Iron Condors Explained

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Iron Condors Explained

Iron Condors are defined risk strategies with two break-even-points. They are one of the most commonly used option strategies.

Video Breakdown:

Short Iron Condor Strategy

Market Assumption:

When trading Short Iron Condors you should have a neutral/range bound market assumption. This means you hope for relatively small or no move at all in the underlying. Short Iron Condors can be very slim (just a few strikes apart) or very wide (far apart strikes) depending on your assumption. Many people including me use Short Iron Condors with two high probability strikes as a high probability strategy.

Setup:

  • Buy 1 OTM Put
  • Sell 1 OTM Put (higher strike)
  • Sell 1 OTM Call
  • Buy 1 OTM Call (higher strike)

This should result in a credit (You get paid to open).

Profit and Loss:

As you can see on the payoff-diagram a Short Iron Condor isn’t just a defined risk trade, but also a defined profit trade. The maximum profit is achieved when the underlying price is somewhere between the two short strikes. The maximum loss occurs when the price is anywhere outside of the two long strikes. It doesn’t matter if the price is $10 or $100 outside of the profitable range because the two long options on both sides act as a hedge. The maximum loss is higher than the maximum profit.

Maximum Profit: Premium received – Commissions

Ex. $20 Premium – $3 Commission = $17 (max profit)

Maximum Loss: Width of Call Strikes * 100 – Premium Received + Commissions Paid

Ex. (Call Strikes: 50 and 52) => $2 Width * 100 – $20 Premium + $3 Commissions = $183 (max loss)

(a normal option contract controls 100 shares, therefore *100)

Implied Volatility and Time Decay:

A Short Iron Condor profits from a drop in Implied Volatility (IV), because the options sold then lose value. Therefore, it is best to use this strategy in times of high IV (IV rank over 50).

Time Decay also works in favor of this strategy. The more time goes by the more the sold options lose in their extrinsic value. The time decay for each day increases the closer you get to expiration.

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Long Iron Condor Strategy/Reverse Iron Condor

Market Assumption:

When trading a Long Iron Condor (aka. Reverse Iron Condor) you would expect a relatively big move in a short period of time, but you don’t quite know in which direction this move will be. The bigger a move you expect, the further the long strikes have to be apart. This strategy isn’t used that often but can be quite profitable when used correctly. But keep in mind it is much harder to predict an unusual big move than predicting something to stay range-bound.

Setup:

  • Sell 1 OTM Put
  • Buy 1 OTM Put (higher strike)
  • Buy 1 OTM Call
  • Sell 1 OTM Call (higher strike)

This should result in a Debit (You pay to open)

Profit and Loss:

This also is a defined risk/profit strategy. Maximum profit is achieved when the price of the underlying asset moves further than one of the short positions. It doesn’t matter if it’s above the highest strike or below the lowest. Maximum loss, on the other hand, occurs when the price stays at the same position or just moves a little (stays between the two long options). For long Iron Condors, the max profit exceeds the max loss.

Maximum Profit: Width of Call Strikes * 100 – Premium Paid + Commissions Paid

Ex. (Call Strikes: 50 and 52) => $2 Width * 100 – $20 Premium + $3 Commissions = $183 (max profit)

Maximum Loss: Premium paid + Commissions

Ex. $17 paid to open + $3 commission = $20 (max loss)

Implied Volatility and Time Decay:

Just like in the other categories a Long Iron Condor also here is just the opposite of a Short Iron Condor. It profits from a rise in IV, therefore should be bought in times with relatively low IV (IV rank under 50).

Time decay works against a Long Iron Condor because the Long options lose a bit of value every day. They lose more and more value the closer you get to expiration.

Trader’s Note:

Iron Condors are a very useful, popular and profitable option strategy. Together with Credit Spreads, Short Iron Condors make up the easiest and best strategies for high probability trading. Short Iron Condors are a range bound strategy, profiting from no or small moves in the underlying price. If you set your strikes out far enough, these spreads will have a high chance of being profitable. The further you go OTM with your strikes, the higher your probability of success will become. But your max loss will rise and your max profit will decrease. When used correctly, Iron Condors can be very profitable and that is the reason why I use them and do recommend them in my training as well (check out my training here).

