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Building Iron Condors Without A Roof

Successful market neutral trading assumes that markets don't move in one direction. More often than not, the markets are mean-reverting and spend their time in ranges well defined by support and resistance levels. Trend-based swing traders wait for moves out of these ranges to place their trades, while market-neutral traders rely on the markets' frequent inability to breakout (or breakdown).

A breakout market is the biggest risk to iron condor traders. If they have an open position, they either roll or close, taking the loss with the knowledge that they can establish a new position in the next expiration cycle. But for the trader looking to open a position, the choices aren't always so obvious.

The current state of the Russell 2000 (RUT) is a perfect example. With a 14 day relative strength reading of over 70, it is clearly overbought. Relative to other world markets and indices, it is more overbought than nearly all of them. Looking at the usual array of technical studies from Bollinger Bands to stochastics to distance from various moving averages, the RUT is overbought. And as the old trading truism goes, markets can remain overbought (or oversold) longer than a trader can remain solvent.

In addition to being overbought, the RUT is sitting at an all-time high. Uncharted territory. A new frontier. There is no group of trapped investors sitting at some level just above the current price who are eagerly waiting to cash out once the index gets a little bit higher. In the absence of classic overhead resistance, what's an iron condor trader to do?

Do you treat the current level as your new mid-point and pick a short call based on your normal criteria (delta, open interest, etc.)? Do you structure your trade with a slightly directional bias? Convince yourself that you can call the direction (and timing) well enough to leg into a trade?

Every trader's approach varies, depending on their time frame, risk tolerance and overall portfolio construction. But a pullback in the RUT at this point would clarify all of the above questions and give traders the chance to determine if the RUT is topping or simply digesting in advance of more upward movement. A pullback, whether met with more of the buying-on-the-dip that has characterized the market over the past several years or the beginning of a more significant move downward, will result in greater volatility premiums, the kind that can make a real impact on a trader's year.

Iron condor traders, especially those who view this style of trading as a monthly income strategy, believe that they need to be in the market at all times. In markets like these, it's better to think like an major league batter and wait for your pitch.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.