In my article last week on Research In Motion's (RIMM) earnings, I recommended using a 'reverse iron condor' spread to profit on a modest move in either direction. In fact, the trade could have been sold before Research In Motion even reported earnings after the market closed on Thursday. The trade was a huge success, returning a 70% ROI. I closed the position on Friday morning.
The 'reverse iron condor' spread is a neutral options strategy that is placed with a net debit instead of a net credit to the buyer, and can be placed with a lower level trading account. Most brokers will let you place this trade if you are approved with a Level 2 or Level 3. Please check with your broker, and if not approved, you can also request to be upgraded.
This trade is a limited risk, limited profit strategy. Yet, there is a very healthy return awaiting if the stock should make even a modest move after reporting earnings.
Here is how the 'reverse iron condor' trade is placed accurately using only one contract each for explanation purposes:
Reverse Iron Condor Construction
- Buy 1 OTM Put
- Sell 1 OTM Put (Lower Strike)
- Buy 1 OTM Call
- Sell 1 OTM Call (Higher Strike)
Oracle Corporation (ORCL) is scheduled to report earnings on Tuesday, December 20, 2011, after the market closes. The stock is currently trading at $29.74/share. The 52-week range is $24.72 - $36.50.
| 52wk high: | 36.50 |
| 52wk low: | 24.72 |
| EPS: | 1.77 |
| PE: | 16.40 |
| Div Rate: | 0.24 |
| Yield: | 0.826731 |
| Market Cap: | 150.73 B |
| Volume: | 15.61 M |
Here is how I will be placing the trade. The 'reverse iron condor' has four legs. (Note: you can increase or decrease the number of contracts to suit your preferred investment in the trade):
- Buy (20) ORCL December Week 4 $29.00 put options
- Sell (20) ORCL December Week 4 $28.00 put options
- Buy (20) ORCL December Week 4 $30.00 call options
- Sell (20) ORCL December Week 4 $31.00 call options.
The current bid/ask spread for this trade is $0.57 -$0.68. You should be able to place a limit order of $0.64 and get your order filled.
Requirements
| Cost/Proceeds | $1,300.00 |
| Option Requirement | $0.00 |
| Total Requirements | $1,300.00 |
| Estimated Commission | $100.00 |
Here is the profit/loss chart for this trade.
Current Price: $29.74
| Price | Profit / Loss |
|---|---|
| 21.00 | $700.00 |
| 24.41 | $700.00 |
| 27.99 | $700.00 |
| 28.00 | $700.00 |
| 28.35 | $0.00 |
| 29.00 | ($1,300.00) |
| 30.00 | ($1,300.00) |
| 30.65 | $0.00 |
| 31.00 | $700.00 |
| 31.58 | $700.00 |
| 38.75 | $700.00 |
Since this trade is placed with a net debit instead of a net credit, the maximum risk is $1,300.00. This is the most you can lose on the trade. The highest amount of profit you can make is $700.00 (or 53.8% ROI) when using 20 contracts on each "leg."
The break-even points for this trade are $28.35 and $30.65. From Oracle's current price of $29.90/share, the stock will only have to move 6.3% to the downside or 4.2% to the upside to gain the maximum potential profit. With Oracle reporting earnings on Tuesday, I feel this is easily attainable.
When using the 'reverse iron condor,' you always want to make sure to close the position before expiration.
Disclosure: I am long ORCL.
