Welcome to my weekly column with International Business Times.
One of the things stock traders cannot stand is having their stocks trade within a tight sideways price range for months. Yes, holding a position for months without any profits can be one of the most painful experience stock traders go through.
One such stock is Yum! Brands inc. trading under the stock symbol YUM.
Yum! Brands inc. is the proud owner of famous international fast food restaurants such as Kentucky Fried Chicken, Pizza Hut and Taco Bell. In fact, Yum! Brands inc. earnings have beaten estimates through the recession to become one of the almost recession beating business of the world. Indeed, fast food is in demand recession or not. In fact, YUM is also one of those few stocks that have recovered to its pre-recession 2007 levels within just half a year into 2009.
However, YUM seem to have hit a strong resistance level ever since and has been trading within a tight price range of about $36 to $33 since April 2009. Yes, even great earning stocks hit such frustrating stagnant levels sometimes. So, what can options traders do about it?
This is where the famous Iron Condor Spread options trading strategy comes into play.
The Iron Condor Spread is an options strategy that is designed to generate a profit when a stock is trading within a tight and generally predictable sideways price channel. It is a complex neutral options strategy involving 4 legs (trades) to establish and set up as a credit spread. As a credit spread, you actually gain money for putting on the position rather than pay for the position! Ok, there is no free lunch in this world and all credit spreads require a significant amount of money as collateral in your trading account known as margin. As a credit spread, you also want the position to resolve as quickly as possible while still maintaining a reasonable profit potential.
So, how do we do an Iron Condor Spread on YUM?
Since we expect YUM to continue trading with a price channel of $36 to $33, we can establish a November 32/33/36/37 Iron Condor Spread. This involves writing the Nov36Call and the Nov33Put and buying the Nov37Call and Nov32Put. Based on last Friday's (Sep 30) end of day price quotes, the net effect of this position is: ($0.40 + $1.50) - ($0.30 + $1.15) = $0.45 x 100 = $45. Yes, you get $45 credited into your trading account (before commissions) when you put this position on! There is no need to pay anything for it. This is what is known as a credit spread in options trading.
So, how might this position work out?
If YUM remains within the price range of $36 to $33, all the options bought and written expires out of the money and you keep the $45 credited into your trading account right from the start as profit.
If YUM should stage a sudden rally or drop, your maximum loss is limited to $55. This means that instead of making $45, you would pay $55 to close out the position. In order to prevent this from happening, the position could be closed at its upper or lower breakeven points, incurring only the commissions involved as loss.
For more detailed calculations, please read my free tutorial on the Iron Condor Spread athttp://www.optiontradingpedia.com/free_iron_condor_spread.htm . Learn everything about Options Trading atOptiontradingpedia.com.
Disclaimer : Neither I nor Masters 'O' Equity or Optiontradingpedia.com and any of the staff, own any shares in YUM nor hold the above mentioned options trading position. The above article uses closing prices on 2nd October 2009. Actual prices on Monday opening may differ. This article is for education purpose only and should not be taken as individual investment recommendation. Options trading is not suitable for everyone and advise should be sought from your local financial adviser.