What are Iron Condors?

An iron condor is an options trading strategy that utilizes a put spread and a call spread, and one in which the trader option positions with four different strike prices, all having the same expiration dates/times. From this definition of the iron condor and the fact that there are four different strike prices make it a form of vertical spread just like the butterfly spread.

There are two forms of the iron condor:

a)      Long iron condor: the outer strike prices (1st and 4th) are in long positions while the inner strike prices (2nd and 3rd) are in short positions.

b)      Short iron condor: the outer strike prices (1st and 4th) are in short positions while the inner strike prices (2nd and 3rd) are in long positions.

In the iron condor, there are always two call spreads and two put spreads. There is no lopsidedness in the number of call or put spreads.

The iron condor is used when the trader is neither bullish nor bearish on the future price movement of the underlying asset in which the option contract is held. Such outlook is usually held when there is low volatility on the asset, or when the asset is in a tight, consolidated range of price movement.

Trade Example

For this trade example, we have a stock XY, which is trading at $45 a share. The trader will place the iron condor options contract as follows:

–          Long 1 XY 35 Put @ $0.50 per share ($50)

–          Short 1 XY 40 Put @ $1.00 per share ($100)

–          Short 1 XY 50 Call @ $1.00 per share ($100)

–          Long 1 XY 55 Call @ $0.50 per share ($50)

Maximum Profit

The maximum profit for the trade is limited to the premium the trader receives when the iron condor trade is setup, minus any commissions paid. For this to happen, the iron condor option must expire with the price located in between the short put and call option. For the trade example above, this is $100 (total of shorts {200} – total of longs {100}).

If on expiration, the price of the stock remains at $45, then the option expires and the trader keeps the premium collected on the trade. Remember that the expectation for profit is for the price of the asset not to have shifted to the upside or downside.

 

 

Maximum Loss

If the stock price falls to $35 on expiration, all the options except the Short 40 call will expire worthless. The intrinsic value of this particular option is calculated by subtracting the present price of the asset ($35) from the strike price ($40), which is $5 per share or $500 for the contract. If you deduct the premium ($100) from this, this gives the net loss as $400.

Considerations

In addition to a maximum loss/profit, there are two breakeven points located at the levels of the short call (+ net premium) and the short put (less net premium).

As in other options trade types, the trader must analyse the underlying asset to see that it will probably remain unchanged by expiration, in order to get this trade right. If the trader is able to get this right, then he will smile to the bank on payday.

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