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Textbook
1. Introduction
2. Strategies
2.1 Fundamentals
2.2 Contracts & the market
2.3 Basic strategies
2.4 Advanced strategies
2.4.1 Collars
2.4.2 Long straddles
2.4.3 Short straddles
2.4.4 Combinations
2.4.5 Introduction to spreads
2.4.6 Naming spreads
2.4.7 Call spreads
2.4.8 Ratio call spreads
2.4.9 Put spreads
2.4.10 Ratio put spreads
2.4.11 Butterfly spreads
2.4.12 Iron condors
2.5 Non-equity options
2.6 Suitability
3. Customer accounts
4. Rules & regulations
5. Wrapping up
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2.4.12 Iron condors
Achievable Series 9
2. Strategies
2.4. Advanced strategies

Iron condors

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Like butterfly spreads , iron condor strategies involve all four option types and initially seem complex. We’ll cover the following in this chapter:

  • Long iron condors
  • Short iron condors

Long iron condors

Let’s dive right in and look at 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 “heart” of this strategy is similar to a long strangle. As a reminder, a long strangle involves purchasing a call and put, both of which are “out of the money” (maintain no intrinsic value). A long strangle would exist if the long 55 put and long 60 call were extracted together. A $500 total debit would be incurred if the investor only traded these two contracts. The sale of the 50 put and 65 call bring in $200 in premiums, reducing the overall cost of this long iron condor to $300.

Maximum gain
Like a long strangle, the investor is seeking volatility. Best-case scenario, ABC’s market price falls to $50 or rises to $65. If ABC falls to $50, the long 55 put is “in the money” by $5, or $500 overall ($5 x 100 shares per contract). Netting this intrinsic value gain against the initial $300 debit results in a $200 gain. If ABC rises to $65, the long 60 call is “in the money” by $5, or $1,000 overall. Netting this intrinsic value gain against the initial $500 debit also generates a $200 gain. Therefore, $200 is the strategy’s maximum gain in either scenario.

The two short options limit the investor’s gain potential. If ABC’s market price falls below $50, the long 55 put’s intrinsic value gains are offset by the short 50 put’s intrinsic value losses. If ABC’s market price rises above $65, the long 60 call’s intrinsic value gains are offset by the short 65 call’s intrinsic value losses. In either circumstance, the investor makes the maximum gain of $200.

Breakeven
The investor must obtain a return equal to the $300 initial net debit to break even. Long iron condors have two breakeven points because a return can be made in either direction (in a bear or bull market). If ABC’s market price falls to $52, the long 55 put is $3 “in the money,” providing an intrinsic value gain of $300 ($3 intrinsic value x 100 shares per contract). If ABC’s market price rises to $63, the long 60 call is $3 “in the money,” providing an intrinsic value gain of $300. Either scenario offsets the original $300 net debit, so the investor will break even at $52 or $63.

Maximum loss
The investor loses when the market stays flat. All contracts will assumptively expire with no intrinsic value if ABC’s market price remains between $55 and $60. If this occurs, the investor is stuck with their initial net debit, resulting in a $300 maximum loss.

Short iron condors

Let’s dive right in and look at 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 “heart” of this strategy is similar to a short strangle. As a reminder, a short strangle involves selling a call and put, both of which are “out of the money” (maintain no intrinsic value). A short strangle would exist if the short 40 put and short 50 call were extracted together. A $600 total credit would be obtained if the investor only traded these two contracts. The purchase of the 30 put and 60 call cost $200 in premiums, reducing the overall credit of this short iron condor to $400.

Maximum gain
Like a short strangle, the investor is seeking a flat market. In the best-case scenario, XYZ’s market price stays between $40 and $50. Between these two price points, all contracts are “out of the money” and will expire worthless. The investor would keep the $400 net credit with no further action taken. Therefore, $400 is the strategy’s maximum gain.

Breakeven
The investor must lose an amount equal to the $400 initial net credit to break even. Short iron condors have two breakeven points because a loss can be incurred in either direction (in a bear or bull market). If XYZ’s market price falls to $36, the short 40 put is $4 “in the money,” providing an intrinsic value loss of $400 ($4 intrinsic value x 100 shares per contract). If XYZ’s market price rises to $54, the short 50 call is $4 “in the money,” providing an intrinsic value loss of $400. Either scenario offsets the original $400 net credit, so the investor will break even at $36 or $54.

Maximum loss
The investor loses when the market is volatile. Worst-case scenario, XYZ’s market price falls to $30 or rises to $60. If XYZ falls to $30, the short 40 put is “in the money” by $10, or $1,000 overall ($10 x 100 shares per contract). Netting this intrinsic value loss against the initial $400 credit results in a $600 loss. If XYZ rises to $60, the short 50 call is “in the money” by $10, or $1,000 overall. Netting this intrinsic value loss against the initial $400 credit also generates a $600 loss. Therefore, $600 is the strategy’s maximum loss in either scenario.

The two long options limit the investor’s loss potential. If XYZ’s market price falls below $30, the long 30 put’s intrinsic value gains are offset by the short 40 put’s intrinsic value losses. If XYZ’s market price rises above $60, the long 60 call’s intrinsic value gains are offset by the short 50 call’s intrinsic value losses. In either circumstance, the investor is subject to a maximum loss of $600.

Key points

Long iron condors

  • Long strangle with OTM short call and OTM short put
  • OTM short options reduce establishment cost
  • Volatile sentiment
  • Limited gain & loss potential

Short iron condors

  • Short strangle with OTM long call and OTM long put
  • OTM long options reduce risk potential
  • Neutral sentiment
  • Limited gain & loss potential

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