A Long Iron Condor, on the other hand, is more of a directional strategy. Even though it is not bullish or bearish, it needs the price to move to be profitable. You don’t care in which direction as long as the price moves far enough. Long Iron Condors are best used in times where a big move may stand ahead, but it is unclear in which direction this move will be. This could be the case for special events like earnings, elections, referendums, big market announcements… The further you set your strikes away from the underlying trading price, the lower your probability of profit will become, but your profit potential will rise.

How To Set Up Iron Condors In A Broker Platform:

You Can Read More About Tastyworks By Reading My Tastyworks Review here!

9 Replies to “Iron Condors Explained”

Wow!! I have traded stocks before and have never understood this. That was explained very well. I will be watching your sight in the near future to understand it better. Thanks for sharing this knowledge

Hey Kim,
So so glad that you are learning more and enjoying my site.

So I see the iron condor is a strategy that involves the combination of two vertical spreads. So in the case of a short iron condor, rather than saying that you believe a stock will move in a direction, are we saying that we think the stock will stay within certain upper and lower limits? And visa versa for the long? Rather than stay in a range, we want it to go up or down. Either one would be fine, right? What kind of probabilities are you shooting for when you apply an iron condor?

Thank you for your help!

That is correct. The short iron condor is a range bound strategy, whereas the long iron condor is a price indifferent strategy (you don’t care where the price moves, as long as it moves). I only trade short iron condors and usually aim at a probability of ITM of 70%.

I like it! Thanks for being responsive to comments as well. So a 70% probability of being in the money. How many days until expiration do you usually like to sell at? Do you stick with monthly or do you use weeklies?

Hey once again,
I normally stick to monthly contracts and enter iron condors around 30 days before expiration. But I actually trade much more credit spreads than iron condors. If you want to learn my entire option strategy (option premium selling), you could also check out my intermediate course here. In there I thourougly explain how I make money with options.
If you have any further questions, I would be happy to answer them.

Glad found your website here to learn option. Do u think to trade Iron Condor we should find 30% Prob ITM instead of 70% Prob ITM as taught by Sky View Trading?. Please help me to explain this.Thanks.

Hi Harry,
Thanks for your question. I recommend focusing on the probability of profit (POP) instead of the probability of ITM. The probability of profit tells you what the probability of actually making money is, whereas the probability of ITM doesn’t. Your overall POP on a short Iron condor should ideally be over 50%.
I recently wrote an entire article about the different options trading probabilities. So make sure to check that out for a more detailed explanation of all the different probabilities.
Hopefully, this helps. Please let me know if you have any other (follow-up) questions or comments).

Glad I found your website to lear Option. hmmm do you think we should find 30% Prob ITM instead of 70% Prob ITM taught by Sky View Trading. Please help me explain about this.Thanks

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The Iron Condor

You may have heard about iron condors, a popular option strategy used by professional money managers and individual investors. Let’s begin by discussing what an iron condor is, and then how you can benefit from learning how to trade them.

What Is an Iron Condor?
An iron condor is an options strategy that involves four different contracts. Some of the key features of the strategy include:

  • An iron condor spread is constructed by selling one call spread and one put spread (same expiration day) on the same underlying instrument.
  • All four options are typically out-of-the-money (although it is not a strict requirement).
  • The call spread and put spread are of equal width. Thus, if the strike prices of the two call options are 10 points apart, then the two puts should also be 10 points apart. Note that it doesn’t matter how far apart the calls and puts are from each other.
  • Most often, the underlying asset is one of the broad-based market indexes, such as SPX, NDX or RUT. But many investors choose to own iron condor positions on individual stocks or smaller indexes.
  • When you sell the call and put spreads, you are buying the iron condor. The cash collected represents the maximum profit for the position.
  • It represents a ‘market neutral’ trade, meaning there is no inherent bullish or bearish bias.

