Expert: Mark Hodge - 7/11/2008

Question
I have two questions. First, different brokers have different margin requirements for selling options. With that in mind, since the broker controls the margin amount, can brokers sell options without margin?
Also, there is an option strategy called the Iron Condor spread where one buys and option while simultaniously selling another options. I was told that with this strategy, the risk is only the amount you use to buy one of the two options. My second question is, how could that be the only risk? What if the option that was sold is exercised? Since there is nothing to cover it, wouldn't that be a risk?

Answer
Hello Frankie,

I apologize for the delay but was traveling. I'm not quite clear on your question about brokers selling options, but market makers and institutional traders typically have more lenient requirements. You might want to take a look at the CBOE website for more information:

www.cboe.com

As far as an Iron Condor goes, you basically initial two credit spreads. Example

Stock is at 50

Buy 60 call for $1.00
Sell 55 call for $3.00
Sell 45 put for $3.00
Buy 40 put for $1.00

If you look above, you will see that you will receive a $2 credit for the calls and a $2 credit for the puts, for a total credit of $4.00. You would be able to keep that ENTIRE credit if the price at expiration was anywhere between 45 and 55.

In this example the risk is going to be the difference between the strikes (60-55=5) minus the credit. So you would have a max profit of $4 and max risk of $1. Now these numbers are a little inflated but you get the idea.

If you are trading a Long Iron Condor, you would be BUYING the strikes inside nearest the stock price, and selling the OTM call and put, essentially putting on two debit spreads. IF the price closes OUTSIDE of of the strike you bought, plus the debit, you would be making money. Your profit would be capped by the the options you sold though, so the max risk would be the amount you are paying.

Example: If you are long a 55 Call and sold the 60 call, your upper breakeven would be the 55 strike PLUS the debit for the Long Iron Condor.

Happy Trading!
Mark