Getting aggressive return on investment (ROI) in our self-directed individual retirement account (IRA) is a great enterprising and entertaining way of spending time instead of watching brain-less TV or brain-less chatting on social media. There are 168 hours in a week, and lets allocate 80 hours (2 x 40 hours in a work week) for a full-time day job. That still leaves another 88 hours at our disposal. Studying the market and putting in the ‘iron condor’ trade probably will take 4 hours or less.

While I (probably most of you too, if you are investing yourself) use the long term strategy of value investing (Warren Buffet’s way, for example) as the base strategy, I also use the short term strategy to get aggressive ROI on the risk capital using options strategy which the hedge fund managers and institutional traders and investors use. It is simply for the enterprising investor as opposed to the defensive (passive) investor as Ben Graham (father of value investing, Warren Buffet’s Guru) would classify.

The options are derivatives of the underlying stock. What makes them short term financial instruments is that they expire on a specific date. There are call options and put options. Either one of them can be bought or sold. When you buy an option you have the right to buy (if it is a call) or sell (if it is a put) your stocks at the strike price on or before the expiration date. When you sell an option you have the obligation to sell (if it is a call) or buy (if it is a put) stocks at the strike price on or before the expiration date. Confusing? Yes, it is. It is extremely important to be very clear on these concepts before attempting even a paper trade using advanced options strategy like the “Iron Condor.”

“Iron Condor” is a combination of two credit spreads. One a call vertical spread and the other a put vertical spread. The vertical spreads in turn comprise a call/put option that is sold and a call/put option that is bought as a hedge to limit the risk capital which is nothing but the difference between the two option strikes prices (for the short iron condor). It is an iron clad strategy with the two wings’ strike prices straddling the current stock price, hence the name “Iron Condor”. It could be set up as either long (buy) or short (sell) depending upon the market condition and the net premium will be a debit or a credit respectively.
Setting up of the “Iron Condor” combo option strategy requires familiarity with advanced options as you might have sensed by now.

1 contract Option trade controls 100 Stocks. There position is highly leveraged and therefore it is a double edged sword.

If you don’t know what you are doing your head will be handed out to you as the experts always warned us!

If you do know what you are doing you can rake in Millions! Well, for the small investor, thousands!
The advantage in setting up this combo strategy (considered as one trade instead of 4 separate ones, so the commission to the broker is reduced) is that it limits the risk capital you put up at the expense of limiting your gain. It is a conservative play. So, going in to the trade one knows exactly how much of the portfolio one is risking and also how much return on risk capital one is getting. So, no surprises. However, as the underlying stock starts moving down or up (it is hard to predict and that is what makes investing interesting) one can change the strategy either to maximize the gain or to minimize the risk as the case may be.

How does one set up a long Iron Condor options trade?

It is a long (buy the option for the right) strangle with a broader short (sell the option to be obligated) strangle to hedge (minimize the risk capital) the long position and also to minimize the initial debit premium. It is also construed as two long credit spreads combo trade. (can’t avoid the Wall Street gibberish)

Here is an execution real time with real money

The earnings announcement for GMCR (Green Mountain Coffee Roasters, Inc.) was on Nov 20, 2013. I knew that based on the negativity (short position held David Einhorn, hedge fund manager, expired patents for k-cup, etc.) the stock was beaten down from $89 to below $60 on Nov 12, 2013. So, I was somewhat sure that he stock was going to make a big move on the next day of the earnings announcement (Nov 20, 2013)  one way or the other,  so I set up this long iron condor as follows on Nov 12, 2013.
I bought 1 contract that controls 100 shares of GMCR ($65 X 100 = $6500 worth of shares but only paying $3.40 x 100 = $340; good deal, right?)

BTO (buy to open) 65 Dec 21 2013 Call   – $3.40 (means I am buying a call option expiring on Dec 21, 2013, the strike price being $65 for the underlying stock and the premium I have to pay is $3.40 per share)

Stock Price on Nov 12, 2013 ~ $60.00

BTO (buy to open) 55 Dec 21 2013 Put    – $3.45

STO (sell to open) 67.5 Dec 21 2013 Call +$2.56
STO 52.5 Dec 21 2013 Put  +$2.57

Net debit = $1.72  = Risk Capital

Max ROI = Return on Risk Capital / Risk Capital = (($67.5 – $65) – $1.72 )  / $1.72 = 45. 3%

The return on risk capital is the difference in the strike prices which is ($67.5 – $65) or ($55 – $52.5)

Annualized ROI = (365/39) * 45.3 = 424% (39 days trade!)
As expected the stock jumped from $60 to $74 on the next day of the stellar earning announcement that smashed all the analyst expectations and closed around $71.

Realizing the good news, I wanted to swing for the fences.

I bought back the (BTC $67.5 Dec 21 Call) Call for $4.20 so that I held only the long position, $65 Dec 21, 2013 Call. My risk capital increased from $1.72 to ($1.72+$4.20). On Dec 16, 2013, when the stock was trading near $74 and rising, I sold the $65 call for $9.0. I did not wait till Friday, the expiration date, Dec 21, 2013. On Dec 21, 2013, the option was around $12. I was not greedy and that is good thing because I could have sold on expiration day and could have made $12 instead of $9.

Final ROI = (9.0 – 4.20 – 1.72) / (1.72 + 4.20) = 52%

Annualized ROI = (365/39) * 52 = 486.66%

The gain (return on risk capital) went from $0.78 to $3.08 per share, ~ 395% increase! quadrupled !

This means I made $308 instead of $78 which was the default plan on 1 contract. Had it been 10 contracts the gain would have been $3080 in 39 days!

Return on Investment annualized 487% !!! (could have been 961% had I sold on expiration day at $12)

This trade sequence demonstrates how the trader has the flexibility to alter the position and gain significantly in the same amount of time originally envisaged.

That is where lies the power of options trading.