Last week, two October Iron Condors for Research in Motion (RIMM) were ranked first and second when completing a Platinum Channel Tool Condor Channel scan. The results were ranked by the probability that RIMM's price would be between the two breakevens for the trade, with the highest probability listed first. The second trade was reviewed, sacrificing a little on the probability side for a slightly better risk-reward position.

In addition to probability and risk-reward data, the scan results provide days to expiration and whether an earnings announcement(s) occurs during the period. That's a good thing; this quarter's earnings seemed to come up quickly. With RIMM's numbers due Thursday (9/24) after the close, it provided a great opportunity to monitor price and implied volatility conditions as earnings approaches.

After taking another look at the Sep 16 RIMM October Iron Condor (95-90c, 70-65p), the same scan was run after the close on Wed Sep 23. This week RIMM held the top three positions in the rankings and the third ranked iron condor will be viewed along with the one discussed last week. In terms of the scan, selecting the third ranked position means taking a slightly lower probability for the underlying to close between the breakevens at expiration, in order to have a slightly better risk-reward profile. Figure 1 provides the position, risk and Greek data for the new scan, a RIMM October Iron Condor (100-95c, 80-75p).


Figure 1: RIMM Oct Iron Condor (100-95c, 80-75p) using Condor Channel Tool Scan
click here for larger view

An iron condor is established for a credit and combines a bear call spread with a bull put spread. It generally is used to capture profits in sideways trading markets, depending upon the various strikes/spreads that are combined. In the 9-16 iron condor reviewed last week, a risk graph was displayed given the potential for continued sideways movement OR continued upward movement using the trend channel stress test option.

Figure 2 provides a current view of RIMM using Platinum's stock chart with the Stock Channel option selected for Chart Type. In addition, a channel stress test was run with all three directions selected (up, sideways, and down). This process draws the best channel for each over a 40 through 150 day period. In this case, a longer-term sideways channel and a short-term upward trending channel appear. Note that the former does actually have a slight upward slope.

Not surprisingly, the movement over the period has not been especially conducive for a reliable downward trending channel to emerge. Quick reminder, we all know that can change over a pretty fast period of time in the markets. Channels rely on future stock movement resembling that from the past-specifically the period of time when the channel was drawn.


Figure 2: Six-Month Channel Price Chart for RIMM after Stress Test

RIMM closed at 84.16 last week and slightly higher, at 85.77 on Wednesday 9-23 when this article is being written. It appears an upward bias is in place for the stock with price near the upper channel line of both channels. So what could cause problems for either position? Table 1 provides position information as of today's close to start that discussion.

*PoP: probability of profit

Table 1: RIMM Oct Iron Condors from Sep 16th and Sep 23rd Scans

What Could Go Wrong?

Ahh, if only I really asked that question every trade. In this instance, while both trades still look pretty good, the RIMM earnings report after the close could still throw a wrench in the either one. Really, any news that creates a situation where the underlying no longer moves in a similar manner to its recent past may create problems. Here's a top three list of things to consider:

1. What if there is a price shock throwing RIMM out of either channel
2. What if statistical volatility [SV] increases, similarly resulting in RIMM movement out of either channel, but taking a longer period of time for this to occur
3. What if implied volatility [IV] increases resulting in an unrealized net loss for the position.

To get to the heart of the matter, what factors could result in RIMM's price closing outside of the breakeven levels at expiration? The last item (#3) is only a problem if IV increases due to an increasing SV that results in RIMM moving outside either breakeven. In this example, IV plays a bigger role in position entry rather than exit since it will be a non-factor at expiration.

Stock price shocks have definitely resulted after an earnings report, so Figure 3 takes a sixteen month look at RIMM's 20-day SV with earnings dates noted. At the same time, anticipation of those shocks can increase IV in advance of expected news such as earnings or a Fed announcement. Figure 4 takes a sixteen month look at RIMM's 7-30 day IV with earnings dates noted.



Figure 3: Sixteen-Month Chart for RIMM 20-day SV with Earnings

In four of the five cases, SV increased immediately after the earnings report, three times significantly. It is reasonable to expect something similar this Friday, but it doesn't mean a trader can necessarily wait until then to see if price will likely remain in its channels going forward. By waiting for a day, looking for a better guarantee for the position, the trader could miss an opportunity-especially since there aren't any guarantees in the markets. One problem with this approach is that Figure 4 displays the opposite situation for IV. In four of five instances, IV dropped following earnings making the environment less favorable for credit positions such as an iron condor.

Traders who seek measured risks for measured rewards will have to decide whether this position is appropriate for them, as well as entry timing. In anticipation of increased SV, it is possible to see how this increase changes the probabilities picture by increasing the SV used in the probability of profit (PoP) calculation. Table 1 provides both the lower 20-day SV and the higher 90-day SV for RIMM, the latter of which results in lower, but reasonable PoP for both positions. Platinum users may also want to use the SV values based on the Figure 3.



Figure 4: Sixteen-Month Chart for RIMM 7-30 day IV with Earnings

You may also want to take a look at last week's article to see the original scan and risk graph data, as well as setting changes that were completed to see what would happen under less than optimal conditions for the position (see Analytical Toolbox: Platinum Channel Tool Scan by Strategy, 9/16/09).

To access other articles written by Clare White, please click here.

Clare White
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site
Questions for Clare? Visit the Optionetics.com Discussion Board