Simply put, an iron condor is a short strangle with long options that are purchased further out-of-the-money (OTM) to define your risk. Just like with a strangle, this is a great way to get exposure to stock without taking a directional position. It benefits from the passage of time and any decreases in implied volatility (IV). It’s also a way of potentially playing a non-movement and a volatility contraction going into earnings.
An iron condor is a directionally neutral, defined risk strategy that profits from a stock trading in a range through the expiration of the options. It benefits from the passage of time and any decreases in implied volatility.
An iron condor options strategy is nothing more than an OTM short put credit spread combined with an OTM short call credit spread sold at the same time and in the same expiration cycle. Iron condors are neutral strategies because the bullish nature of our short put spread is offset by the bearish nature of our short call spread. Both hedge each other, and benefit from expiring OTM.
An iron condor works just like a strangle. A short strangle is a position that is a neutral strategy that profits when the stock stays between the short strikes as time passes, as well as any decreases in implied volatility.
An iron condor uses four options at different strikes, making it a defined risk strangle:
The total option premium collected is $17.00 for selling the 450 put and the 550 call. While the total premium paid is $5.00 for buying the 600 call and 400 put. The net premium collected is $2.00; since you’ll collect $7.00 for the short options and paid $5.00 for the long options.
With this example, more option premium was collected from the short options than paid for the long options. This leaves you with a $12.00 net credit. ($17.00 - $5.00).
You’ll get a maximum profit if all options expire worthless and the iron condor’s value is $0.00 at expiration, which will happen if all options expire OTM. The maximum profit potential occurs at any price between $450.00 and $550.00, which is ±10% from the stock price at entry. The maximum profit potential is $1,200.00. This is calculated by the $12.00 net credit you’ll collect for selling the iron condor x 100 = $1,200.00 per iron condor sold if the value is $0.00.
The maximum loss for this trade is $3,800.00. This is calculated by the $50.00 wide max spread width (put and call spreads are the same width) - $12.00 net credit x 100 = $3,800.00 per iron condor sold.
The maximum loss potential will happen if the price is below $400.00 or above $600.00 at expiration, in 60 days (±20% stock price movement).
The lower breakeven price for this trade is $438.00. ($450.00 put strike - $11.38 iron condor credit = $438.62). The short $450.00 put will have $12.00 of intrinsic value at expiration, while all of the other iron condor options will have expired worthless. Leaving you with a trade of $12.00, the same amount you sold the iron condor for at the time of entering the trade, thus no profits or losses.
The upper breakeven price for this iron condor is $562.00. ($550.00 short call strike + $12.00 iron condor credit = $562.00). The $550.00 call option will have $12.00 of intrinsic value at expiration, while the put side will also expire worthless, exactly like with the lower breakeven.
We approach iron condors with similar entry tactics. We shoot for collecting 1/3rd the width of the strikes in premium upon trade entry. For example, if we have an iron condor with three point wide spreads, we will look to collect $1.00 for the trade. This gives us a probability of success around 67%, which is acceptable to us.
Much like other standard premium selling strategies, we close iron condors when we reach 50% of our max profit. This can increase our win rate over time, as we are taking risk off the table and locking in profits.
We manage iron condors by adjusting the untested side, or profitable side of the spread. We look to roll the untested spread closer to the stock price to collect more premium. We can go as far as rolling our untested spread to the same short strike as our tested spread, which creates an iron fly. Learn more about Iron Condor Management.
Iron condors are defined risk trades where the maximum loss and profit potential are capped. Max profit is capped at the credit received up front, and max loss is limited to the width of the widest spread being ITM at expiration, less the credit received, since our long options protect the risk in our short options if the spread moves ITM.
The maximum profit potential for an iron condor is the net credit received when constructing the four-leg options positions. Maximum profit is realized when the underlying settles between the short strikes of the trade at expiration, where all options expire worthless. Iron condor traders don’t need to hold the strategy to expiration though – if they see a 50% profit where the spread is trading for 50% of the credit received up front for example, they can close the trade by simply routing the opposite order or “buying back” the iron condor using the same strikes and same expiration cycle.
Net Credit Received
Maximum profit is realized when the underlying settles between the short strikes of the trade at expiration.
When selling options, you can use the credit received on trade entry to improve your breakevens. See the example above and how even if the short option moves ITM and takes on intrinsic value, we can offset that with the extrinsic value premium we collected up front to enter the trade and take the risk of being in it.
See how to calculate your breakevens with short options using the formula below:
Short Call Strike + Credit Received
Short Put Strike - Credit Received
Widest Spread - Credit Received
Maximum loss is realized when one credit spread is fully ITM at expiration - this results in the spread trading for maximum value against us (spread width), less the credit received up front.
A reverse iron condor, also known as a long iron condor, is a limited risk options strategy that is entered for a net debit. You can expect a profit when there’s volatility, and the price moves significantly in either direction. It’s the exact inverse of a regular iron condor where we collect a credit up front and we are betting against the movement of a stock, where we want our strikes to expire OTM. With a reverse iron condor, we pay a debit up front and we need one of the spreads to move ITM at expiration to potentially profit by selling out of the spread for a greater value than we paid for it up front
How to construct a reverse iron condor:
An iron condor is considered a strategy that can enhance your probability of success due to the fact that you can limit your risk, and you don’t need an underlying to move anywhere. It’s a high probability trading strategy and the likelihood of making money when selling an iron condor is typically greater than 50% when we sell spreads far OTM.
You’d use iron condor in a neutral bias stock market, where you think the implied volatility of the market is higher than the realized volatility you may see. When selling an iron condor, you are betting against the underlying moving past your short put or short call spread.
You can let an iron condor expire if all your options are OTM and worthless. You’ll keep all of the extrinsic value you collected upfront (minus commission) when selling the iron condor. If one of the strikes is close to moving ITM, we close the iron condor prior to expiration to avoid unwanted shares – if one strike slides ITM after the market closes, the short strike can be assigned, and you can be left with 100 shares or – 100 shares of stock. To avoid this, just close the trade prior to expiration.
You should take profit on an iron condor when you reach a profit target that you are shooting for. At tastytrade, we shoot for 50% of max profit for OTM credit trades like iron condors, since the more profit we see, the less we can make moving forward but we hold all the risk of the initial position plus the unrealized profit on the table. Closing winners early will increase your win rate over time, as you are taking risk off the table and locking in profits.
An iron condor is a lower risk options trading strategy than an iron butterfly because all strikes are far OTM with lower potential reward, while the iron butterfly is higher risk with higher reward due to the ATM nature of the strikes.
There is always risk with options trading, but an iron condor is one of the safer strategies since risk is defined upfront, and you control what that risk is on trade entry.
A reverse iron condor is a limited risk, limited profit options trading strategy that benefits from significant movement in the stocks’ price in any direction. You are betting on the stock moving past one of your put or call debit spreads by the expiration of the contracts:
It’s made up of:
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