If you check the price of S&P 500, you will find out that the rate of change for the S&P 500 over the past three weeks was +0.1%. It was a wild ride. The market fell over 8% and then recovered all the losses.
There is a way to profit from sideways markets by using a strategy called Iron Condor. This is one of my favourite strategies for sideways markets. The Iron Condor is a combination of a bull put spread and a bear call spread. The whole trade is done for a credit.
One of the major considerations of this strategy is the choice of strikes. If you choose strikes close to the money, the trade will provide more credit but reduce the probability of success. Going further OTM (Out of The Money) will reduce the credit but increase the probability of success.
Let’s take a look at one possible trade using the Russell 2000 Index (RUT). RUT is currently trading at $742. I will be executing this trade for my personal account. Small accounts might use the Russell 2000 Index ETF (NYSEARCA:IWM) instead. Here is the trade:
- Buy RUT January 2012 670 put
- Sell RUT January 2012 680 put
- Sell RUT January 2012 800 call
- Buy RUT January 2012 810 call
The trade can be done for $4.60 credit and hence the maximum profit of the trade is $460 per spread. The margin requirements are $540, so the maximum gain is 85% if held till expiration. The maximum gain is realized if RUT stays between 680 and 800 till January expiration. However, this gain is very unlikely. I will probably close the trade long before the expiration.
This is a delta neutral trade. The deltas of the short strikes are about 25.
I will use the following guidelines to manage the trade:
- Place a $0.20 Buyback GTC (Good Till Cancel) Order for each spread separately.
- Exit the trade if the loss exceeds 15% or the profit exceeds 30-35%.
- Adjust the trade if RUT reaches one of the short strikes by rolling the spread in danger further OTM.
I will follow up on this trade in a week or so and provide some additional considerations about trade parameters and risk management.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I`m planning to initiate the RUT Iron Condor