The iron condor is an enhanced option trading method using 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 short iron condor is produced. The converse produces a long iron condor. The number of call spreads will be identical to the number of put spreads.
One of the valuable advantages of an iron condor over a single vertical spread (a put spread or call spread), is that the margin needs for the iron condor are usually the same as the margin requirements for a single vertical spread, the iron condor provides the profit potential of two credit premiums rather than only one. This can significantly improve the possible rate of return on capital risked when the trader doesn't anticipate the underlying instrument's price to change substantially.
Another beneficial advantage of the iron condor is that if the price of the underlying asset is between the inner strikes towards the conclusion of the option contract, the trader can avoid additional transaction fees by simply letting the options contracts expire worthless.
Example of a Short Iron Condor
Trader Joe doesn't think the market will move too much before his options expire and he wants additional income so he sets up a short iron condor as follows:
XYZ stock is currently trading at 50. He doesn't expect the stock to go any higher than 58 or any lower than 42. So he does the following:
sells 10 calls at 60 for .75 which gives him a premium of $750
buys 10 calls at 62 for .50 which cost him $500
sells 10 puts at 40 for .70 which gives him a premium of $700
buys 10 puts at 38 for .45 which cost him $450
Thus he ends up with a net premium of $750 - $500 + $700 - $450 or $500
If the stock price at options expiration is 40 or greater or 60 or less, Joe has made a gain of $500.
A closing stock price anywhere between $60 and 62 or between 38 and 40 would give Joe a smaller loss or smaller gain; the breakeven stock price is either $60.50, or $39.50, which is the higher strike price minus the credit.
If the stock price is either 62 or greater or 38 or lower, Joe would have a loss of $2,000 minus his premium of $500 or a net loss of $1,500.
Example of a Long Iron Condor
Trader Joe thinks the market will move sharply before his options expire, but not sure which way it will move, so he sets up a long iron condor as follows:
XYZ stock is currently trading at 50. He expects the stock to either past 60 or below 40. So he does the following:
sells 10 calls at 62 for .50 which gives him a premium of $500
buys 10 calls at 60 for .75 which cost him $750
sells 10 puts at 38 for .45 which gives him a premium of $450
buys 10 puts at 40 for .70 which cost him $700
Thus he ends up with a net debit of $500 - $750 + $450 - $700 or minus $500
If the stock price at options expiration is 40 or greater or 60 or less, Joe has lost $500
A closing stock price anywhere between $60 and 62 or between 38 and 40 would give Joe a smaller loss or smaller gain; the breakeven stock price is either $60.50, or $39.50, which is the higher strike price minus the credit.
If the stock price is either 62 or greater or 38 or lower, Joe would have a gain of $2,000 minus his premium of $500 or a net gain of $1,500.
Most people get lured into options because of the huge POTENTIAL gain. But what they do NOT realize is the large gains seldom materialize. The average investor only wins 30% of the time. What they fail to do is to consider the probability of success of getting a high gain. They are told to make sure they have a reward to risk ratio of at least 2:1. BUT they are never told to consider the probability of success!!! What good does it do to have a high reward to risk ratio if the probability of success is only 10% or less.
The trading strategy below insures a monthly gain of 3 to 8% with a success rate of 99+%.
After spending hundreds of hours analyzing how the market moved weekly for 25 years, I’ve developed what I call the Remarkable Iron Condor Strategy.
It has the following characteristics:
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