The iron condor option strategy is a risk-defined, neutral options trading strategy that benefits from premium decay and minor up or down moves in the underlying asset. Essentially, an iron condor is a call credit spread combined with a put credit spread that, when executed properly, produces a trade with a net delta of around zero.
Key Points
- Iron condors perform best when the underlying asset hardly moves, or moves up or down minimally
- This is a risk defined strategy
- The passage of time is favorable to iron condors due to theta decay
- Iron condors are very popular trades among traders looking to “generate portfolio income”
Tastyworks is one of the most popular online brokerages to iron condor spreads because of $0.00 commissions and free professional options trading platforms.
Iron Condor Option Strategy Definition
-Sell 1 call
-Buy 1 call further OTM short long call
-Sell 1 put
-Buy 1 put further OTM from short put
Note: Iron condors can be very narrow or wide and balanced or unbalanced, the width of the strikes and the distance from the price of the underlying asset does not matter; it’s still an iron condor.
Iron Condor Example
Stock XYZ is trading at $50 a share.
Sell 53 call for $0.50
Buy 55 call for $0.20
Sell 47 put for $0.60
Buy 45 put for $0.40
By doing this, the trade would create a net credit of $0.40 ($40). The credit comes from the combined premium of the call credit spread and put credit spread.
The best case scenario for an iron condor is for the underlying instrument not to move at all. If stock XYZ stayed at $50 until expiration, this trade would be a full winner.
Iron Condor Summary
| Maximum Profit | Defined |
|---|---|
| Maximum Loss | Defined |
| Risk Level | Low |
| Best For | Quite times in the market |
| When to Trade | When you are neutral and expect limited or no price movement in a stock |
| Legs | 4 legs |
| Construction | call credit spread + put credit spread |
| Opposite Position | Short iron condor, i.e. call debit spread + put debit spread |
Maximum Profit and Loss for the Iron Condor Option Strategy
Maximum profit for an Iron Condor = PREMIUM RECEIVED
Maximum loss for an Iron Condor = WIDTH OF STRIKES (minus) PREMIUM RECEIVED
In the example above, the max profit (most you can make on the trade) is $0.40 ($40).
The max loss is $3.60 ($360). Max profit will be reached when the iron condor expires with stock XYZ trading between the short strikes of the iron condor (53 call and 47 put) at expiration.
Break-Even for an Iron Condor
There are two break-even points the iron condor option strategy: the upside break-even and the downside break-even. Essentially, these are the same break-even points for a call credit spread and a put credit spread.
Downside break-even point = strike price of short put (minus) premium received
Upside break-even point = strike price of short call (plus) premium received
Why Trade Iron Condors?
The logic behind employing the iron condor option strategy is to capitalize on theta decay while expressing a neutral outlook on an optionable security and avoiding undefined risk. Afterall, who really knows if a stock or futures contract is going to move up or down?
Note, this does not mean iron condors are not speculative trades. Iron condors are indeed highly speculative. By placing an iron condor, you’re speculating that the underlying instrument will be within the short strikes at expiration.
The reason why the iron condors options strategy is popular is because large moves in the underlying asset are not needed for the trade to be profitable. If the underlying asset does absolutely nothing before expiration, the trade will be a winner.
The underlying can also move up or down, within the distance of the short strikes, and the trade will still be profitable. Moreover, the iron condor option strategy is risk-defined. This means there’s no potential for a disastrous loss that is always possible with uncovered short options positions.
What about Theta (Time) Decay?
Theta decay for iron condors is highly favorable. In fact, it’s essentially the only way the strategy makes money.
Everyday, premium will be systematically priced out of the short option legs of the iron condor. This means premium will also come out of the long options of the iron condor, but because the short options are closer to the money and worth more, this loss from the long option legs is completely offset.
When Should I close out an Iron Condor?
If the remaining premium in an iron condor is near zero prior to expiration, the short strikes should always be closed out – always. When there is no premium left to decay, there is no profit left to make on the trade. Holding on to short options positions with no premium is not a savvy trading decision.
However, holding on to long options positions with no premium is fine, because they are either going to stay near zero or rise in value. If the short strikes of an iron condor are closed out prior to expiration, the remaining long strikes are essentially a free-ride, so it’s wise to leave them alone.
Typically, one side of the iron condor will depreciate faster than the other side due to changes in the price of the underlying. If this happens, the same principle applies. Consider closing out either the put or call short strike that has minimal value and reestablishing at a further out strike price.
Of course, if the price of the underlying is between the short strikes of the iron condor at expiration, it’s possible to leave the trade alone. You will keep all of the premium and the trade will fall off of your account after expiration.
Anything I Should Know about Expiration?
Yes. It is only possible for one side of an iron condor to expire ITM. No matter what happens, one side of the iron condor is going to expire worthless, and no action needs to be taken for that side.
If one side of an iron condor does expire completely ITM, the whole trade will be a loser, even with all of the premium received from the other side.
The expiration risk with iron condors is one side of the iron condor (like the put or call credit spread) partially expiring ITM. If the price of the underlying asset is between the short and long options strikes at expiration, for either side of the condor, you may consider closing out the position to prevent unwanted assignment.
Ideally, your options broker will notify you of upcoming expiring options positions that could cause trouble for your account. However, as an active options trader, it behooves you to stay on top of your account and monitor all of your positions.
Important Iron Condor Trading Tips
Commissions and fees are the biggest things to be aware of when trading iron condors. At a minimum, you will be trading 4 options contracts. Brokers like Tastyworks are great, because their commissions are low and they only charge one ticket charge per iron condor trade.
If you are trading with a broker who isn’t friendly to options traders, commissions will quickly eat into your profits.
Keep in mind that exchange fees are also costly with iron condors. This is especially the case with iron condors on index options, as index options usually incur a higher exchange fee (around $0.60-$1.00/contract) than stock options.