Iron condors can produce a return on stocks that stay within a specified range over the trade period.
This can be a welcome change for buy and hold investors who are reliant on markets always going up.
So today, we're going to look at an example on Lululemon Athletica. The stock broke below its 10-week moving average this week.
An iron condor can be set up via a combination of a bull put spread and a bear call spread.
The idea with the trade is to profit from time decay while expecting that the stock will not move too much in either direction.
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First, we take the bull put spread. Using the July 21 expiry, we could sell the 290 put and buy the 280 put. That spread on LULU stock could be sold Wednesday for around $1.20.
Then we set up the bear call spread, which could be placed by selling the 410 call and buying the 420 call. This spread could be sold Wednesday for around $0.85.
In total the iron condor will generate around $2.05 in premium.
The profit zone ranges between 287.95 and 412.05. This can calculated by taking the short strikes and adding or subtracting the premium received.
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Because both spreads are $10 wide, the maximum risk in the trade is 10-2.05 x 100 = $795.
Therefore, if we take the premium ($205) divided by the maximum risk ($795), this iron condor trade has the potential to return 25.8%.
If price action stabilizes, then iron condors will work well. However, if LULU stock continues to bounce around, the trade will suffer losses.
One way to set a stop loss for an iron condor is based on the premium received. In this case, we received $205, so we could set a stop loss at 1.5 times the premium, or around $300.
LULU stock is showing an IV percentile of 63%. That means the current level of implied volatility is higher than 63% of all readings in the last 12 months.
The retailer reports earnings on June 1, an event that may cause volatility before this trade's expiration.
LULU Stock Leads Its Industry
According to the IBD Stock Checkup, LULU stock is ranked No. 1 in its industry group and has a Composite Rating of 91, an EPS Rating of 97 and a Relative Strength Rating of 87.
A covered call on Arista Networks explained March 15 could potentially be closed early after gaining $450.
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Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
