Iron Cockroach Trade
XLE Iron Cockroach description and strategy
The strategy that I will chose for a bearish trade is one of Random Walk Trading's favorite strategies - The Iron Cockroach. The Iron Cockroach is a modified Iron Condor, where one side of the Iron Cockroach has more risk, or a wider spread than the other side. By making one side wider than the other, the Iron Cockroach structure is setup to reduce the risk to one side, in the direction of the wider spread. When picking the proper strikes for the Iron Cockroach, the trade should be setup for zero debit or a slight credit. The whole credit of the trade should be equal to, or greater than the width of the shorter spread. What? Clear as mud?
Here is my current open short term trade on the XLE, setup as an Iron Cockroach:
Sell 1 XLE DEC14 84 Call
But 1 XLE DEC 15 85.5 Call
Sell 1 XLE DEC14 80 Put
Buy 1 XLE DEC14 79.5 Put
Credit = $.55, Max Risk = $.95, Days to Expiration at the Open: 15 Days
In the risk graph below of this trade, you can see that the risk is to the upside, because the Call Spread is wider than the Put Spread. The width of the Put Spread is $.50, and by getting a credit of $.55, the trade is setup where if the XLE drops dramatically, the trade past the 79.5 Put strike, a profit of $5 will be realized at expiration. The maximum profit of $55 for this Iron Cockroach trade will occur between the 84 Call and 80 Put strike at expiration. The Iron Cockroach is an Options Strategy for high implied volatility, and will benefit from a crush in implied volatility. Due to the breakdown of crude oil and energy stocks, the implied volatility in the XLE has risen making the Iron Cockroach an ideal options strategy at this time.
To prevent losses that would occur on a directional market had one elected to do an iron butterfly instead. It is not as sexy to the naive trader, as a smaller profit may be received than had he done an iron condor, but like the Broken Wing Butterfly spread, the risk averse properties of the trade more than make up for a slightly smaller 'potential' profit. This strategy is ideal at support and/or resistance levels.