The iron condor is a limited risk, non-directional option trading strategy that is designed to have a large probability of earning a small limited profit when the underlying security is perceived to have low volatility. The iron condor strategy can also be visualized as a combination of a bull put spread and a bear call spread.
Sell 1 OTM Put, Buy 1 OTM Put (Lower Strike), Sell 1 OTM Call, Buy 1 OTM Call (Higher Strike)
Using options expiring on the same expiration month, the option trader creates an iron condor by selling a lower strike out-of-the-money put, buying an even lower strike out-of-the-money put, selling a higher strike out-of-the-money call and buying another even higher strike out-of-the-money call. This results in a net credit to put on the trade.
Limited Profit
Maximum gain for the iron condor strategy is equal to the net credit received when entering the trade. Maximum profit is attained when the underlying stock price at expiration is between the strikes of the call and put sold. At this price, all the options expire worthless.
Net Premium Received - Commissions Paid
Profit achieved when: Price of Underlying is in between Strike Prices of the Short Put and the Short Call
Limited Risk
Maximum loss for the iron condor spread is also limited but significantly higher than the maximum profit. It occurs when the stock price falls at or below the lower strike of the put purchased or rise above or equal to the higher strike of the call purchased. In either situation, maximum loss is equal to the difference in strike between the calls (or puts) minus the net credit received when entering the trade.
Strike Price of Long Call - Strike Price of Short Call - Net Premium Received + Commissions Paid
Loss occurs when: Price of Underlying >= Strike Price of Long Call OR Price of Underlying <= Strike Price of Long Put
Breakeven points
Strike Price of Short Call + Net Premium Received
Strike Price of Short Put - Net Premium Received
Example
Suppose XYZ stock is trading at $45 in June. An options trader executes an iron condor by buying a JUL 35 put for $50, writing a JUL 40 put for $100, writing another JUL 50 call for $100 and buying another JUL 55 call for $50. The net credit received when entering the trade is $100, which is also his maximum possible profit.
On expiration in July, XYZ stock is still trading at $45. All the 4 options expire worthless and the options trader gets to keep the entire credit received as profit. This is also his maximum possible profit.
If XYZ stock is instead trading at $35 on expiration, all the options except the JUL 40 put sold expire worthless. The JUL 40 put has an intrinsic value of $500. This option has to be bought back to exit the trade. Thus, subtracting his initial $100 credit received, the options trader suffers his maximum possible loss of $400. This maximum loss situation also occurs if the stock price had gone up to $55 instead.
To further see why $400 is the maximum possible loss, lets examine what happens when the stock price falls to $30 on expiration. At this price, both the JUL 35 put and the JUL 40 put options expire in-the-money. The long JUL 35 put has an intrinsic value of $500 while the short JUL 40 put is worth $1000. Selling the long put for $500, he still need $500 to buy back the short put. Subtracting the initial credit of $100 received, his loss is still $400.
Commissions
These examples exclude commissions and fees. Include all transaction costs when evaluating the profit or loss of a position.
Similar strategies
The Reverse Iron Condor
The converse strategy to the iron condor is the reverse or short iron condor. Short iron condors are used when one perceives the volatility of the price of the underlying stock to be high.
Wingspreads
The iron condor spread belongs to a family of spreads called wingspreads whose members are named after a myriad of flying creatures.