Iron Condor is a options trading strategy with limited risk, non-directional outlook and defined maximum profit. Structured to have a big probability of success. This trade works best when there are no volatility spikes in the market. The strategy can be broken down into four singular option positions, consisting of:

All of the above mentioned options are of the same expiry date. Creation of an iron condor trade results in generating net credit for the trader.

## Limited Risk

Maximum loss is limited to the difference between either calls or puts strike prices. Minus the credit received when opening the position. Almost always this potential loss is much higher then maximum possible profit. That’s because the probability of loss is smaller than of gaining a profit. The trader loses money when underlying exceeds the short calls strike price + credit received. Or when it falls below the strike price of short put – credit received. Maximum loss will occur when the underlying touches or goes above/below the strike of long call/put respectively.

##### Summary of loss calculation:

- Maximum loss = short put strike price – long put strike price + maximum profit = long call strike price – short call strike price + maximum profit
- Current loss (if underlying price outside of short call/put strike bounds and exceeds credit received) = (current underlying price – short call strike price + maximum profit) or (short put strike price – current underlying price + maximum profit)

## Maximum profit

The trader realises a maximum profit when the underlying stays within the boundaries of short call and put. That’s because all options expire out of the money. In consequence there is no assignment. To calculate the maximum profit one needs to:

- Add up the premium of short option legs.
- Subtract from that the cost of long legs.
- Subtract transaction costs.

##### Summary of maximum profit calculation:

- Maximum profit = (short call premium + short put premium) – (long call premium + long put premium) – transaction costs.
- Achieved when underlying price is between short strikes.

## Assignment risk

Stock options in the United States can be exercised on any business day, and holders of short stock option positions have no control over when they will be required to fulfill the obligation. Therefore, the risk of early assignment is a real risk that you must consider when entering into positions involving short options. While the long options in an iron condor spread have no risk of early assignment, the short options do have such risk. Early assignment of stock options is generally related to dividends.

## Iron condor example

Let’s imagine that an XYZ stock is currently priced at 100$. A trader decides to enter an iron condor spread. As she/he believes that the stock will remain calm. Therefore a trader assumes price range of 95-105$. Because of that 95$ OTM put and 105$ OTM call get sold for 1$ each. To limit risk trader buys 92$ OTM put and 108$ OTM call for 0.7$ each. As a result the broker credits his/hers account with 60$. The maximum risk of this strategy is equal to 95-92 = 108 – 105 = 3 which translates to 300$.

First let’s see what happens when price of the underlying remains within 95-105$ range.

Iron condor payoff diagram:

## Cash flow on opening

Iron condor is a credit strategy, hence initial cash flow is positive, because the inner strike put and call which you sell are more expensive than the outer strike put and call which you buy. In the last example. Assuming one contract which represents 100 shares of the underlying. Initial cash flow is:

- -70$ for the long put
- +100$ for the short put
- +100$ received for the short call
- -70$ for the long call

Therefore we get 200$ for the short legs and pay 60$ for the long legs. Net premium credited is 60$.

## Iron condor delta of strikes

Iron condors are advanced options trades designed as an income strategy. There is one major problem, how to determine your desired strike prices? Finding them takes a bit of finesse. So, how do you decide which strikes to sell? Options have probabilities built into their prices in the form of delta. If you take the strike prices of the call and the put where both have a delta around 16, you’ve found what may be the far end of the expected range for that expiration period. This can be one approach for selecting the strikes for your iron condor. If the 16-delta call marks the high end of the expected range. Then the 16-delta put marks the low end. Using the strikes of these options gives you one example of a mathematically based rationale for choosing your iron condor strike price.

## How volatility affects this trade

Short iron condor spreads have a negative vega. This means that the net credit for establishing a trade rises when volatility rises (and the spread loses money). When volatility falls, the net credit of the strategy falls (and the spread makes money). Short iron condor spreads, therefore, should be established when volatility is “high” and forecast to decline.

**Remember: **Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices. As volatility rises, option prices tend to rise if other factors such as stock price and time to expiration remain constant.

## Iron condor hedge with calendar spread

To protect against increased volatility arising from falling prices, you can hedge your iron condor with an out-of-the-money put calendar spread. In this spread, you sell short-term out-of-the-money puts and buy longer-term puts at the same strike. All the puts benefit from increased volatility, but the long-term long puts are more sensitive to it because they have more time value. The calendar is a debit spread, which means it will cut into your condor’s credit. The long put provides downside protection, but it won’t help if the stock index moves sharply higher.