What is an iron condor?

By , CEO of Volcube.

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An iron condor is an options strategy that involves four options (2 calls and 2 puts) struck on the same underlying product with the same expiration date. The calls and puts are traded as spreads. For example, 98/99/100/101 iron condor means the 99/98 put spread  traded with the 100/101 call spread. Buying the iron condor means buying the call spread and the put spread.

Iron condors have a limited-risk profile. This means profit and loss for both the buyer and seller of the strategy is limited. For the buyer, his loss is limited to the amount he pays for the iron condor. His potential profit depends on the strike ranges of the iron condor. If the strikes are evenly spaced (for example as in the case of the 98/99/100/101 iron condor) then the potential profit is the difference between the strikes of the spreads, less the amount paid for the iron condor as a whole. Let’s take an example. If I pay 0.10 cents for the 98/99/100/101 iron condor, my potential loss is 0.10 cents. My potential profit is 0.90 cents (1.00 [difference between 99 and 98 or between 100 and 101] minus 0.10 cents). The seller of this iron condor has the reverse payoff profile. His maximum gain is the 0.10 cents that he receives from me; his maximum loss is 0.90 cents. Note that this is the case for simple, regularly spaced iron condors (where the strikes are evenly spread). Otherwise, the potential profits/losses are different.

Iron condors are often traded as a volatility play. The seller of the iron condor expects the underlying product to trade within a certain range (ie between the middle strikes of the iron condor), or at least to be trading in this range come the options’ expiration date. The iron condor can also be viewed as buying a strangle (say the 99/100) versus selling another strangle (the 98/101). The seller of a strangle usually expects the underlying product to trade within a certain range. But by purchasing a second strangle with strikes outside the range of the first strangle, he limits his losses should his expectation prove incorrect.

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