What is an iron condor? And how could this options trade work out in a blue chip such as UnitedHealth?
UNH appears stuck in a trading range between 450 and 500. That could mean it is a good time for an iron condor option trade. Implied volatility is hitting a 12-month high due to broad market nervousness.
High volatility means iron condors become more attractive as option premiums increase.
When volatility is high, the iron condor can be placed further out of the money, giving the trade a higher chance at success.
What Is An Iron Condor? Setting Up The Trade
Let's look at an example using UNH stock.
As a reminder, an iron condor combines a bull put spread and a bear call spread. The idea with the trade: Profit from time decay while expecting that the stock will not move too much in either direction.
First, we take the bull put spread. Using the April 14 expiry, we could sell the 430 monthly put option and buy the 420 put. That spread could have been sold Tuesday for around $1.40 a share. Then consider the bear call spread; sell the 510 call and buy the 520 call; on Tuesday, this spread sold for around $1.75.
In total, the iron condor will generate around $3.15 per contract, or $315 of premium received for a block of 100 shares.
The profit zone ranges between 426.85 and 513.15. Calculate this by taking the short strikes and adding or subtracting the premium received.
As both spreads are $10 wide, the maximum risk in the trade is 10 – 3.15 x 100 = $685. Therefore, if we take the premium ($315) divided by the maximum risk ($685), this iron condor trade has the potential to return 46%.
If price action stabilizes, then iron condors will work well.
Managing Risk
One way to set a stop loss for an iron condor is based on the premium received. In this case, we received $315, so we could set a stop loss equal to the premium, or a loss of around $315. Another way to manage the trade? Try setting a point on the chart where the trade will be adjusted or closed. That could be around 440 on the downside and 500 on the upside.
According to the IBD Stock Checkup, UNH stock ranks number 4 in its group and has a Composite Rating of 94, an EPS Rating of 95 and a Relative Strength Rating of 91.
Please remember that options are risky, and investors can lose 100% of their investment.
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.
