Looking for strength in sectors that are likely to perform this year, I suspect energy has some real traction in the future. Given the big move up this week in Constellation Energy, it may be worth investigating a short iron condor trade in Constellation Energy stock.
However, the run-up we have seen over the last 24 months might suggest we are due for a bit of consolidation. Therefore, Constellation Energy stock is my choice today. Choosing the short iron condor in expectation of "price consolidation" seems logical.
Markets continue to uptick in intraday volatility, but from a wide-angle lens weekly charts show we are stuck in ranges. This is very likely due to big money waiting to see what kinds of bills come onto the U.S. political landscape that will determine what kind of motion we see in prices.
When we position with short iron condors, we attempt to collect time decay while a stock forms a base on its chart, or settles into a new direction. As always, we assume that we don't know the direction but are able to estimate the magnitude of the move using the ATR (average true range, as measured on the weekly chart as this trade's time frame, is under 40 days).
I also use the option chains and the stated implied moves that market makers have priced into the move over the time during the position.
Let's see how a short iron condor gets set up.
Why Constellation Energy Stock Is Soaring On This Huge Acquisition
Constellation Energy Stock: Short Iron Condor
The trade consists of two spreads: a short call spread and a short put spread. This defines the range of motion that we estimate the price action will not exceed.
- Sell to open one CEG Feb. 21-expiring call with a 310 strike price
- Buy to open one CEG Feb. 21 320 call
- Sell to open one CEG Feb. 21 230 put
- Buy to open one CEG Feb. 21 220 put
Based on Friday afternoon trading, the credit received in Constellation Energy stock comes out to $4.40 per set of put options. So, $440 serves as the maximum profit we could collect overall.
With this kind of position, we collect a premium and as this premium erodes, we collect revenue from the position. I like to collect a minimum of 20% of the range of the strikes to make the trade worthwhile.
Risk Vs. Reward
Calculate maximum risk by taking the distance between strikes (both at $10 for calls and puts) at $10 minus credit collected ($4.40), or $5.60.
Why take a trade where the risk is often more than twice the size of the reward? The probability of the short iron condor with strikes further out of the money (meaning further away from the price of the stock currently) potentially returning gains is often as much as six times more likely than the long iron condor, at least in this specific example for Constellation Energy stock.
Trading on the side of probabilities, rather than the possibility of outsize gains, is the way most traders who sell options as their primary revenue generation go. Lean on the law of large numbers, or what happens over the long haul.
Defending The Trade
Price patterns in Constellation Energy stock tend to show an initial move, then a period of consolidation after earnings news. This has certainly been the case since the last earnings event. With the next earnings date estimated on Feb. 21, we could consider closing the trade before an earnings risk surprise catches us at either of the short strikes.
Also, this trade holds inside current areas of congestion, related to upside support and downside resistance in price. So, if we use the recent past as a guide of future price movement, we expect Constellation Energy stock to trade in a range, below our near-term highs and above our near-term lows.
Three Choices
This strategy results in three choices to exit the trade. One, buy back the iron condor once it gets to an acceptable profit margin for you. I customarily look for 30%-to-60% profit for these kinds of trades in the current environment of volatility. Two, buy back the iron condor once it hits a loss threshold as determined by personal risk. I customarily look at about 65%, although depending on my size, I will choose 50%.
Finally, we could buy back the spreads into the week before expiration, if all is going well and we have decided to hold the trade closer to the end of expiration. But I have had many a trade go sideways, taking it down to the wire and not capturing gains. So I do not advise this.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can find her on X at @AnneMarieTrades
