Order Entry: Net Credit (1/3 width of the strikes)
Ideal Environment: High IV
Profit Target: 50%
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.
Iron Condor Setup
Sell 1 OTM Put
Buy 1 OTM Put (lower strike)
Sell 1 OTM Call
Buy 1 OTM Call (lower strike)
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.
Max Profit= Net Premium Received - Commissions Paid
To calculate the breakeven stock price for the trade, use the following formulas:
Upper Breakeven Point = Strike Price of Short Call + Net Premium Received
Lower Breakeven Point = Strike Price of Short Put - Net Premium Received
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 Long Call - Strike Price of Short Call - Net Premium Received + Commissions Paid
Suppose stock ABC is trading at $20 in July. An options trader is neutral on ABC decides to enter an iron condor position by selling a bull put spread & bear call spread(selling 1 put at $18/buying 1 put at $16/selling 1 call at $22/buying 1 call at $24). Both spreads have a DTE of 45. The trade results in a credit of $68.
The price of ABC stock over the period of the trade ends up at $21. All of the options end up expiring worthless. None of the options end up ITM. The trade ends up netting $62 after commissions. This scenario winds up with the trade making maximum profit.
If the stock had rallied to $25 at the end of expiration, the trade would have resulted in a max loss of $132. The puts that were sold and bought are worthless. The call that was sold is ITM so you have to deliver 100 shares at the price of $22, but you’re buying at $25. So in that case you lose out on $300. You also own an ITM call that was purchased at $24, so that is worth $100. Right now you are out of $200, but you have to remember that you collected $68 at the beginning of the trade. Therefore after everything you have now incurred the max loss of $132 (may be more with commissions buying back you’re losing bear call spread).
When to use an iron condor strategy?
At Tradezy, we recommend to 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 66% probability of profit. The goal is to buy back the spreads at 50% of max profit.