Iron Condor Positions, Step by Step

To illustrate the necessary components or steps in buying an iron condor, take the following two hypothetical examples:

To buy 10 XYZ Oct 85/95/110/120 iron condors:

  • Sell 10 XYZ Oct 110 calls
  • Buy 10 XYZ Oct 120 calls
  • Sell 10 XYZ Oct 95 puts
  • Buy 10 XYZ Oct 85 puts

To buy three ABCD Feb 700/720/820/840 iron condors:

  • Sell three ABCD Feb 820 calls
  • Buy three ABCD Feb 840 calls
  • Sell three ABCD Feb 720 puts
  • Buy three ABCD Feb 700 puts

How Do Iron Condors Make/Lose Money?

When you own an iron condor, it’s your hope that the underlying index or security remains in a relatively narrow trading range from the time you open the position until the options expire. When expiration arrives, if all options are out-of-the-money, they expire devoid of worth and you keep every penny (minus commissions) you collected when buying the iron condor. Don’t expect that ideal situation to occur every time, but it will happen.

Sometimes it’s preferable to sacrifice the last few nickels or dimes of potential profit and close the position before expiration arrives. This allows you to lock in a good profit and eliminate the risk of losses. The ability to manage risk is an essential skill for all traders, especially ones employing this strategy.

The markets are not always so accommodating, and the prices of underlying indexes or securities can be volatile. When that happens, the underlying asset (XYZ or ABCD in the previous examples) may undergo a significant price change. Because that’s not good for your position (or pocketbook), there are two important pieces of information you must understand:

  • How much you can lose; and
  • What you can do when the market misbehaves.

Maximum Loss Potential

When you sell 10-point spreads (as with XYZ), the worst-case scenario occurs when XYZ moves so far that both calls or puts are in the money (XYZ is above 120 or below 85) when expiration arrives. In that scenario, the spread is worth the maximum amount, or 100 times the difference between the strike prices. In this example, that’s 100 x $10 = $1,000.

Because you purchased 10 iron condors, the worst that can happen is that you are forced to pay $10,000 to cover (close) the position. If the stock continues to move further, it won’t affect you further. The fact that you own the 120 call (or 85 put) protects you from further losses because the spread can never be worth more than the difference between the strikes.

Loss Buffer in Premiums

There’s some better news: Remember, you collect a cash premium when buying the position, and that cushions losses. Assume you collect $250 for each iron condor. Subtract that $250 from the $1,000 maximum, and the result represents the most you can lose per iron condor. That’s $750 in this example.

Note: If you continue to hold the position until the options expire, you can only lose money on either the call spread or the put spread; they cannot both be in-the-money at the same time.

Depending on which options (and underlying assets) you choose to buy and sell, a few different circumstances can come about:

  • The probability of loss can be reduced, but reward potential is also reduced (choose further out-of-the-money options).
  • Reward potential can be increased, but the probability of earning that reward is reduced (choose options that are less far out-of-the-money).
  • Finding options that fit your comfort zone may involve a bit of trial and error. Stick with indexes or sectors that you understand very well.

Introduction to Risk Management

The iron condor may be a limited-risk strategy, but that doesn’t mean you should do nothing and watch your money disappear when things don’t go your way. Although it’s important to your long-term success to understand how to manage risk when trading iron condors, a thorough discussion of risk management is beyond the scope of this article.

Just as you don’t always earn the maximum profit when the trade is profitable (because you close before expiration), you often lose less than the maximum when the position moves against you. There are several reasons that this might occur:

  • You may decide to close early to prevent larger losses.
  • XYZ may reverse direction, allowing you to earn the maximum profit.
  • XYZ may not move all the way to 120. If XYZ’s price at expiration (settlement price) is 112, then the 110 call is in-the-money by two points and is worth only $200. When you buy back that option (the other three options expire without worth), you may still have earned a small profit – $50 in this scenario.

Practice Trading in a Paper-Trading Account

If this strategy sounds appealing, consider opening a paper-trading account with your broker, even if you are an experienced trader. The idea is to gain experience without placing any money at risk. Choose two or three different underlying assets, or choose a single one using different expiration months and strike prices. You’ll see how different iron condor positions perform as time passes and markets move.

The major objective of paper trading is to discover whether iron condors suit you and your trading style. It’s important to own positions within your comfort zone. When the risk and reward of a position allow you to be worry-free, that’s ideal. When your comfort zone is violated, it’s time to modify your portfolio to eliminate the positions that concern you.

