Iron condor trading is an incredibly profitable option trading strategy, especially for beginning traders.
Yet if you don't know how to manage your risk, you can end up getting blown out on a trade.
That's when the honeymoon phase is over.
Some traders adapt and overcome, getting over that hump and becoming even more profitable with iron condors.
For others, that's when they move on to another strategy.
(Hopefully you're in the first group!)
To be honest, it doesn't matter how many times I tell you this, it'll take that one trade where you get knocked around a little...
... that's when you'll start to pay attention.
Let's step through some of the huge pitfalls when it comes to the risk in iron condors.
Don't Look at Iron Condor Expiration Outcomes
I know it's tempting to eyeball this chart:
And say to yourself:
"Oh as long as the market doesn't selloff 10% or rally another 5% then I'll be profiable."
Or maybe you say:
"Hey the probability of profit (PoP) is really high so this trade will be a layup!"
That's bad voodoo. You're just asking for the market to prove you wrong.
I won't lie to you... if you come into the market at the right time, those first few trades will feel great as the profits roll in.
But then something stupid happens.
We can blame China, or the Fed, or the Oil markets. Whatever.
And if you were planning on doing a "set and forget" strategy with this iron condor, you're gonna get smoked.
The Real Risk In Iron Condors
Believe it or not, iron condors are incredibly forgiving to the downside.
The premiums available on out of the money puts allow you to have more "wiggle room" in case the market sells off.
It's the upside risk where you get in trouble.
When you start off an iron condor trade, it's not a market neutral trade.
It's actually net short.
That means if you put it on and the market rips to the upside, you'll start the trade in a drawdown.
How You Can Manage Iron Condor Risk
No matter what you do it's crucial that you have a plan before you enter the trade.
Ideally you make it as systematic as possible so you know at what point you will adjust the trade.
Here are a couple considerations:
Enter Iron Condors In Overbought Markets
This may seem counterintuitive but it works.
When the market is ripping higher it's actually a pretty good time to enter a new iron condor.
That's because the odds of reversion is higher, and the net short actually benefits your trade.
Also, there will still be plenty of premium on the put side because of option skew.
Unbalance Your Iron Condor
If you're concerned about the upside, just don't go full risk on the call spread.
Then, if the market continues to rip, you can add to the call spread at a much better basis.
Have an Adjustment Plan in Place
If the directional exposure becomes to great, you can simply use iron condor adjustments to work your position back down to a better risk/reward equation.
Remember, no matter what you need to have a plan. Iron condors are a dynamic risk strategy and if you can manage that risk, the profits will come flowing in.