Iron Condor Briefly Defined
An Iron Condor is an option spread trade built from two other separate spread trades: a bullish put spread and a bearish call spread.
It is essentially a bet that a stock will not trade above or below specified levels for a set period of time. If the stock closes at expiration within that range, the trader retains the maximum profit from it, which can be very lucrative based on ROI and for such a short period of time.
Like any option trading strategy, there are advantages and disadvantages to trading the iron condor.
Advantages
- Double premium. By far the biggest advantage is the opportunity to collect twice the premium that you would get by setting up just a single Bull Sell Spread or Bear Call Spread position.
- A more secure single premium. You can also take a more conservative approach and choose to receive the same total net premium available on a single bull put or bear call spread position. In theory, you take less risk (by setting strike prices further from the current stock price) and receive the same amount of money.
- Guaranteed maximum profits in the middle of the operation. Because the stock cannot simultaneously close below the bull sell strike price and above the bear call strike price, one of those legs is guaranteed to expire worthless, ensuring your maximum profits on that part of the trade.
- Double leverage at half price. Similarly, because the stock cannot close both below the low end of the range and above the high end of the range, a pro-options broker will only require you to collateralize half of the trade. Because you cannot sustain a loss on both the up and down options, your hold requirement (for brokers that take options) will be the equivalent of just one of those trades.
- flexibility. Options trading, by its very nature, is flexible. That is also true with the iron condor. In the event of a large movement in the price of a stock on which you have built an iron condor, the underwater short option can be bought back at a loss and the corresponding long option can remain open. If the stock continues its directional move, the long option will increase in value, potentially offsetting and even reversing the loss.
Disadvantages
- Two ways to lose instead of one. Because you’re betting that a stock won’t break above a specified trading level in either direction, you’ve essentially doubled the ways you can lose money.
- Big potential losses. While your maximum potential gains based on ROI may be very lucrative, your maximum potential losses based on ROI may be much higher. If the stock makes a large and unexpected move in either direction, you will most likely suffer significant loss of capital at risk.
- On leverage of indications. Because the capital required to establish a single iron condor is very small (the difference between the strike prices within the bull or bear sell range times 100 minus the net premium received), and because that number will not change during the holding period, it is very easy to establish more iron condor positions than is prudent.
Conclusion:
Iron Condors can produce tremendous rates of return. But they are definitely not without risk. Investors are advised to carry out additional and thorough research and consider all risks involved before employing this strategy.