Summary

Iron condors allow you to invest in the stock market with a neutral bias, something that many traders find quite comfortable. This options strategy also allows you to own positions with limited risk and a high probability of success.

Iron Condor Explained

Iron condor. That might sound like a term that belongs in a World War II documentary, but it’s actually a very effective options trading strategy. With an iron condor, you utilize four different options contracts, or legs, to profit off of relatively stable stock prices. This is a bit different from most investment strategies, which typically rely on asset prices moving up or down. For investors, however, the ability to generate returns off of stable markets, or sideways prices movements as they are often called, adds yet another tool to the investing tool box.

The Risks & Benefits of the Iron Condor Explained

As with all investments, there are risks with the iron condor trading strategy. When you break down the probabilities, there is a high probability of the iron condor being profitable when markets are trending flat. However, you will have to risk a relatively large amount of money in order to secure a comparatively small profit. Before making any investments, it’s important to understand the risk profiles of that investment.

That being said, the iron condor trading strategy is relatively easy to implement and the chance of producing a profit can be relatively high. Iron condors are “credit” options, which means you will be paid money up front. However, you are exposed to long-term risks and could have to pay out more money than what you put it (more on that later). So how does iron condor work? Lets explain.

The Nuts & Bolts of Iron Condor Explained

An iron condor uses two vertical spreads for more on vertical spreads CLICK HERE, and four options contracts with four different strike prices. Let’s use a fictional stock, ACME Computers to illustrate. And let’s assume that ACME is currently trading for $43 dollars a share at the beginning of September. You believe stock prices are going to remain stable over the next several weeks, and so you decide to set up an iron condor to profit off of that stability.

You are going to set up two vertical spreads. First, you are going to create a put spread by selling a put option, and then buying another put option with a lower strike price. Next, you are going to create a call spread by selling a call option, and buying another call at a higher strike price. This will create the four legs needed to set up an iron condor. With most brokers you can place both legs of this trade at the same time.

Remember, ACME is currently trading for $43. Let’s say you sell a put at $45 and buy another put at $40. Then you sell a call at $50 and buy a call at $55. You’re making these trades in early September with an expiration date in October (meaning, the Saturday following the third Friday of October). Thus, you have four legs to your Iron Condor as such (numbers fictionalized):

Buy 10 ACME Oct $55 calls at $.50

Sell 10 ACME Oct $50 calls at $ 1

Sell 10 ACME Oct $45 puts at $1

Buy 10 ACME Oct $40 puts $ .50

So what does that mean in actual numbers? Let’s break it down.

Breaking Down an Iron Condor Trade

Keep in mind that options are bought and sold in batches of 100, meaning one option represents 100 share of the underlying asset. First, you sell 10 ACME $50 calls at $1 a stock, getting $1000 dollars. Then you buy 10 ACME $55 calls at $0.50 cents a share, thus giving you a credit of $500 dollars. You do the same with the put options; sell 10 ACME $45 puts at $1.00, and buy 10 ACME $40 puts at $0.50. Between the calls and puts, you end up with with a $1,000 credit (meaning $1,000 cash in your account). Ideally, ACME will stay somewhere between $45 and $50. If this happens, the options all expire worthless, and you get to keep the full $1,000 credit. This is your maximum profit potential.

Your maximum losses are determined by the differences in strike prices, which in this case is $5. At a maximum, you could be on the hook for $5 x the total number of shares, which in this case is 1,000 (10 option contracts @ 100 shares per contract). This means your total risk is $5,000. Risks won’t exceed this because the options you bought (versus sold) will cover any losses that would exceed it. So, if ACME jumps to $60 dollars, you’d exercise your call options to buy ACME at $55 per share. Likewise, if ACME fell to $35 dollars, you’d exercise your put options to sell the shares at $40.

In this way, the iron condor limits your exposure. However, it’s important to remember that you are risking up to $5,000 dollars in order to secure a profit of $1,000. On top of this, you will also have to pay commissions for each contract, which must then be added to your losses, or subtracted from your gains. Still, when markets are stable, the iron condor offers a great way to produce profits off of that stability.

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