The iron condor not only has the coolest name of all option trading strategies, it also is one of the easiest trades to understand as a novice options trader.
An iron condor is an options trading strategy that is made up of four options contracts, at four different strike prices. An iron condor is typically sold (meaning that you receive a credit for the trade) when you have a neutral market assumption about the underlying.
When To Use An Iron Condor
Typically an iron condor is sold when an underlying's implied volatility rank is high to take advantage of increased option premium. You want to make sure you collect a big enough credit to make the iron condor worth selling, but you also want to place the strike prices far enough away so they don’t go in the money.
How Do I Make Money On An Iron Condor?
If the options expire while the stock price is in between the short strike prices (the two red legs in the image above), the trade will be profitable. Depending on the implied volatility and the option prices, we can also potentially close out of the trade before expiration for a profit. If you trade on tastyworks, the profit area is marked by the green profit zones - seen pictured above.
If the underlying moves outside the green profit zones, into either of the red loss zones, you will lose money on the trade.
Simple enough, right?
Good. Now let's make it a little more complex by breaking down an iron condor into its different components so you understand the fundamentals.
Iron Condor Mechanics
An iron condor is a great trade for smaller accounts and beginners because you define your max loss when choosing strike prices at order entry. Because it is a defined risk trade, it requires less buying power which frees up capital to place other trades.
When you place an iron condor, you are selling two credit spreads:
- A short put spread (called a ‘short put vertical’ in tastyworks)
- A short call spread (called a ‘short call vertical’ in tastyworks)
When selling each spread you will need to decide how wide to make the credit spreads. The width of the spread is the distance between the short and long strike prices.
Credit spreads have defined risk equal to the distance between the two strike prices, minus the credit received for selling the spread. Your max profit is the credit received for selling the spread at order entry. To calculate the max loss for an iron condor, subtract the credit received from the width of the widest spread.
Typically, both sides of an iron condor (the put and call side) have the same spread width. The wider the strike prices, the more credit you will receive for the trade, increasing your probability of profit and your max potential loss.
Setting Up An Iron Condor In tastyworks
On the tastyworks curve page, try playing around with option strike prices to give yourself more or less credit. Notice how moving the long options further out of the money (making the spread wider) increases the credit received and probability of profit.
Make sure to also click on the “REVIEW & SEND” button to view the max loss and max profit of the trade.
The last piece of information you need to understand an iron condor is where to place the call spread and where to place the put spread. The call spread is sold above (higher strike prices) the put spread and each spread is sold out of the money.
When selling an iron condor in tastyworks you can set the width of vertical spreads and their distance from the current stock price by dragging the options or using the Strikes and Width buttons once the iron condor is on the trade screen. If you are looking at an iron condor on the curve page, the out of the money put spread will be to the left of the stock price, and the out of the money call spread will be to the right. If you are selling an iron condor, the options you sell will be closer to the stock price than the options you buy.
A 1 point wide iron condor in Facebook (ticker symbol FB), whose stock price is near $139.50, might look something like below...
Short Put Vertical:
- $138.00 short put
- $137.00 long put
Short Call Vertical:
- $141.00 short call
- $142.00 long call
The max loss would be: (width of the widest spread if they're not the same) - credit received. The max profit would be the total credit received from selling both spreads.
Notice how both spreads are about the same distance away from the current price of the stock. The iron condor seller hopes that the stock price will stay in between the short strikes prices. If the stock is in between the short strikes, above the short put and below the short call, at expiration all of the options will expire worthless. You will see the profit area in green in tastyworks.
That was a lot of information on iron condors...let's recap the 4 biggest takeaways from this post.
Iron Condor Recap
- Iron condors are a combination of a short put spread and short call spread
- Iron condors are a neutral, defined risk trade (good for small accounts and new traders alike)
- To profit off of an iron condor, you want the stock price to remain in between the two short strike prices (and/or volatility to decrease)
- Max loss is the width of the wings, less credit received
Check out Step Up to Options to learn more trading strategies.
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