Definition: An iron condor consists of simultaneously selling a bull put spread and a bear call spread at the same time. The trade results in net credit and is an overall neutral position. Max profit and max loss are determined at the beginning of the trade. Iron condors make money when the underlying has little movement in price and volatility contracts.
1. Sell 1 call (lower strike) and buy 1 call (higher strike) with the same expiration dates (usually both OTM)
2. Sell 1 put (lower strike) and buy 1 put (higher strike) with the same expiration dates (usually both OTM)
3. Another way to think of it is selling a bearish call spread and a bullish put spread at the same time
Risk: Defined. Since you have two credit spreads on you have a max loss and profit determined at the entry of the trade.
Order Entry: Net Credit. This is due to selling a bear put spread and a bull call spread.
Direction: Neutral. You want the stock to stay relatively flat.
Ideal Environment: High IV. Since you are selling two spreads together, you want to sell in an environment where options are more expensive relative to their historical pricing and volatility.
Profit Target: 50%. This is the target we use at Mainstreetwolf (MSW) to lock in gains to keep our emotions out of it and be more efficient with using our capital.
Suppose stock ABC is trading at $20. An options trader is neutral on ABC decides to enter into an iron condor by selling a bull put spread & bear call spread(selling 1 put at $18/buying 1 put at $15 for $50 credit and selling 1 call at $22/buying 1 call at $25 for $50 credit). Both spreads have a DTE of 45 and the total trade results in a credit of $100.
All scenarios assuming 0 commissions and kept to expiration to make explanations simpler to understand.
Breakeven Stock Prices
To calculate the breakeven stock prices for the trade, use the following formulas:
Upper Breakeven Point = Strike Price of Short Call + Net Premium Collected
$23 = $22 + $1
Lower Breakeven Point = Strike Price of Short Put – Net Premium Collected
$17 = $18 – $1
Max Profit – Stock is at or Above the Short Put Strike Price (Put Spread) or Stock is at or Below the Short Call Strike Price (Call Spread)
Iron condors have limited risk, and with that comes a lower max profit. The max profit for an iron condor is the net credit received when the trade is put on. The best-case scenario is that all the options expire worthless. This would be the situation if the stock closed at $20 and none of the call options or put options would have intrinsic value.
Max Profit= Net Premium Collected
$100 = Premium Collected
Profit – Stock is Above Breakeven Stock Price (Put Spread) or Stock is Below Breakeven Stock Price (Call Spread)
When the stock is above the breakeven stock price on the put spread side or below the breakeven stock price on the call spread side you have a partial profit. If the stock ended up at $17.75, your profit would be $75. The only option with value would be the short put at the $18 strike.
Profit = Long Call Value – Short Call Value + Long Put Value – Short Put Value + Premium Collected
$75 = $0 – $0 + $0 – $25 + $100
Loss – Stock is Below Breakeven Stock Price (Put Spread) or Stock is Above Breakeven Stock Price (Call Spread)
When the stock is below the breakeven stock price on the put spread side or above the breakeven stock price on the call spread side you have a partial loss. If the stock ended up at $24, your loss would be $100. The only option with value would be the short call at the $22 strike.
Loss = Long Call Value – Short Call Value + Long Put Value – Short Put Value + Premium Collected
-$100 = $0 – $200 + $0 – $0 +100
Max Loss – Stock is at or Below the Long Put Strike Price (Put Spread) or Stock is at or Above Long Call Strike Price (Call Spread)
If the stock price goes up past the purchased call or below the purchased put. Iron condors have limited risk, with the most money that can be lost is fixed. The most money that can be lost on an Iron Condor is the difference in strikes of the calls/puts minus the premium collected while adding back in the cost of commissions.
Max Loss = ((Strike Price of Short Call – Strike Price of Long Call) x 100 shares per contract) + Net Premium Collected
Max Loss = ((Strike Price of Long Put – Strike Price of Short Put) x 100 shares per contract) + Net Premium Collected
-$200 = (($22 – $25) x 100) + $100
Or -$200 = (($15 – $18) x 100) + $100
Another way to think of it is width of strikes of one of the spreads minus premiums is the max loss.
Understanding Implied Volatility and the Greeks
With an iron condor you are really trying to benefit from implied volatility contraction or the passage of time without much movement in the underlying stock price.
When to use an iron condor strategy?
The best time to use this strategy is when a stock implied volatility has spiked, and you want to benefit from an expected reversion to the mean for implied volatility.
Once the implied volatility has contracted or the passage of time, the spreads become less valuable and you can buy it back at less than what you sold the iron condor for to begin with.
At Mainstreetwolf, we use this strategy for stocks with a high implied volatility. The trader should have a short to intermediate neutral thesis. We look to collect 1/3 the width of the strikes (meaning $1 for $3 dollar wide strikes on the bear call spread/bull put spread). We look to buy a position that has around 45 DTE with a 68% – 70% probability of profit. The goal is to buy back the spreads at 50% of max profit.
A real example of this was a trade I put on when the VIX spiked back around May 11th. With the fear in the market, I looked to put on a trade to capitalize on a higher implied volatility but at the same time not picking a direction for the markets to go.
To reduce risk in a single company, I looked to trade an iron condor in QQQ (Nasdaq ETF). I traded a $4 wide iron condor with the following setup:
Collected $127 or around 32% of the width of the strikes and chose an expiration at the time that was a little over a month. Now I need QQQ to trade within that range and for IV to contract to make money in the trade.
If you want to follow for real-time trades or gain access to the full options guide with quiz questions and answers, click the link: https://www.patreon.com/join/mainstreetwolf/checkout?rid=6794640