An iron condor is a market-neutral options strategy that professionals use when they believe that a stock or index will trade in a relatively narrow range until the expiration of the contracts. An iron condor trade includes four separate options contracts, two calls and two puts. Usually, all of the options contracts are out-of-the-money but this is not required. The four contracts are actually two spreads, a call spread and a put spread with the spread of each being the same numbers of points apart. All contracts are for the same expiration date. This trade is commonly used on broad market indices such as the RUT, NDX, or SPX but it can be just as easily used on individual stocks.
How Does an Iron Condor Work?
First, you will choose a stock or index which you believe will trade within a narrow price range for the foreseeable future. Then you will buy a call spread in which you sell a call and buy a call. The call that you buy will be cheaper and for a higher strike price than the one that you sell. You will also buy a put spread in which you sell a put and buy a put for a lower price and at a lower strike price than the one that you sell. The point spreads should be the same for these two paired contracts. If the stock or index does not move out of its narrow trading range the options will all expire worthless. Your profit will be what you earned from selling the call and the put minus what you paid for the call and put, minus fees and commissions.
How Do Iron Condors Make or Lose Money?
As we noted, you make money with an iron condor when the price of your stock or index does not budge out of its narrow price range. The ideal situation is when all options expire worthless. Your maximum gain is the difference between the contracts that you sold and the contracts that you purchased, minus fees and commissions. As a practical matter, traders often exit their trades before expiration in order to lock in a profit and avoid a loss when the stock or index becomes more volatile than they had anticipated.
The worst that you can do with an iron condor is when the price of the stock or index moves above the higher call strike price or below the lower put strike price. In either case, your maximum loss is the difference between the strike prices plus fees and commissions minus what you earned by selling calls and puts for more than you paid for calls and puts.
Iron Condor Premiums Are Your Profit or Loss Buffer
This trade can net a nice and safe profit in a tranquil market. If you are good at spotting indexes and stocks that will behave themselves for the next month or two, the iron condor can be a money-making machine. When you misjudge, the premium differential in this trade cushions your loss. When setting up this trade, you can reduce your maximum potential loss by picking options that are further out-of-the-money. But this also reduces your potential profit. You can increase your maximum potential gain with options that are barely out-of-the-money but this also increases your loss if the stock or index wanders out of your predicted price range.
You can learn how to set up and execute an iron condor by trial and error, hopefully with practice trades. Or, you can become a member of Top Gun Options and learn by looking for the shoulder of professional traders during real live trading.