What is an Iron Condor?

An iron condor is an options trading strategy designed to profit from low volatility in the underlying asset.

Imagine that a hypothetical company called Condor Inc. is trading at $100 a share, and you believe the stock price won’t change much in the next couple of months. You decide to construct an iron condor in the hopes of profiting from your opinion.

Building your iron condor: First, you build a call credit spread above the current stock price. For example, you could sell a call option with a strike price of $110, receiving a premium of $2. Then you buy a call option with a strike price of $120, paying $1. The net credit for the call credit spread is $2 - $1 = $1.

Next, you build the other half of the iron condor, the put credit spread. Let’s say you sell a put option with a strike price of $90 and receiving a premium of $2. You also buy a put option with a strike price of $80, paying $1. Notice that both of the put options strike prices are below the current share price. The net credit for the put credit spread is $2 - $1 = $1. All of the options (both the calls and puts) expire on the same day, two months from the date you bought them.

Risk/Reward: The most you can expect to profit from selling an iron condor is the premium you collect for the entire package. In this example you are collecting $1 for selling the call spread and $1 for selling the put spread, for an overall net credit of $2 (remember, options control 100 shares and have a standard multiplier of 100, so your total net credit would be $200). You only make this profit if all the options expire worthless, which means Condor Inc.’s share price has to stay between $90 and $110 at expiration.

The maximum theoretical loss for selling an iron condor is the difference between the strikes minus the credit you receive for selling the entire iron condor (not including exercise/assignment risk, which we discuss later). In this example, the maximum width of each spread is $10 (110/120 call spread; 80/90 put spread; total of $1,000 per spread). Meanwhile, you are collecting $2 dollars ($200 per spread) in premium for selling the entire iron condor. This means your maximum theoretical loss on the entire strategy is $8, or $800 per spread ($10 - $2 = $8 x 100 = $800)

Breakeven: Because you are selling two different credit spreads, there are two breakeven points. The breakeven prices at expiration for this type of strategy are the short strikes plus/minus the credit received. On the call side, it is your short $110 call plus your total credit of $2. On the put side, it is your short $90 put minus the credit of $2. This means in order to at least breakeven on this trade, the stock must stay between $88 and $112 at expiration.

If the stock trades between the breakeven prices and the long strikes of your credit spreads, you will begin to take on losses. In this example, losses (not max loss) would occur between $112.01 and $120 on the call side, and $87.99 and $80. Anything outside of $80 and $120 would incur max theoretical loss.

Opening your position: To open an iron condor, you would enter a single order to sell both the call and put credit spreads simultaneously, as one package. Keep in mind, if you decide to sell one of the credit spreads before the other, or buy and sell the four individual options separately, you would be “legging” into the iron condor. This can change the potential risk/reward of the iron condor. If you are unable to fill one one of the credit spreads, or one of the options within a credit spread, you could potentially be left with a position you did not intend to put on. Whenever trading iron condors, it is generally best to submit your opening order as one package, using a limit order.

Closing your iron condor: If the underlying stock closes between $90 and $110 at expiration, both credit spreads would expire worthless, and you would keep the $2 you collect in premium ($200 overall). In this scenario, there’s nothing to do.

If the stock closes below $80 or above $120 at expiration, you would incur the maximum theoretical loss of $8 per spread. In this scenario, one side of the iron condor would expire worthless and the other will be trading at maximum value ($10). Don’t forget, you collect $2 in premium, which would offset some of the $10 loss. For the credit spread trading at maximum value, you can either attempt to buy the spread back before expiration for max loss, or allow your broker to exercise and assign your in-the-money options. Always check with your broker and understand how and when options will be automatically exercised/assigned in your account.

Generally speaking, most options traders would close a spread like an iron condor before expiration, even if it looks to be expiring worthless. You may do this by “buying to close” the iron condor. If you buy it back cheaper than the price you sold it for, you would profit. If you buy it back for more than you sold it, you would incur a loss. This ensures you avoid any unnecessary risk from a potential exercise or assignment, which can introduce new risk into your portfolio.

Don’t forget: If, at expiration, the stock closes between the short and long strike of either of your credit spreads, there is a chance you could end up with a long or short position of 100 shares of stock. In this example, this would happen if the stock closed at expiration between $89.99 and $80 on the put side and $110.01 and $120 on the call side.

If this happens, your potential risk/reward profile completely changes and takes on the risk of 100 shares of stock. The maximum gain/loss discussed above, no longer applies. Add to this that assignment usually happens over a weekend, meaning if the stock gaps up or down on Monday morning, you could see large losses in your account (depending on your long or short stock position). This is yet another reason to be diligent when managing options in your account, and avoid, whenever possible, unintended exercise and assignment of your options.

The above examples are for illustrative purposes only and do not reflect the performance of any investment, and do not factor in trading expenses and taxes. Investing involves risk, and you could lose your money.