Iron condors

Like butterfly spreads, iron condor strategies use all four option types and can look complex at first. This chapter covers:

• Long iron condors
• Short iron condors

Long iron condors

Here’s an example of a long iron condor:

Short 1 ABC Feb 50 put at $1
Long 1 ABC Feb 55 put at $2
Long 1 ABC Feb 60 call at $3
Short 1 ABC Feb 65 call at $1

ABC’s market price = $58

The core (or “heart”) of this strategy is similar to a long strangle. A long strangle involves buying an out-of-the-money call and an out-of-the-money put (so both have no intrinsic value at entry).

In this iron condor, the long 55 put and long 60 call form that long strangle. Buying those two options costs a total debit of $500. Selling the 50 put and 65 call brings in $200 in premium, reducing the net cost of the position to a $300 debit.

Maximum gain
Like a long strangle, this position benefits from volatility. The best outcomes occur if ABC moves down to $50 or up to $65.

• If ABC falls to $50, the long 55 put is in the money by $5, giving $500 of intrinsic value ($5 × 100). Netting that against the $300 debit produces a $200 gain.
• If ABC rises to $65, the long 60 call is in the money by $5, giving $500 of intrinsic value ($5 × 100). Netting that against the $300 debit also produces a $200 gain.

So, the maximum gain is $200.

The two short options cap the upside beyond the short strikes:

• Below $50, additional gains on the long 55 put are offset by losses on the short 50 put.
• Above $65, additional gains on the long 60 call are offset by losses on the short 65 call.

In either case, the position is capped at the $200 maximum gain.

Breakeven
To break even, the position must earn back the $300 net debit. A long iron condor has two breakeven points because the underlying can move either down or up.

• On the downside, breakeven occurs at $55 − $3 = $52. At $52, the long 55 put has $3 of intrinsic value, or $300 ($3 × 100).
• On the upside, breakeven occurs at $60 + $3 = $63. At $63, the long 60 call has $3 of intrinsic value, or $300.

So, the breakeven points are $52 and $63.

Maximum loss
This position loses when the market stays relatively flat. If ABC finishes between $55 and $60, all options expire out of the money (with no intrinsic value). In that case, the entire $300 net debit is lost.

So, the maximum loss is $300.

Short iron condors

Here’s an example of a short iron condor:

Long 1 XYZ Dec 30 put at $1
Short 1 XYZ Dec 40 put at $3
Short 1 XYZ Dec 50 call at $3
Long 1 XYZ Dec 60 call at $1

XYZ’s market price = $44

The core of this strategy is similar to a short strangle. A short strangle involves selling an out-of-the-money call and an out-of-the-money put (so both have no intrinsic value at entry).

In this iron condor, the short 40 put and short 50 call form that short strangle. Selling those two options brings in a $600 total credit. Buying the 30 put and 60 call costs $200, reducing the net credit to $400.

Maximum gain
Like a short strangle, this position benefits from a flat market. The best outcome is for XYZ to finish between $40 and $50.

Between $40 and $50, all options are out of the money and expire worthless. The investor keeps the $400 net credit.

So, the maximum gain is $400.

Breakeven
To break even, the position must lose an amount equal to the $400 net credit. A short iron condor has two breakeven points because losses can occur on either side.

• On the downside, breakeven occurs at $40 − $4 = $36. At $36, the short 40 put has $4 of intrinsic value, creating a $400 loss ($4 × 100).
• On the upside, breakeven occurs at $50 + $4 = $54. At $54, the short 50 call has $4 of intrinsic value, creating a $400 loss.

So, the breakeven points are $36 and $54.

Maximum loss
This position loses when the market is volatile. The worst outcomes occur if XYZ falls to $30 or rises to $60.

• If XYZ falls to $30, the short 40 put is in the money by $10, creating a $1,000 intrinsic value loss ($10 × 100). Netting that against the $400 credit results in a $600 loss.
• If XYZ rises to $60, the short 50 call is in the money by $10, creating a $1,000 intrinsic value loss ($10 × 100). Netting that against the $400 credit also results in a $600 loss.

So, the maximum loss is $600.

The two long options cap the loss beyond the long strikes:

• Below $30, gains on the long 30 put offset additional losses on the short 40 put.
• Above $60, gains on the long 60 call offset additional losses on the short 50 call.

In either case, the position is limited to the $600 maximum loss.