An iron condor is a neutral strategy pairing an OTM short call vertical spread and an OTM short put vertical spread on the same underlying with the same expiration.
With price expected to stay between the short call and put strikes, the time value erodes and premium on both sides can be collected. Iron condors are positive theta trades since they benefit from time decay. Because each vertical spread is sold for a credit, iron condors are sold for credits. Iron condors benefit from stagnating price, as well as the collapse of implied volatility since they are short vega. This means that higher implied volatility will result in a greater initial credit when selling an iron condor.
An iron condor is sold for a credit as a defined-risk, defined-profit strategy. The max profit potential is the premium collected on the sale of the two verticals. The max loss is the width of either vertical spread less the credit received. Because price can only move through one of the verticals (either the call side or put side), it limits the max risk to the width of the vertical spread.
The downside breakeven can be calculated by subtracting the total premium collected from the short put strike, whereas the upside breakeven is the total premium collected added to the short call strike.
The farther OTM the short strikes, the less the initial credit an iron condor will collect. Iron condors will also collect smaller initial credits when the short strikes are farther apart, although wide iron condors will carry a higher probability of success.
The probability of success for an iron condor can be found by dividing the real risk by the width of the spread. For example, take a $5 wide iron condor which is sold for a $2 credit. Because $2 is collected up front and the spread itself is only $5 wide, the real risk in the trade is $3 ($5 – $2 = $3). $3 (real risk) divided by $5 (the width of the spread) gives a 60% probability of success.
Non-Directional Iron Condors
Typically, iron condors are executed with both short strikes equidistant from the current price. This allows for matching freedom of movement in either direction before either side (short call or short put) would be tested.
Directional/Skewed Iron Condors
A standard iron condor is executed with the short strikes on both the call and put sides being equidistant from the current price. An example would be an iron condor on a $50 stock where the short call is at $55 and the short put is at $45, both $5 away from the current price.
Iron condors can be entered as directional positions by placing one of the short strikes closer to the money. By altering the proximity of one of the short strikes to the current price, price is allowed less freedom of movement before that vertical spread would be tested, but now it has more freedom of movement in the other direction before a test of that short strike would occur.
For example, a neutral to bullish iron condor might look something like this:
XYZ trading at $70
Sell the $67.50/65 put vertical
Sell the $77.50/80 call vertical
Both vertical spreads are $2.50 wide, but the put vertical is placed closer to the money ($2.50 away) than the short call vertical ($7.50 away). This would be a neutral to bullish trade where XYZ is expected to stay between the short strikes ($67.50 to $77.50), but more room is allowed on the upside, giving it a slightly bullish bias.
It’s important to note that even directional iron condors still have defined risk and defined profit.
Unbalanced Iron Condors
A standard iron condor is composed of short call and put vertical spreads which match in size, width, or both. Unbalancing the iron condor can give it a directional bias.
Strike Width
An unbalanced iron condor will have one vertical spread wider than the other. For example, an unbalanced iron condor might be the $60/$70/$75/$80 iron condor where the put spread is $10 wide ($60/$70) but the call spread is only $5 wide ($75/$80).
Taking this $60/$70/$75/$80 example further, if enough credit can be brought in to fully cover the narrower of the two vertical spreads (the $5 wide call spread), there would be no upside risk for the position.
To create a bullish bias in an iron condor, a wider put spread would be sold.
To create a bearish bias in an iron condor, a wider call spread would be sold.
Contract Size
Another way in which some traders will unbalance an iron condor is to begin with a standard or skewed iron condor but increase the number of contracts in one of the vertical spreads vs. the other. To create a bullish bias in an iron condor, increase the number of contracts for the put spread. To create a bearish bias in an iron condor, increase the number of contracts for the call spread.
For example, suppose a trader is entering a $55/$60/$70/$75 iron condor but wants to unbalance it through contract size in order to create a bit of a directional bias.
The trader could sell 1 of the $70/$75 call spreads but 2 of the $60/$55 put spreads to create a slightly bullish bias for the position.
Alternately, the trader could sell 2 of the $70/$75 call spreads but only 1 of the $60/$55 put spreads to create a slightly bearish bias for the position.
Iron condors allow great flexibility when it comes to constructing a position which will benefit from somewhat range-bound price action.
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