Iron condor
Encyclopedia
The iron condor is an advanced option
trading strategy utilising two vertical spreads
– a put spread and a call spread with the same expiration and four different strikes. If the outer strikes are bought and the inner strikes sold a long iron condor is produced. The converse produces a short iron condor. The number of call spreads will be equal to the number of put spreads.
The position is so named because of the shape of the profit/loss graph, which loosely resembles a large-bodied bird, such as a condor
. In keeping with this analogy, traders often refer to the inner options collectively as the "body" and the outer options as the "wings". The word iron in the name of this position indicates that, like an iron butterfly, this position is played across the current spot price of the underlying
instrument having one vertical spread below and one vertical spread above the current spot price. This distinguishes the position from a plain Condor position, which would be played with all strikes above, or below the current spot price of the underlying instrument. A Call Condor would be played with all call contracts and a Put Condor would be played with all put contracts.
One of the practical advantages of an iron condor over a single vertical spread (a put spread or call spread), is that the initial and maintenance margin requirements for the iron condor are often the same as the margin requirements for a single vertical spread, yet the iron condor offers the profit potential of two net credit premiums instead of only one. This can significantly improve the potential rate of return on capital risked when the trader doesn't expect the underlying instrument's spot price to change significantly.
Another practical advantage of the iron condor is that if the spot price of the underlying is between the inner strikes towards the end of the option contract, the trader can avoid additional transaction charges by simply letting some or all of the options contracts expire. If the trader is uncomfortable, however, with the proximity of the underlying's spot price to one of the inner strikes and/or is concerned about pin risk, then the trader can close one or both sides of the position by first re-purchasing the written options and then selling the purchased options.
To buy or "go Long" an iron condor, the trader will buy (long) options contracts for the outer strikes using an out-of-the-money put
and out-of-the-money call
. The trader will also sell or write (short) the options contracts for the inner strikes, again using an out-of-the-money put and out-of-the-money call. The difference between the put contract strikes will generally be the same as the distance between the call contract strikes.
Because the premium earned on the sales of the written contracts is very likely greater than the premium paid on the purchased contracts, a long iron condor is typically a net credit transaction. This net credit represents the maximum profit potential for an iron condor.
The potential loss of a long iron condor is the difference between the strikes on either the call spread or the put spread (whichever is greater if it is not balanced) multiplied by the contract size (typically 100 or 1000 shares of the underlying instrument), less the net credit received.
A trader who buys an iron condor speculates that the spot price
of the underlying instrument will be between the short strikes when the options expire where the position is the most profitable. Thus, the iron condor is an options strategy considered when the trader has a neutral outlook for the market.
The long iron condor is an effective strategy for capturing any perceived excessive volatility risk premium
, which is the difference between the realized volatility of the underlying and the volatility implied by options prices.
Buying iron condors are popular with traders who seek regular income from their trading capital. An iron condor buyer will attempt to construct the trade so that the short strikes are close enough that the position will earn a desirable net credit, but wide enough apart so that it is likely that the spot price of the underlying will remain between the short strikes for the duration of the options contract. The trader would typically play iron condors every month (if possible) thus generating monthly income with the strategy.
To sell or "go short" an iron condor, the trader will buy (long) options contracts for the inner strikes using an out-of-the-money put and out-of-the-money call options. The trader will then also sell or write (short) the options contracts for the outer strikes.
Because the premium earned on the sales of the written contracts is very likely less than the premium paid for the purchased contracts, a short iron condor is typically a net debit transaction. This debit represents the maximum potential loss for the short iron condor.
The potential profit for a short iron condor is the difference between the strikes on either the call spread or the put spread (whichever is greater if it is not balanced) multiplied by the size of each contract (typically 100 or 1000 shares of the underlying instrument) less the net debit paid.
A trader who sells an iron condor speculates that the spot price of the underlying instrument will not be between the short strikes when the options expire. If the spot price of the underlying is less than the outer put strike, or greater than the outer call strike at expiration, then the short iron condor trader will realise the maximum profit potential.
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...
trading strategy utilising two vertical spreads
Vertical spread
In options trading, a vertical spread is an options strategy involving buying and selling of multiple options of the same underlying security, same expiration date, but at different strike prices...
– a put spread and a call spread with the same expiration and four different strikes. If the outer strikes are bought and the inner strikes sold a long iron condor is produced. The converse produces a short iron condor. The number of call spreads will be equal to the number of put spreads.
The position is so named because of the shape of the profit/loss graph, which loosely resembles a large-bodied bird, such as a condor
Condor
Condor is the name for two species of New World vultures, each in a monotypic genus. They are the largest flying land birds in the Western Hemisphere.They are:* The Andean Condor which inhabits the Andean mountains....
. In keeping with this analogy, traders often refer to the inner options collectively as the "body" and the outer options as the "wings". The word iron in the name of this position indicates that, like an iron butterfly, this position is played across the current spot price of the underlying
Underlying
In finance, the underlying of a derivative is an asset, basket of assets, index, or even another derivative, such that the cash flows of the derivative depend on the value of this underlying...
instrument having one vertical spread below and one vertical spread above the current spot price. This distinguishes the position from a plain Condor position, which would be played with all strikes above, or below the current spot price of the underlying instrument. A Call Condor would be played with all call contracts and a Put Condor would be played with all put contracts.
One of the practical advantages of an iron condor over a single vertical spread (a put spread or call spread), is that the initial and maintenance margin requirements for the iron condor are often the same as the margin requirements for a single vertical spread, yet the iron condor offers the profit potential of two net credit premiums instead of only one. This can significantly improve the potential rate of return on capital risked when the trader doesn't expect the underlying instrument's spot price to change significantly.
