Iron Condors 101

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Alex Partida

Oct 28th 2022  .  7 min read

Why Iron Condors?

There is no strategy that every single trader unanimously uses. This is because every trader has a style formed throughout their career by their personality and experiences. The iron condor options strategy is not for everyone, but its versatility may allow for a fit in your trading style. Understanding the risk and rewards associated with any given system that sparks your interest is essential. Generally speaking, the iron condor is a strategy that can be low risk in comparison to some other methods. Another value investors love about the iron condor is the flexibility to make the strategy range from very conservative to very risky, depending on your risk profile. In short, this strategy is betting that the price of an underlying asset will expire within a specified range. 

KEY TAKEAWAYS

  • An iron condor is an options strategy that utilizes two credit spreads to generate a profit zone between them, allowing a trader to benefit from sideways pinning action.
  • An iron condor can be a great way to take advantage of low-volatility environments or range-bound stocks when appropriately placed.
  • Iron condors allow for strategic risk management as the max profit and loss are predetermined, allowing a trader to properly size their position before entering the trade.
  • The iron condor options strategy can be either a staple or a good side strategy, depending on how you use them.

What is an iron condor?

An iron condor is a two-part option strategy that comes together to create the desired outcome. If you are familiar with a vertical debit spread, this strategy will likely make sense. When constructing an iron condor, you essentially have two different credit spreads that will create a “zone” in which you would achieve max profit on each credit spread and, ultimately, the iron condor itself. By widening the zone between the sold call options, you can create higher probability trades using this strategy. Making the area between the sold strikes wider will make the setup more probable, but the risk to reward will change as you finagle the strikes selected. 

Example of Iron Condor

In this example, we will assume that Tesla is trading at $200 evenly. You then look at the chart and generate a thesis that Tesla will remain range bound for the next couple of weeks. After doing your technical analysis, you think that Tesla will stay between $195 and $205 and that $200 will be a good midpoint to formulate the trade around.

When you have finished creating a thesis on why Tesla will remain in this range and how long, you start to look at the option chain, finding strikes with an expiration date of 8 days.

Because you don’t think that Tesla will fall below $195, you will create a bull put credit spread using the $195 put strike as the option you sell to make the edge of your iron condor. Then you buy the $190 put strike to complete the bull put credit spread. It is important to note that this is purely an example, and you can give yourself more wiggle room than just your expected range. 

An iron condor is a two-part strategy, and the second part is made by creating a bear call credit spread to complete the range that the underlying stock needs to stay within. You will do this by selling a $205 call and buying the $210 call.

This will effectively create two credit spreads where both would achieve max profit, as illustrated in the example below:

How to use this strategy

The first step to placing an iron condor is to identify a range on the underlying stock on which you plan to utilize this strategy.

The second step in legging into an iron condor is to create a bull put credit spread. This can be opened by selling an option at the edge of your range that you have predetermined. From this point, you will go ahead and finish creating the bull put credit spread by buying an option that is further out of the money than the strike you sold. 

The next step to complete the iron condor is to place a bear call credit spread on the other side of the range. This can be established by selling an option at the other side of the range that you have determined. To complete the bear credit spread, you will need to purchase an option that is further out of the money than the strike you just sold.

If done right, this should create an iron condor by creating a range between the two credit spreads. This range between the credit spreads is the area that you want the price to pin at the time of the options expiration.

In the example above, this was signified with $190 and $195 being the bull put credit spread and $205 and $210 being the bear call credit spreads. Together, this creates an iron condor anticipating a pin between $195 and $205 on the underlying stock. 

Now that you have the trade successfully placed, you will ideally capitalize on time decay as the underlying stock has minimal price movement and stays within the range heading into the expiration date.

Are iron condors right for you?

As always, every trader differs in their approach to this game. There are many ways to find success within the stock market, and finding a strategy that fits your personality will be the path of least resistance. An iron condor is a very flexible strategy that can frequently find a home in anyone’s toolbox that likes to sell options rather than buy them. The ability to make them fit your risk tolerance and goals keeps the iron condor at the top of the discussion. 

How long do you hold an iron condor?

This will entirely depend on the trade plan you have when placing the iron condor. Some investors prefer to keep the iron condor close to expiration to realize potential profits faster, but a standard distance to the expiration date is in the 30-45 day range. The key factors to consider are current sentiment and implied volatility in the overall market and the underlying stock. 

How do you maximize an iron condor?

You will maximize your profit potential when the underlying stock is in between the two legs sold on the options chain through the strike price. For example, if you sold the $95 put and the $105 call, then any price between those prices at expiration would yield a max profit.

Are iron condors always profitable?

No, iron condors are not always profitable. This strategy requires the underlying stock to stay within the sold strike prices at expiration. The stock does not have to remain within the sold strikes for the entirety of the duration of the trade, but for max profit, it will have to close within those strike prices on the day of expiration. You will suffer a maximum loss if the underlying stock closes outside the bought strikes.

When should I take profit on an iron condor?

The first thing to consider is what it takes to reach maximum profit and how realistic it is considering the number of days until expiration. For maximum gain to be achieved, the underlying stock will have to close in between the iron condor range at the expiration time. As time and theta work on your side, you will slowly build a profit as long as the price stays contained. Another reason to take profit may be to roll into another position or if you anticipate volatility to rise soon.

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