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The Iron Condor

Richard Croft
October 17, 2012
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Global markets appear to have hit a wall on the upside. And with third quarter earnings expected to reinforce the position that growth is slowing, the markets may well remain in neutral through the end of the year. And perhaps longer if President Obama gets re-elected and carries through with his “tax-the-rich” strategy!

On the other hand with central banks continuing to add liquidity there is a strong case to be made that downside risk is limited. There is also the possibility that bulls could gain momentum if the US government takes serious action on the fiscal cliff issue. A second term President might make those hard decisions where he has nothing to gain politically.

The Eurozone is another matter entirely. You can expect news from that sphere to take center stage periodically and markets will react quickly and negatively. The Eurozone has dug itself into such a deep hole that most observers believe nothing positive will happen until well into 2014. All told investors are locked in a bull / bear tug of war which will likely result in an ever widening trading range.

To play this you might consider writing an Iron Condor. The Iron Condor is simply a bear call spread combined with a bull put spread. The strategy works best if the market trades in a range bounded by the two short strikes. Because you are short two credit spreads, your risk is limited.

Take a look at options on iShares S&P/TSX 60 Index Fund recently trading at $17.80. The bear call spread could be initiated with the sale of the XIU December 18 calls at 35 cents combined with the simultaneous purchase of the XIU December 19 calls at 5 cents. The net credit is 30 cents.

The bull put spread could be implemented with the sale of the XIU December 17.50 puts at 35 cents combined with the simultaneous purchase of the XIU Dec 16.50 puts at 15 cents. The net credit in this position is 20 cents the difference between the money received from the sale of the XIU December 17.50 puts versus the cost of buying the XIU December 16.50 puts.

The maximum risk is the difference between the strike prices on the bear call spread or the bull put spread (i.e. $1 per share or $100 per contract) less the net credit of 50 cents which is the amount received from both spreads.

Despite the fact you are incorporating two spreads the risk is still limited to the difference in the strike prices less the net credit received against only one wing of the condor (hence the name “iron”). Only one side of the Iron Condor would actually be at risk at any point in time.

The Iron Condor earns its maximum profit if XIU closes between $17.50 and $18.00 at the December expiration. In that scenario all the options would expire worthless and you would retain the net credit.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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