Iron Condor

An iron condor is an options strategy built from four options on the same underlying with the same expiry: a put and a call are sold out of the money, and a further put and call are bought even further out of the money to cap the risk. The trader receives a net premium at the start and keeps it if the underlying finishes between the two sold strikes. It is a defined-risk way of taking the view that a market will stay within a range.

The position can be seen as two examples of an option spread placed side by side, a put credit spread below the market and a bear call spread above it. It is related to the condor spread, which produces a similar payoff using only calls or only puts, and to the strangle, of which it is the hedged, short version.

The four legs, from the lowest strike price to the highest, are:

• Buy one put at strike $K_1$, the lower wing.
• Sell one put at strike $K_2$.
• Sell one call at strike $K_3$.
• Buy one call at strike $K_4$, the upper wing.

The underlying usually trades between $K_2$ and $K_3$ when the position is opened, and the two wings are normally the same width. The sold options bring in more premium than the bought options cost, so the trade is opened for a net credit.

At expiry the best outcome is:

The worst outcome is:

Wing width is $K_2 - K_1$, or equally $K_4 - K_3$. The break-even prices are $K_2 - \text{Net credit}$ on the downside and $K_3 + \text{Net credit}$ on the upside.

Suppose a share trades at 100. A trader buys the 85 put for 0.50, sells the 90 put for 1.20, sells the 110 call for 1.10 and buys the 115 call for 0.40. The net credit is $1.20 + 1.10 - 0.50 - 0.40 = 1.40$, or $140 on contracts covering 100 shares. If the share finishes anywhere from 90 to 110, all four options expire worthless and the trader keeps the $140. The maximum loss is $5.00 - 1.40 = 3.60$, or $360, reached if the share ends at or below 85 or at or above 115. The break-even prices are 88.60 and 111.40. Only one side can lose at expiry, since the share cannot finish below 90 and above 110 at once.

An iron condor is a short-volatility position. It gains from the passing of time, measured by theta, as the sold options lose value faster than the bought ones. It has negative vega, so a fall in implied volatility helps and a rise hurts. It is opened close to delta neutral, but negative gamma means the position becomes directional as the underlying approaches either short strike. Traders tend to open iron condors when implied volatility is high relative to its history, which widens the range for a given credit. The strategy is one way of collecting the volatility risk premium and is a common form of selling volatility.

The payoff is lopsided. In the example the trader risks 3.60 to make 1.40, so one maximum loss offsets more than two and a half maximum gains. A high probability of profit does not by itself make the trade favourable. What matters is whether the credit received is fair compensation for the size and likelihood of the loss. Sharp moves, gaps on news and earnings announcements are the main dangers.

Other risks are practical. Four legs mean four commissions and four bid-ask spreads, which take a meaningful share of a small credit. With American-style options the short legs can be assigned early, especially a short call just before a dividend. If the underlying closes between a short strike and its wing at expiry, the short option is exercised and the long one is not, leaving an unintended share position. Many traders close or adjust the position before expiry to avoid this.

An iron butterfly sells the put and the call at the same strike, giving a larger credit and a narrower profit zone. It is the iron version of the butterfly spread. A broken-wing condor uses wings of unequal width to shift the risk to one side. The reverse, or long, iron condor buys the inner options and sells the outer ones, paying a debit to profit from a large move in either direction. Without the two protective wings, the position is a short straddle or short strangle, which has no limit on losses.