Iron Condor

What Is an Iron Condor?

An iron condor is an options strategy consisting of two puts (one long and one short) and two calls (one long and one short), and four strike prices, all with the same expiration date. The iron condor earns the maximum profit when the underlying asset closes between the middle strike prices at expiration. In other words, the goal is to profit from low volatility in the underlying asset.

The iron condor has a similar payoff as a regular condor spread, but uses both calls and puts instead of only calls or only puts. Both the condor and the iron condor are extensions of the butterfly spread and iron butterfly, respectively.

Understanding the Iron Condor

The iron condor strategy has limited upside and downside risk because the high and low strike options, the wings, protect against significant moves in either direction. Because of this limited risk, its profit potential is also limited.

For this strategy, the trader ideally would like all of the options to expire worthlessly, which is only possible if the underlying asset closes between the middle two strike prices at expiration. There will likely be a fee to close the trade if it is successful. If it is not successful, the loss is still limited.

The commission can be a notable factor as there are four options involved.

The construction of the strategy is as follows:

1. Buy one out of the money (OTM) put with a strike price below the current price of the underlying asset. This OTM put option will protect against a significant downside move to the underlying asset. 
2. Sell one OTM or at the money (ATM) put with a strike price closer to the current price of the underlying asset.
3. Sell one OTM or ATM call with a strike price above the current price of the underlying asset.
4. Buy one OTM call with a strike price further above the current price of the underlying asset. This OTM call option will protect against a substantial upside move.

One way to think of an iron condor is having a long strangle inside of a larger, short strangle — or vice-versa.

The options that are further OTM, called the wings, are both long positions. Because both of these options are further OTM, their premiums are lower than the two written options, so there is a net credit to the account when placing the trade. 

By selecting different strike prices, it is possible to make the strategy lean bullish or bearish. For example, if both the middle strike prices are above the current price of the underlying asset, the trader hopes for a small rise in its price by expiration. In any case, the trade still carries a limited reward and limited risk.

Image by Julie Bang © Investopedia 2019

Iron Condor Profits and Losses

The maximum profit for an iron condor is the amount of premium, or credit, received for creating the four-leg options position.

The maximum loss is also capped. The maximum loss is the difference between the long call and short call strikes, or the long put and short put strikes. Reduce the loss by the net credits received, but then add commissions to get the total loss for the trade.

The maximum loss occurs if the price moves above the long call strike, which is higher than the sold call strike, or below the long put strike, which is lower than the sold put strike.

Example of an Iron Condor on a Stock

Assume that an investor believes Apple Inc. will be relatively flat in terms of price over the next two months. They decide to implement an iron condor, with the stock currently trading at $212.26.

They sell a call with a $215 strike, which gives them $7.63 in premium, and buy a call with a strike of $220, which costs them $5.35. The credit on these two legs is $2.28, or $228 for one contract — each options contract, put or call, equates to 100 shares of the underlying asset. The trade is only half complete, though.

In addition, the trader sells a put with a strike of $210, resulting in a premium received of $7.20, and buys a put with a strike of $205, costing $5.52. The net credit on these two legs is $1.68, or $168 if trading one contract on each.

The total credit for the position is $3.96 ($2.28 + $1.68), or $396. This is the maximum profit the trader can make and occurs if all the options expire worthless, which means the price must be between $215 and $210 when expiration occurs in two months. If the price is above $215 or below $210, the trader could still make a reduced profit, but could also lose money.

The loss gets larger if the price of Apple stock approaches the upper call strike ($220) or the lower put strike ($205). The maximum loss occurs if the price of the stock trades above $220 or below $205.

Assume the stock at expiration is $225. This is above the upper call strike price, which means the trader is facing the maximum possible loss. The sold call is losing $10 ($225 - $215) while the bought call is making $5 ($225 - $220). The puts expire. The trader loses $5, or $500 total (100 share contracts), but they also received $396 in premiums. Therefore, the loss is capped at $104 plus commissions.

Now, assume the price of Apple instead dropped, but not below the lower put threshold. It falls to $208. The short put is losing $2 ($208 - $210), or $200, while the long put expires worthless. The calls also expire. The trader loses $200 on the position but received $396 in premium credits. Therefore, they still make $196, less commission costs.