Iron Condor Options Strategy: Definition, Implementation, And Profit

What Is An Iron Condor Options Strategy?

The iron condor is a non-directional limited risk options trading strategy that is specially designed to get a higher probability of profit when the underlying asset is perceived to have lower implied volatility. The iron condor options strategy can be perceived as the combination of a bull put spread and a bear call spread.

An iron condor spread is created by selling one call spread and one put spread having the same expiration date of the same underlying asset (generally stocks or market indices). All the four options contracts are basically out-of-the-money, although traders can choose of its own not necessarily out-of-the-money.

The goal of this strategy is to make profits from lower volatility in the underlying security. In different terms, the iron condor options strategy earns the maximum profit when the underlying security settles between the middle strike price during the expiration.

Construction of Iron Condor Options Strategy

Traders can create an iron condor options strategy by following these steps:

  1. Buy one out-of-the-money put option with a strike price below the current market price of the security. This will protect against a potential downside movement.
  2. Sell one out-of-the-money put option with a strike price closer to the current market price of the security.
  3. Buy one out-of-the-money call option with a strike price above the current market price of the security. The out-of-the-money call option will protect against a potential upside movement.
  4. Sell one out-of-the-money call option with a strike price above the current market price of the security.

Understanding The Iron Condor Options Strategy

The iron condor strategy has a limited upside and downside risks because of the higher and lower strike price options and the wings to protect against a significant move in both directions. Due to the limited risk, the profit potential is also very limited.

In the ideal scenario, the trader would like all of the options contacts to expire worthlessly, which is possible if the security’s price closes between the middle strike prices during expiration. If not that the loss is still limited.

By selecting different strike prices a trader can make this strategy neutral from partial bullish or bearish, depending upon his uses and requirement.

Iron Condor Options Strategy Profit And Loss

iron condor options diagram

Maximum Profit

  • Maximum Profit = Net Premium Received – Commissions Paid

The maximum profit for the iron condor options strategy is equal to the net credit received when the trader enters the trade. Maximum profit is achieved when the underlying security price during expiration is between the strikes of the call option and the put option sold. At this price, all the options will expire worthlessly.

Maximum Loss

  • Maximum Loss = Strike Price of Long Call Option – Strike Price of Short Call Option – Net Premium Received + Commissions Paid

The maximum loss for the iron condor option spread is also limited but slightly higher than the maximum profit. It occurs when the stock price falls at or below the lower strike price or rises above the higher strike price of the call option purchased. In either case, the maximum loss is equal to the difference in strike between the call options (or put options) minus the net premium received while entering the trade.

Breakeven

  • Upper Breakeven Price = Strike Price of Short Call + Net Premium Received
  • Lower Breakeven Price = Strike Price of Short Put – Net Premium Received

Using the above two formulas, you can calculate the breakeven price for the underlying security.

Example

Suppose there is a stock is trading at $102 in Oct having lot size of 100, to execute Iron condor options strategy the trader buys a $110 call option at $3 and sells a $100 call option at $6. Along with that he further buys a $90 put option at $2 and a sells a $100 put option at $5.

in the ideal scenario, if the stock expires at $100 all the call option and put option becomes worthless and the trader will loss $5 from the buy position and gain $11 dollar from the sell position, so his net profit from the strategy would be $11-$5 = $6 x 100 (lot size) = $600.

In the worst case if the stock price expires above or below the second out-of-the-money strike price, suppose the stock expires at $85, then the call options become worthless where the trader will get a profit of $6 – $3 = $3 x 100 = $300. In case of the put options, the $100 put option becomes $15 with a loss of $15- $5 = $10 and the $90 put option becomes $5, so his profit would be $5 – $2 = $3, so net position from the put options would be $10 – $3 = $7 x 100 = $700.

Limitations

Iron condor options strategy is quite worst in the highly volatile market scenario because the chances of accruing loss are higher than the profit and for the iron condor strategy maximum loss is always higher than the maximum profit. For a higher volatile market, there is an options strategy called reverse-iron condor spread options strategy.

Key Takeaways

  • The iron condor is basically a neutral strategy and the trader gets profits when the underlying asset doesn’t move much. Although, the options strategy can be composed of a bullish or bearish view.
  • The iron condor options strategy is comprised of four options; a long put further out-of-the-money and a short put closer to the money, and a long call further out-of-the-money and a short call closer to the money.
  • Maximum profit achieved when the price of the underlying asset is in between strike prices of the short put option and the short call option
  • Maximum loss occurs when the price of the underlying asset is greater than or equals to the strike price of a long call option or price of underlying less than or equals to the strike price of the long put option.

Conclusion

Iron condor options trading strategy is one of the most famous multi-legged options strategies for a neutral to sidewise market. This strategy is mainly used with market indices and works quite well with them as either side movement in indices is quite limited. There is a slightly similar options trading strategy call reverse iron condor spread using which trader can get maximum out of profit in a highly volatile market condition.

Video Source: Sky View Trading

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