Welcome back to the wrap-up of our first market condition. We are talking about the consolidation phase of the market. This sideways trending market has unique characteristics as all market phases do and this is why it is important that we are able to recognize these phases and trade accordingly. We have covered these conditions extensively to this point and we are also going through the best trades to use in each phase. We have gone through several different types of trades and we have come to the last of our short list. The trades we are referring to are the covered call, the naked put, the bull put and bear call spreads. This brings to our final trade that works quite well in a consolidation phase and that is the iron condor.
The iron condor is a combination of the bull put spread and the bear call spread. We are essentially placing a trade on the top and bottom of a range that we believe the equity or the index will remain in. This trade is unique in the fact that we are no longer looking for a direction but we are actually looking for a directionless trade. Our goal with this trade is to stay within the prescribed range and benefit from time decay of the options.
All the trades we have talked about in this phase have a few things in common. Those commonalities are that each one of these types of trade is considered cash flow trades which means that although we are looking at the direction of an equity or index we are more concerned with the flow of time as this is how these trades pay off. Another key difference of these trades is that we get paid to put them on and then wait to see what the outcome will be.
Last week we went over the bear call spread and looked at an equity that had hit resistance and pulled back. This trade draws a line in the sand of how far up an equity can go before it starts to become a negative for the trade. This is the upper limit of the iron condor or one of the wings of the condor. We drew the other line in the sand in the previous week’s blog when we did the bull put spread. In the case of the iron condor, the wings are done on the same equity with the same expiration.
We have a couple of mock trades on right now and in this weeks video we will go over them and we will look for an iron condor trade. We can trade iron condors on equities or indexes. One of the favorite iron condor trades is on the Russell 2000 index. This trade is a favorite because this index has a tendency to consolidate a lot of the time and this could be understood in this manner. If the index consists of 2000 individual equities and then is averaged out then adverse movements in a number of equities is smoothed out because of the large number of equities.
Check out the video and see the iron condor in action. In the next blog we are going to move onto the second phase of the market and that is the breakout to the trend. Many traders and investors alike salivate at new trends breaking out as they can ride the wave to profits. There are certain trades that can better take advantage of this new movement and we will cover them all.
Happy Independence Day to all our American friends. Trade well my friends.