What is an iron condor?
An iron condor is a type of options strategy where you sell a call credit spread and a put credit spread that are out-of-the-money with the same expiration date. You can sell iron condors at any distance from the stock's current price and with any size spread between the short and long options.
The closer the strike prices are to the underlying stock's price, the more credit will be collected, but there is also a higher probability that the option will finish in-the-money. There is greater upside when putting on iron condors with a wider difference between the short and long options, but there is also a higher risk of loss.
When to use an iron condor strategy
Traders use iron condors when they expect the stock to exhibit range-bound movement for a certain amount of time. The strategy is designed to take advantage of a decrease in volatility, the passing of time, and little or no movement from the underlying asset.
An iron condor functions like a short strangle with long option protection purchased above and below the short strikes in order to limit risk. This strategy is considered market neutral, which means it lacks a bias in one direction or another.
How to manage an iron condor position
Iron condors benefit from time decay. A trader that puts this strategy on wants all four options to expire worthless. The effect of implied volatility on the value of an iron condor position changes depending on how close the underlying stock trades relative to the strike prices that make up your position.
If the stock is close to or between the middle strikes, you want the volatility to go down. This will make all of the options worth less, and ideally, you would like the iron condor to expire without any value. The underlying stock price remaining stable is a good sign. It typically signals implied volatility is decreasing.
Generally, you want volatility to increase when the stock price trades close to or beyond the higher and lower strike prices. An increase in volatility will make the option that you own at the near-the-money strike price more valuable, while having less of an effect on the short options at the middle strikes. In this scenario, the overall value of the iron condor will decrease, making it less expensive to close your position.
Iron condor maximum profit potential
The total amount you receive from the spreads is your maximum profit.
Iron condor maximum loss potential
The maximum loss potential is the difference between the spread widths, minus the amount you received from the spreads.