Iron Condor Option Strategy Explained (A Simple Guide)
How would you like to profit from a stock when you think its price won’t change much in the short term?
If so, then check out the iron condor option strategy.
Unlike many other options strategies, the iron condor puts cash in your account right away. That cash is your profit if the price of the underlying security doesn’t swing up or down significantly.
In other words, you make money when the price stays flat.
It’s a tricky strategy, though. The iron condor is designed for advanced options traders.
In this guide, I’ll go over the iron condor option strategy in detail. Then, you can determine if it’s a strategy you’d like to use in your online trading.
What Is an Iron Condor Option?
The bull put spread targets lower strike prices and the bear call spread targets higher strike prices. Since you sell options at a higher price than the options you buy, the result of the transaction is a net credit to your account.
If the underlying stock doesn’t move much, then all the options expire worthless. You keep the money you earned from the iron condor.
The cash that’s credited to your account when you open the trade is your maximum profit.
When Would You Use an Iron Condor Option?
It’s best to use an iron condor option when you think the underlying asset has low volatility.
In investing, volatility is the range of price change of an asset. A stock that fluctuates up and down in price a lot has high volatility. A stock that only moves a little bit over time has low volatility.
Please note: it doesn’t matter which direction the stock moves (up or down). If it moves either way considerably, then it’s considered volatile.
It’s best to stay away from volatile stocks with an iron condor option trade.
Why? Because the ideal situation in an iron condor is that the stock trades at about the same point it was when you opened the position. That’s how all the options expire worthless and you keep your credit.
By the way, that’s also why many investors prefer to open an iron condor position against a stock index fund instead of an individual stock. The implied volatility of index ETFs (such as SPY) is often lower than the implied volatility of individual stocks.
How Does an Iron Condor Option Work?
Before you even think about trying the iron condor strategy, make sure your trading platform supports multi-leg options orders.
Why? Because you’re placing four trades. It’s best to place them at the same time so you can see up-front how much cash will be credited to your account.
You’ll also likely need a margin account. That’s because you’re writing calls and puts against underlying securities that you don’t own.
Your trading platform will inform you if you lack sufficient margin for the trade.
Once you’ve established your margin limit and verified that your trading platform supports multi-leg options orders, you’re ready trade.
To open an iron condor position, start by selling an out-of-the money put option at a strike price below the current price of the underlying security. Then, buy a put option at an even lower strike price.
After that, sell an out-of-the money call option at a strike price higher than the current price of the underlying security. Finally, buy a call option at an even higher strike price.
All of the options should have the same expiration date (ideally, 30-45 days out).
Once you’ve completed that trade, you’ll notice that you’re a little richer. An iron condor results in a credit to your account.
If everything goes as planned, the price of the stock or ETF won’t move much and all the options will expire worthless. In that case, you pocket the cash you earned from the trade.
Real Life Example Using an Iron Condor Option?
Let’s say the S&P 500 ETF is trading at $272.50 per share. You think it isn’t going to move much over the next month, so you decide to open an iron condor position.
First, you need to open the bull put spread. You sell the $270 put option for for $4.51. You also buy the $268 put option for $3.98.
Remember, though, that options contracts are traded in groups of 100 shares. That means you pay $398 ($3.98 x 100) for the put option you purchased while pocketing $451 ($4.51 x 100) for the put option you sold.
That results in a credit to your account of $53 ($451 – $398), minus commissions.
Next, you open the bear call spread. You sell the $275 call for $4.56. At the same time, you buy the $277 call for $3.45.
As a result of that transaction, you get a credit of $111 ($456 – $345).
Your total credit is $164 ($111 + $53). That also happens to be your maximum profit for this trade.
Important point: all options must have the same expiration date.
As long as the index ETF share price is between the short options strike prices at contract expiration, you’ll stay profitable. In this case, that means it has to stay between $270 on the low end and $275 on the high end.
If that happens, all the options expire worthless and you keep the cash.
However, if the price of the index fund goes above the short put or below the short call, you’ll have to buy back one of the short positions to close it out. In that case, you’ll likely lose money.
What Are Similar Strategies Related to an Iron Condor Option?
There are a few advanced options strategies similar to an iron condor option:
- Neutral Calendar Spread – Involves buying long-term calls while writing short-term calls. All options have the same strike price.
- Long Put Butterfly – Involves buying one out-of-the-money put, selling two at-the-money puts, and buying one in-the-money put. It offers limited profit with limited risk.
- Iron Butterfly – Involves buying an out-of-the-money put and an out-of-the-money call while simultaneously selling an at-the-money put and an at-the-money call. It’s another limited risk, limited profit trading strategy.
Iron Condor Option Compared to Other Options Strategies?
As you can see, the iron condor option strategy is designed for veterans. It’s not for people who are new to options.
Other strategies, like the long call or protective put, are much better strategies if you’re just getting started.
The iron condor option also gives you the maximum profit up front. All the cash you take in when you open the position is the most that you’ll ever realize.
Many other options strategies make you wait for your profit.
Advantages & Risks of Iron Condor Option?
- Limited risk – Your risk is limited because you’re using spreads. That means the combination of short and long positions will cover you if the underlying asset skyrockets in price or bottoms out.
- Quick cash – You get your maximum profit right away. That might be an important factor if you’re considering the time value of money.
- You could take a relatively significant loss – It’s possible that you could succeed with an iron condor option a few times and then suffer a loss that wipes out all your previous profits. Make sure you do some practice trading before you invest real money.
- Limited profit – Although the spreads protect you from a catastrophic loss, they also limit your profit. The most you’ll ever get from an iron condor is the credit you receive when you open the position.