The Iron Condor Options Strategy is an advanced, low-volatility Options strategy that is designed to increase a trader’s chances of earning a small, limited profit. A non-directional Options strategy, Iron Condor involves combining two vertical spreads, a Put spread and a Call spread, to generate a profit.
The Iron Condor is typically employed when there’s a great probability of the market being range bound. For those not aware of the term, a range bound market is one in which prices fluctuate between a specific high price and a low price.
Favored mostly by traders who want a consistent return, the Iron Condor strategy saves a lot of the time spent preparing and executing trades. If you learn how to execute the strategy properly, Iron Condor can ensure a high probability of return for you. Here, I will try to explain everything that you need for getting started with and successfully execute the Iron Condor strategy.
Understanding the Iron Condor Strategy and Its Purpose
As mentioned earlier, the Iron Condor is an Options strategy that takes advantage of low volatility in the market. The probability of earning a profit is high with this strategy since there is limited risk involved. A neutral position, Iron Condor is a strategy you get by combining an out-of-the-money (OTM) short call spread, which is a bearish strategy, with an OTM short put spread, a bullish strategy. The combination is achieved with Options that all have the same expiry date.
To execute the Iron Condor strategy, you will have to sell an OTM money call and OTM money put, while simultaneously buying a further OTM money call and further OTM money put. This allows you to spread your wings to cover all bases. Let me explain this.
When you execute an Iron Condor in this way, you sell two separate OTM vertical spreads to collect premiums from both sides of the iron condor as a single order. Since the market cannot be in two places at the same time, only one spread can go against you at expiration. Genius, isn’t it? Yes, but only if you’re looking for a limited profit. Let’s look at the maximum profit you can attain with an Iron Condor.
Maximum Profit with an Iron Condor Strategy
When you use the Iron Condor strategy, your maximum profit will be equal to the net credit received when you entered the trade. You attain the maximum profit with this strategy when the price of the underlying stock at expiration is between the call and put sold strikers. All options expire worthless at this price. Following is the formula for calculating the maximum gain with Iron Condor:
Maximum Gain/Profit=Net Premium Received-Commissions Paid
You achieve maximum gain with Iron Condor when the Underlying stock’s price is between the Short Put and Short Call strike prices. We discussed above how you can calculate the maximum gain with an Iron Condor. However, since this strategy has limited risk involved, it would only be right to find out the maximum loss possible with Iron Condor.
Maximum Loss with an Iron Condor
Although it is limited like the maximum profit with the same strategy, the maximum loss with an Iron Condor is significantly higher than the gain you get with the strategy. When do you experience a maximum loss with Iron Condor? When the price of the underlying stock becomes equal to or falls lower than the purchased put’s lower price. It can also occur when the stock’s price is equal to or goes above the purchased call’s higher strike.
In both the situations for maximum loss mentioned above, the maximum loss equals the difference in strike between puts or calls minus the net credit received when the trade is entered. Following is the formula for calculating the maximum loss with Iron Condor:
Maximum Loss= Long Call’s Strike Price-Short Call’s Strike Price-Net Premium Received+ Commissions Paid
Maximum loss is reached with Iron Condor when the underlying stock’s price is greater than or equal to the Long Call’s Strike Price. Another scenario for maximum loss is when the price of the underlying stock is less than or equal to the Long Put’s Strike Price.
Break even Point (s)
In addition to maximum profit and maximum loss, Iron Condor with a break even point, two in fact. Following is how the two break even points with Iron Condor are calculated:
Lower Breakeven Point = Short Put’s Strike Price – Net Premium Received
Upper Breakeven Point = Short Call’s Strike Price + Net Premium Received
Example Explaining the Iron Condor Strategy
Say a stock trades at $103. Now, you sell the call spread at 105-111 and the put spread at 100-94 to execute the Iron Condor strategy for $2.25. On both spreads, the highest the risk can be is $6-$2.25, or $3.75 per spread. If you consider an entire contract, then this risk would amount to $375 plus transaction costs.
If the stock at the time of expiry is above 100 and below 105, then both spreads will expire worthlessly and you will get to keep the $2.25 ($225 per spread) minus transaction costs as the profit. Selling both spreads will not increase your dollar risk since the maximum potential for loss for both the put spread and the call spread is $3.75.
However, your risk of loss for which direction the market can head for that loss to occur will increase. For example, if you sell only the put spread, then the stock could reach $117 at expiry without any worry. Or, if you sell only the call spread, then the stock could drop to $88 without any issue.
What I’m trying to tell you here is that the success of your Iron Condor strategy will be determined by the market not going outside a specific range of prices. For this reason, you would do well to work with an experienced professional who can help you with deciding the appropriate range for an underlying stock when using the Iron Condor Options Strategy.
Keep following my page! I will soon update it with strategies for choosing a range and strikes for an Iron Condor.
Comment down below if this article helped you understand how to successfully profit in a bull or bear market.