I am often asked why I choose to use a 'strangle option strategy or a 'reverse iron condor' strategy? This is a good question and I will try my best to explain why I may choose one over another.
The 'Reverse Iron Condor' Trade
There are some traders/authors out there who will tell you that it is not a good idea to use a 'reverse iron condor' trade on stocks that are below $100.00/share. While this is true in certain situations, I can assure you that you will be missing out on plenty of great trades if you stick to that formula.
The 'reverse iron condor' spread is a neutral options strategy. It is placed as a net debit, instead of a net credit. The most you can ever lose on this trade is your one-time investment at the beginning when placing this trade.
So what is the general rule when making this decision? There are a few factors that come into play here. First, I personally prefer to use a 'reverse iron condor' trade on stocks that have weekly options available and that are reporting earnings that same week. This prerequisite does not apply if the stock is reporting earnings on the third week of the month, i.e. options expiration, which means any stock that has earnings that week would work if the stock is expected to see a significant, but not a major price move. Since this applies to only a select number of stocks (see the weekly list of options available here), for only three out of four potential weeks, picking which ones to use is critical.
Here, I want to use an example of a stock that has weekly options available: Intel Corp. (NASDAQ:INTC).
Intel is a great company, but it is a bad candidate for a 'reverse iron condor' strategy. It simply does not move enough around earnings to justify placing this sort of a trade. I can guarantee you that if you choose to use it ten times, you will lose on nine of them, if not all. I am writing this to inform those that are new to options trading. This is a common mistake that even veteran option traders make. I know this because I read articles all the time suggesting this sort of a trade with a stock such as Intel.
Cisco (NASDAQ:CSCO) is similar to Intel in that it makes a horrible 'reverse iron condor' trade around earnings. It has too little price movement to make the trade profitable.
On the other hand, a stock like Molycorp (MCP), which also has weekly options available, is an excellent candidate for a 'reverse iron condor' trade around earnings. In fact, I love to use this stock as a weekly trade using the RIC just because of the volatility it brings. You can read more about that type of trade here.
Other candidates for this type of trade that are well under $100.00/share are the following stocks:
Abercrombie & Fitch (NYSE:ANF)
Freeport McMoran Copper (NYSE:FCX)
First Solar (NASDAQ:FSLR)
Green Mountain Coffee Roasters (NASDAQ:GMCR)
Las Vegas Sands (NYSE:LVS)
United States Steel (NYSE:X)
Now, am I saying that some of these cannot be used effectively with a 'strangle' earnings trade? No, definitely not. However, this is the much safer trade, in my opinion, than a 'strangle or 'straddle' play.
The one main issue with stocks that are over $100.00/share in most earnings trades is that the strike prices are in $5.00 increments. This may not seem like a big deal when placing the trade initially, but if the move is less than expected, especially with a 'strangle' trade, you can be in deep water. It is not a good spot to be in.
These are some of the stocks I have had a lot of success with using the 'reverse iron condor' trade. All with share prices over $100.00. (Note: all of these stocks have weekly options)
F5 Networks (NASDAQ:FFIV)
Priceline.com brings me back to a point. If you decided to enter a 'strangle' or 'straddle' position before earnings on Monday after the market closed, you would have to pay a very hefty amount. Even though the stock moved a lot on Tuesday, the question of whether or not you made a profit depended on when you bought in. This straddle, a 'strangle' or 'straddle' was extremely expensive to place.
The point here is that with a 'reverse iron condor' trade the breakeven points were much narrower. You would have definitely profited. The same cannot be said for the 'strangle' or straddle' trade. It is true that you would also make less, barring the trade went according to plan, but would you rather be more conservative and have a high likelihood that the trade will profit or take the chance that it will not?
To properly place a 'reverse iron condor' trade, you will need to understand how the four (4) legs are placed accurately. (Note: I will only use one (1) contract on each "leg" 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)
It should also be noted that your broker usually requires a Level 3 or Level 4 trading account to make this trade. If you do not have this level, you can always request an upgrade.
Advantages Using The 'Reverse Iron Condor' Strategy:
Much less total investment.
A debit spread (does not tie up capital).
A much smaller price move needed than a 'strange' or 'straddle' trade.
Knowing a set price-per-share needed ahead of time in order to profit.
Much less drama and nerves both before and after earnings are released.
Easy to manage.
Disadvantages Using The 'Reverse Iron Condor' Strategy:
Much less of a profit obtained in the event that the stock makes a major price move.
Four legs on the trade, which results in higher commission costs.
While you can profit ahead of an earnings release, the 'reverse iron condor' usually profits after the announcement is made. This is not always the case, however, but should be expected going into the trade.
You must choose this trade carefully.
Too much time left on the trade can be a detriment, as it could revert back to the middle strike prices, which is the worst-case scenario with this trade. (the same can be said about the 'strangle' or 'straddle' trade.
The 'Strangle' Trade
I have always traded the 'strangle' strategy around earnings. If there is one complaint about this trade it is that you must be extremely careful as to what stocks you use with this strategy.
If there is anything less than a significant price move, the chances are that you will be dealing with a big loss on your investment. With that being said, there is also great opportunity with this trade when used correctly.
One of the benefits of this trade is the ability to exit ahead of earnings. However, this is not always possible. I generally like to go at least one-month forward on my 'strangle' trades. This gives me time-value in case the stock does not make the anticipated move that was expected.
Among the stocks I will use the 'strangle' trade around earnings with are the following:
Google (if priced well and reasonable strike prices are used).
Intuitive Surgical (NASDAQ:ISRG) - see Google
Zoltek Companies (NASDAQ:ZOLT)
What I will sometimes do is use both the 'reverse iron condor' strategy and the 'strangle' strategy on the same stock that is reporting earnings. Since both trades are neutral-based, under the right circumstances and stocks, you can profit off both. Google is a great example of this because it has a long history of making large price movements quarter after quarter after earnings are released.
To properly place a 'strangle' trade, you will need to understand how the two "legs" are placed accurately. (Note: I will only use one (1) contract on each "leg" for explanation purposes):
Long Strangle Construction
Buy 1 OTM Call
Buy 1 OTM Put
Advantages Using The 'Strangle' Strategy:
By purchasing out-of-the-money call and put options, you are limiting your total investment.
Very high profit potential if the stock makes a very large price move.
You can "leg" into this trade. By legging in, this means that you can purchase one side of the trade when it is less expensive and do the same on the other long side. (Note: I will frequently use my Daily Options Trading Strategy I developed to do this. Please see this article.
You may be able to exit with a profit before earnings are released.
Disadvantages Using The 'Strangle' Strategy:
Expensive to place.
A large price move is required almost every time.
Very stressful trade.
May require a lot of maneuvering before earnings are announced.
Placing this trade too early can create many problems, such as your strike prices too far off what is a realistic expectation.
Must be very selective on which stocks to use. Limited opportunities.
You can buy further out month options. Plenty of time-value left.
If you have any questions, please leave a comment or send me an e-mail. Thanks.