies like SMB Capital and traders around the world, because it provides them with the ability to take profitable trades without relying on predictions about up or down market movements.
By following one high-probability strategy—the Iron Condor—a beginning trader can actually make options trading a much safer and more predictable venture for consistent returns. In this article, you’ll learn how to start options trading using an easy, high-probability technique. It’ll give you a step-by-step look at one of the most effective, yet simplest strategies out there.
Understanding the Basics of Options Trading
Before proceeding with the strategy itself, a word or two should be said as to what options are, just for clarity’s sake. Options are financial contracts providing you with the right—not the obligation—to buy a stock or index, called a call, or sell it, called a put, at a particular price on or before a given date.
Options, therefore, have a greater appeal because they can let traders make profits not only in the presence of actual stock price movements but also in its absence, too—a principle behind high-probability strategies such as the Iron Condor.
Why High Probability?
Options are often misconceived as being outrageously risky. The reality is that the majority of professional traders use options to construct high-probability strategies, thereby containing their risk and maximizing profits. The Iron Condor will be constructed based on selling options that have a 95% probability of expiration without value, so that a trader can simply pocket the premium and not have to predict the market direction.
The Iron Condor Strategy: A High-Probability Strategy
What is an Iron Condor?
An Iron Condor is an option strategy set up in a way that it can take advantage of very low market volatility. The setting up commonly involves selling, normally out of the money, both call and put options far above and below the current stock or index price; then buying protective options at even more extreme prices to limit potential losses.
The beauty of the Iron Condor is that it works perfectly when the stock or index remains within a broad range, which happens frequently in calm or sideways markets.
Step-by-Step: How to Set Up an Iron Condor
Here’s how one might set up an Iron Condor on an index like the S&P 500, reflecting high-probability options trading principles:
- Choose a Stock or Index: We are going to take for example the S&P 500: SPX.
- Choose an expiration date: You want options that expire, preferably 30-60 days out. For this example, we’ll choose an expiration date 60 days out so that the strategy can play out longer.
- Sell Call Option: The concept is to sell a call option that has a Delta of around 5. For us, that happens to be the 4800 call. What this really means is that there is only a 5% probability the S&P 500 will expire above this price.
- Buy the Higher Call Option for Protection: Buying the call option with a strike price somewhat higher than the one sold, at 4825, provides protection in case the market really does go above 4800.
- Sell Put Option: Sell a put option now that has a Delta of 5 on the downside. This can be the 3875 put, meaning there is only a 5% chance of S&P 500 falling below this level.
- Buy Protection – a Lower Put Option: Finally, one can buy a put option well below the one having sold, say at 3850. That way, your losses will be limited if the market falls sharply.
Example of Cash Flows of an Iron Condor
When you sell an Iron Condor, you take in premium from the options you have sold. Using the example above again, you might sell the 4800 call and the 3875 put and buy protective options at 4825 and 3850. You might take in $1,600 in premium.
Okay, let’s break it down:
- Sell the 4800 call for $430 per contract.
- Buy the 4825 call for 330 dollars per contract.
- Sell the 3875 put for 940 dollars per contract.
- Buy the 3850 put for $880 per contract.
You subtract the cost of the protective options from the original receipt to get a net positive cash flow amounting to $1,600. This is potentially your profit if S&P 500 remains within the range as indicated.
Why the Iron Condor is a High-Probability Trade
The key to the Iron Condor strategy is the Delta of the options you are selling. Delta is a measure, or a way of assessing, the probability an option will expire in the money. If you sell options with a Delta of 5, you are basically taking a view that there is only a 5% chance of the market closing above or below your strike prices, which means there is a 95% chance of the options expiring worthless—and you get to keep the premium. For all the options to expire worthless and retain the full $1,600, the market should stay within the range defined by the options that you have sold. This strategy often has a high percentage chance of success should it be averaged over time, simply because markets will remain within a certain range more often than breaking out to the extreme.
Risks and Capital Requirements
Clearly, with any trading strategy comes associated risks, and the Iron Condor is no different. If the market does move significantly beyond the range you have defined, you will lose money. Because you purchased protective options, you have capped your losses.
Capital Requirement
To execute a 10-lot Iron Condor in the style we have described here, you would need to post margin of around $23,400. That’s also your maximum possible loss on the trade. If you’re trading with a smaller account, you can simply reduce the number of contracts you trade. For example, a one-lot trade would be in the region of $2,340.
Case Study: How an Iron Condor Played Out
Now, bring that into the real world. On September 15, 2023, a trader started an Iron Condor in the S&P 500 by selling the 4800 call and the 3875 put while buying the protective options at 4825 and 3850, respectively. Fast-forward two months to November 17th, and the S&P had closed at 4540, well within the Iron Condor’s bounds. That meant all those options expired worthless, which allowed the trader to pocket that entire $1,600 premium without further adjustments.
Conclusion: Start Options Trading the Easy Way
High-probability strategies, like the Iron Condor, are excellent for getting beginners into options trading. Rather than trying to guess which direction the market is moving up or down, in this strategy, traders make small gains based on the lack of movement. By selling options way above and below the current market price and then buying protective options, one is able to enter a trade that has a pretty high probability of success, normally around 90%.
The Iron Condor is a pretty rudimentary and structured way for someone to get into options trading and to keep risk contained. This is not a get-rich-overnight thing, but if you do it with regularity and your discipline is right, the returns will be very consistent.