Iron Condor

An iron condor strategy combines a call spread and a put spread; it involves two call legs and two put legs, all with the same expiration date, generally with consistent distances between strike prices. The strategy gets its name from its 4-part structure, involving the two outer strikes (or "wings") and two inner strikes (representing the "body"). The two inner strikes are typically positioned around the current price of the underlying stock.

Long Iron Condor

A long iron condor is created by selling a lower strike Put, purchasing a higher strike Put, purchasing an even higher strike Call, and selling a consecutively higher strike Call, all with the same expiration date. The two middle strikes are typically positioned around the current price of the underlying stock. In order to be considered a standard condor, the four strike prices involved should be equidistant.

Example:

• Sell to Open 1 XYZ 01/17/2015 40.00 Put
• Buy to Open 1 XYZ 01/17/2015 42.50 Put
• Buy to Open 1 XYZ 01/17/2015 45.00 Call
• Sell to Open 1 XYZ 01/17/2015 47.50 Call

If the distance between the two middle strikes (the "body") is greater than the distance to the outer strikes (the "wings"), then the position may be considered to be an "albatross" spread.

The cost to purchase the inner strikes typically exceeds the premium received from selling the outer strikes; therefore, a long iron condor is typically established as a net debit position.

For use when investor anticipates:

• Significant movement in security price (in either direction)
• Higher volatility

Financial Characteristics:

• Maximum Loss: Initial net debit paid
• Maximum Gain: Difference between the long put strike price and short put strike price, less the net debit paid

Objective:

• Gain from significant change in price of the underlying security (either up or down) by expiration

EXAMPLE - Long Iron Condor

Assume it is August 1st, 2014, and Michelle, an options trader, has identified XYZ as a stock she believes will make a sharp move, either higher or lower, over the next month and a half. Therefore, she decides a Long Iron Condor is an appropriate strategy, given her outlook and the limited risk that the strategy offers. XYZ is currently trading at $27.98, and Michelle decides that the 27.50 strike Put and 30.00 strike Call are appropriate middle strikes. In addition, she feels that the 32.50 strike Call and 25.00 strike Put are acceptable strikes, as she believes the underlying price will either be below $25.00 or above $32.50 at expiration. Lastly, Michelle selects the September expiration; it is 50 days away which is in line with her timing forecast.

 

Source: StreetSmart Edge

Trade Setup

Here is the breakdown for Michelle's setup and trade:

• Current XYZ Price = $27.98
• Current Bid Price, XYZ 09/20/2014 25.00 Put = $0.65
• Current Ask Price, XYZ 09/20/2014 27.50 Put = $1.70
• Current Ask Price, XYZ 09/20/2014 30.00 Call = $0.85
• Current Bid Price, XYZ 09/20/2014 32.50 Call = $0.30
• Michelle's Trade:
  • Sell to Open 1 XYZ 09/20/2014 25.00 Put @ $0.65
  • Buy to Open 1 XYZ 09/20/2014 27.50 Put @ $1.70
  • Buy to Open 1 XYZ 09/20/2014 30.00 Call @ $0.85
  • Sell to Open 1 XYZ 09/20/2014 32.50 Call @ $0.30
  • Net Debit = -$0.65 + $1.70 + $0.85 - $0.30 = $1.60

The Profit/Loss profile for this trade is as follows:

Note: Chart depicts strategy at expiration

• Maximum Gain = ($27.50 - $25.00) - 1.60= $0.90
• Maximum Loss = $1.60
• Lower Break-Even = Long Put Strike Price - Net Debit = $27.50 - $1.60= $25.90
• Upper Break-Even = Long Call Strike Price + Net Debit = $30.00 + $1.60 = $31.60

Note: commissions have been excluded to simplify the calculations. Short options can be assigned at any time and therefore option sellers assume the risk of assignment at any point up until and including expiration.

Commissions, taxes, and transaction costs are not included in any of these strategy discussions, but can affect final outcome and should be considered. Please contact a tax advisor to discuss the tax implications of these strategies. Many of the strategies described herein require the use of a margin account.

Qualified Spreads

With a Qualified Spread, the purchased option is required to expire on the same or later expiration date than the option sold. When there is more than one possible way to pair available options in your Account, Schwab has the discretion to determine the spread pairings. Schwab may pair options in a manner that does not produce the lowest possible margin requirements.

Note: For butterfly and condor spreads, each option leg must have the same expiration date to qualify as those types of spreads.

Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Multiple leg options strategies will involve multiple commissions. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options." Member SIPC