Iron Condor Options Strategy
What is an Iron Condor?
An iron condor is an options structure that involves simultaneously buying or selling an out of the money (OTM) call spread and an out of the money put spread all with the same expiry. The goal of a short iron condor is for price to remain range bound and allow premium to decay in our favor with both spreads expiring worthless. The goal of a long iron condor is for price to move out of a given range in either direction and for one of the spreads to expire fully in the money. Before we can understand how an iron condor works we first must understand how a vertical spread works.
Below is an example of both a short and long iron condor. Both strategies are neutral and have no directional bias.
Short Iron Condor
For the example below let’s assume SPY stock price is currently at $430 per share.
Short Call Spread + Short Put Spread:
- Sell 1 SPY 435C & Buy 1 SPY 440C spread = +$.75 credit
- Sell 1 SPY 425P & Buy 1 SPY 420P spread = +$.75 credit
- Total Risk: $3.5 (width of spread minus total credit collected)
- Max Gain (potential): $1.5
This trade reaches maximum profit if SPY is below 435 (short call) and above 425 (short put) at expiration. This trade will break even if SPY closes exactly at 436.5 (short call + premium collected) or 423.5 (short put – premium collected) at expiration. Max loss is realized at expiration if SPY closes above 436.5 or below 423.5 at expiration.
This strategy looks to capitalize on rangebound price action and/or a reduction in implied volatility. It is a positive theta position that profits as the options contracts lose value over time. The trade can be closed at anytime and does not need to be held through expiration in order to book gains or losses. The main risk to a short iron condor position is a price expansion beyond the short call/put. However being long the further OTM strike does limit losses in that scenario. The ideal scenario for a short condor is for price to remain between the short strikes and for volatility to decrease allowing theta and vega to work in the trader’s favor.
Long Iron Condor
For the example below let’s assume SPY stock price is currently at $420 per share.
Long Call Spread + Long Put Spread:
- Buy 1 SPY 430C & Sell 1 SPY 440C = -$1.5 debit
- Buy 1 SPY 410P & Sell 1 SPY 400P = -$1.5 debit
- Total Risk: $3
- Max Gain (potential): $7 (width of spread minus total debit)
This trade is profitable if SPY is above 433 (long call + total debit) or below 407 (long put – total debit) at expiration. This trade will break even if SPY closes exactly at 433 or 407 at expiration. Max loss is realized at expiration if SPY closes below 433 or above 407 at expiration.
This strategy looks to capitalize on price expansion and/or a rise in implied volatility. It is a negative theta position so it’s critical to have a move in the delta to offset said theta decay just as a normal long premium position would imply. The benefit of a long condor is it does not require a trader to be correct in direction (up or down) as long as a big enough move occurs the trade will profit. The trade can be closed at anytime and does not need to be held through expiration in order to book gains or losses. The main risk to a long iron condor is if price remains stagnant and between the long call/put and if volatility declines. The ideal scenario for a long condor is for price to expand either up or down beyond the long strike and for volatility to rise.
Frequently Asked Questions
Do I need to own 100 shares of stock to sell a call or have the cash equivalent to sell a put?
No, if we sell a particular strike and buy a further OTM strike we are essentially capping our risk. Same goes for if we are long a certain strike and sell a further OTM strike. In both scenarios our losses are limited by the long strike and likewise our gain potential. The long strike protects the position and removes the need to have stock or cash as a hedge.
Are iron condors profitable?
Iron condors can be profitable depending on the movement of the underlying asset and the trader’s ability to accurately predict these movements. However, like all trading strategies, they come with risks and the potential for losses, especially if the market does not move as anticipated.