An iron condor is an options trading strategy used primarily in trading conventional options. In this options trading strategy, the trader opens option positions with four different strike prices, with the same expiry date or time. The essence of the iron condor is to capture trading opportunities when there is low volatility in the market. Many people have the erroneous belief that low volatility does not make for profitable trading opportunities. Thanks to strategies such as the iron condor, such erroneous beliefs have been put down. The iron condor options trading strategy is used when the asset to be traded is range-bound or trading within a tight price range.

An iron condor trade has the best chance of success when the trade is executed at the time that the implied volatility in the marktet is still high, but is expected to drop significantly in a short time. In essence, the iron condor options strategy is designed to see the market opportunity when others do not, and to take position accordingly.

Traders can trade iron condors from two standpoints:
Long position
Short position
a) Long position: In a long position, the trader sets the 4 trades as follows:

– Long call iron condor
– Short put iron condor
– Short call iron condor
– Long put iron condor

In other words, the long iron condors flank the two put iron condors on both sides.

b) Short position: In a short position, the trader sets the 4 trades as follows:

– Short put iron condor
– Long call iron condor
– Long put iron condor
– Short call iron condor

In other words, the short iron condors border the two call iron condors on both sides.

In the iron condor, there are always four trades made up of two call and two put spreads. The difference is in the arrangement of the call and put spread trades, which has just been explained above. Let us illustrate a typical iron condor trade.

Why Iron Condors?
Why would anyone want to trade iron condors? There are a few reasons why traders should consider iron condors as an options strategy.

a) It is a spread option. With some types of spread options, traders earn money on premiums for opening trades. Iron condors is one of such trade types. In an iron condor, the trader receives a credit premium for opening the trade, and once the trade ends according expectation and commissions are paid, the trader pockets the premium.
b) The iron condor works well for those who are not interested in staring at charts all day long. This is because it benefits from the passage of time.
c) The iron condor is also suitable for those who do not want undue fluctuations in their portfolios.

Graph showing an iron condor

 

Trade Example
Let us assume that we are looking to trade an iron condor, and we see an asset called stock ABC looking like it will range trade for some time. It is currently trading at $40 per share. How do we play this?

We have to look at the upper and lower limit of the range, and mark this out on a chart using trendlines. In other words, connect the highs and the lows. Give some allowance on the price range (i.e. use a price a little bit lower than the high and a price a little higher than the low) and set the iron condor. If the high and low of stock ABC are $51 and $30 respectively, the iron condor is set as follows:

– Long 1 ABC 32 Put @ $1.50 per share ($150)
– Short 1 XY 35 Put @ $2.00 per share ($200)
– Short 1 XY 48 Call @ $2.00 per share ($200)
– Long 1 XY 50 Call @ $1.50 per share ($150)

The premium received on the trade will be the difference between the cost of the shorts and the cost of the longs, which is $400 – $300 = $100.

If the iron condor expires in between the short put and short call option (i.e. between $32 and $48), the option will make money. If the price falls below $35, the two shorts and the long call options will expire worthless, forcing the trader to exercise or purchase the Long put option at $32. He will then have to pay $40 – $32 X 100 units = $800, losing $700 in all if the premium received is removed from the cost of exercising the option.

A break-even trade can be achieved if the trade ends at $35 or $48, being the price at which the short call and short put trades were executed.