Another practical advantage of the iron condor is that if the spot price of the underlying is between the inner strikes towards the end of the option contract, the trader can avoid additional transaction charges by simply letting some or all of the options contracts expire. If the trader is uncomfortable, however, with the proximity of the underlying's spot price to one of the inner strikes and/or is concerned about pin risk, then the trader can close one or both sides of the position by first re-purchasing the written options and then selling the purchased options.
Long iron condor
Put option
A put or put option is a contract between two parties to exchange an asset, the underlying, at a specified price, the strike, by a predetermined date, the expiry or maturity...
and out-of-the-money call
Call option
A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument from the seller...
. The trader will also sell or write (short) the options contracts for the inner strikes, again using an out-of-the-money put and out-of-the-money call. The difference between the put contract strikes will generally be the same as the distance between the call contract strikes.
Because the premium earned on the sales of the written contracts is very likely greater than the premium paid on the purchased contracts, a long iron condor is typically a net credit transaction. This net credit represents the maximum profit potential for an iron condor.
The potential loss of a long iron condor is the difference between the strikes on either the call spread or the put spread (whichever is greater if it is not balanced) multiplied by the contract size (typically 100 or 1000 shares of the underlying instrument), less the net credit received.
A trader who buys an iron condor speculates that the spot price
Spot price
The spot price or spot rate of a commodity, a security or a currency is the price that is quoted for immediate settlement . Spot settlement is normally one or two business days from trade date...
of the underlying instrument will be between the short strikes when the options expire where the position is the most profitable. Thus, the iron condor is an options strategy considered when the trader has a neutral outlook for the market.
The long iron condor is an effective strategy for capturing any perceived excessive volatility risk premium
Volatility risk premium
In mathematical finance, the volatility risk premium is a measure of the extra amount investors demand in order to hold a volatile security, above what can be computed based on expected returns....
, which is the difference between the realized volatility of the underlying and the volatility implied by options prices.
Buying iron condors are popular with traders who seek regular income from their trading capital. An iron condor buyer will attempt to construct the trade so that the short strikes are close enough that the position will earn a desirable net credit, but wide enough apart so that it is likely that the spot price of the underlying will remain between the short strikes for the duration of the options contract. The trader would typically play iron condors every month (if possible) thus generating monthly income with the strategy.
Related strategies
An option trader who considers a long iron condor is one who expects the price of the underlying instrument to change very little for a significant duration of time. This trader might also consider one or more of the following strategies.- A short strangleStrangle (options)In finance, a strangle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlying security moves, with relatively minimal exposure to the direction of price movement...
is effectively a long iron condor, but without the wings. It is constructed by writing an out-of-the-money put and an out-of-the money call. A short strangle with the same short strikes as an iron condor is generally more profitable, but unlike a long iron condor, the short strangle offers no protection to limit losses should the underlying instrument's spot price change dramatically. - A long iron butterfly is very similar to a long iron condor, except that the inner, short strikes are at the same strike. The iron butterfly requires the underlying instrument's spot price to remain virtually unchanged over the life of the contract in order to retain the full net credit, but the trade is potentially more profitable (larger net credit) than an Iron Condor.
- A short straddleStraddleIn finance, a straddle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlying security moves, regardless of the direction of price movement...
is effectively a long iron butterfly without the wings and is constructed simply by writing an at-the-money call and an at-the-money put. Similar to a short strangle, the short straddle offers no protection to limit losses and similar to a long iron butterfly, the straddle requires the underlying instrument's spot price to remain virtually unchanged over the life of the contract in order to retain the full net credit. - A bull put spread is simply the lower side of a long iron condor and has virtually identical initial and maintenance margin requirements.
- A bear call spread is simply the upper side of a long iron condor and has virtually identical initial and maintenance margin requirements.
Short iron condor
Because the premium earned on the sales of the written contracts is very likely less than the premium paid for the purchased contracts, a short iron condor is typically a net debit transaction. This debit represents the maximum potential loss for the short iron condor.
The potential profit for a short iron condor is the difference between the strikes on either the call spread or the put spread (whichever is greater if it is not balanced) multiplied by the size of each contract (typically 100 or 1000 shares of the underlying instrument) less the net debit paid.
A trader who sells an iron condor speculates that the spot price of the underlying instrument will not be between the short strikes when the options expire. If the spot price of the underlying is less than the outer put strike, or greater than the outer call strike at expiration, then the short iron condor trader will realise the maximum profit potential.
Related strategies
An option trader who considers a short iron condor strategy is one who expects the price of the underlying to change greatly, but isn't certain of the direction of the change. This trader might also consider one or more of the following strategies.- A strangleStrangle (options)In finance, a strangle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlying security moves, with relatively minimal exposure to the direction of price movement...
is effectively a short iron condor, but without the wings. It is constructed by purchasing an out-ot-the-money put and an out-of-the money call. While the short iron condor is a less expensive trade (smaller net debit), the Strangle does not restrict profit potential in the case of a dramatic change in the spot price of the underlying instrument. - A short iron butterfly is very similar to a short iron condor, except that the inner, long strikes are at the same strike. The resulting position requires the underlying's spot price to change less before there is a profit, but the trade is typically more expensive (larger net debit) than a short iron condor.
- A straddleStraddleIn finance, a straddle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlying security moves, regardless of the direction of price movement...
is effectively a short iron butterfly without the wings and is constructed simply by purchasing an at-the-money call and an at-the-money put. Similar to the strangle, the straddle offers a greater profit potential at the expense of a greater net debit. - A bear put spread is simply the lower side of a short iron condor and has virtually identical initial and maintenance margin requirements.
- A bull call spread is simply the upper side of a short iron condor and has virtually identical initial and maintenance margin requirements.