You are on page 1of 5

Short Iron Condor

Direction: Volatility in Either Direction


Strategy Description

Short Iron Condor is one of the volatility strategies employed in a highly volatile stock.
It is usually a four-legged spread option strategy using a combination of both puts and
calls options with the same expiration date but different strike prices. Typically the
distance between the strike prices for the various options are equal for this strategy.

Unlike the regular butterfly spread, shorting (selling) an Iron Condor is created by using
a combination of puts and calls options instead of all calls or all puts options.

Short Iron Condor =

1 lower strike OTM Short Put + 1 lower middle strike Long Put + 1 higher middle
strike Long Call + 1 higher strike OTM Short Call
OR
1 Bear Put Spread + 1 Bull Call Spread
OR
1 Narrow Long Strangle (Long middle strike puts and calls) + 1 Wide Short
Strangle (Short OTM puts and calls).

Outlook: With this stock option trading strategy, your outlook isdirectional neutral.

You are expecting an increase in volatility of the underlying stock price.

However you are not concern on whether the stock will move in which direction.

Click here to ask a question or discuss in more detail with fellow traders on the topics
relating to Short Iron Condor strategy

Risk and Reward

Maximum Risk:

Limited to the amount of Net Premium Paid for the various options entered. (May
loss 100% of amount invested in this option trading strategy).

Maximum Reward :

Limited to the different in adjacent strikes less net premium paid when the stock is
between the two middle strike price (at expiration).

Breakeven :

Upside Breakeven = Middle Long Call Strike plus Net Premium Paid

1
Downside Breakeven = Middle Long Put Strike less Net Premium Paid.

Net Position:
This is typically a net debit trade as you are combining two debit spread: Bear Put
Spread and Bull Call Spread at the same time.

Advantages and Disadvantages

Advantages:

Make profit from extremely volatile stocks, without having to determine the direction.
Limited risk exposure when the underlying stock is between the two middle strike
prices on expiration date.
Typically lower net premium paid compare to Short Iron Butterflystrategy

Disadvantages:

Usually offer smaller return compare to straddle or strangle strategies with only
slightly lower risk exposure.
Pay double (or near double) premium to a stock that is expanding in volatility.
Significant movement of the stock and options prices is required for this strategy to be
profitable.
Bid/Ask spread from the various option legs may adversely affect the profit potential
of the strategy.

Exiting the Trade

Offset the position by buying back the options that you sold and selling the options
that you have bought in the first place.
As the underlying stock fluctuate up and down, advance option traders may choose to
unravel the spread leg by leg. In this way, the trader will leave one leg of the spread
exposed while he profit from the closure of the other legs.
Remembering that Short Iron Condor is a combination of other strategies, you can
also unravel the spread in two legs. In this way, advance traders can create bullish,
bearish, sideway or volatility strategies based on the underlying stocks movement.

Short Iron Condor Example

Assumption: XYZ is trading at $37.10 a share on Mar 20X1. The verdict of a legal law
suit against the company is expected to be made soon. You are expecting share price of
XYZ to soar up or plummet down once the verdict is out. You would like to profit from
the volatility of this stock with limited risk exposure and lesser cost outlay than a Short
Iron Butterfly strategy.

In this case, you may consider to sell one Jun 20X1 $30 strike put at $0.30, buy one Jun
20X1 $35 strike Put at $1.40, buy one Jun 20X1 $40 strike call at $1.00 and sell one Jun
20X1 $45 strike call at $0.40 to profit from the volatile outlook of the stock. Note:
commissions are NOT taken into account in the calculation.

2
Analysis of Short Iron Condor Example

Maximum Risk
= Limited to the amount of Net Premium Paid
= ($1.40 - $0.30 + $1.00 - $0.40) * 100 = $170
Maximum Reward
= Limited to the different in adjacent strikes less net premium paid
= ($5.00 - $1.70) * 100 = $330
Upside Breakeven
= Middle Long Call Strike Price plus Net Premium Paid
= $40 + $1.70 = $41.70
Downside Breakeven
= Middle Long Put Strike Price less Net Premium Paid
= $35 - $1.70 = $33.30

A Short Iron Condor is a strategy whereby you combine 2 debit vertical spread
strategies: Bear Put Spread and Bull Call Spread to profit in the event of a big move by
the underlying stock. It is a four legged spread option strategy consisting of puts and
calls options and is the opposite of Long Iron Condor, which is a sideway strategy

3
Typically the strike prices between the options legs are equal. However if you have a
stronger view in one of the direction, you do not need to space them equally apart. You
can weight more toward calls versus puts, or vice versa, by tailoring the position
according to your view of the underlying stock and the risk-reward parameters.

Before you executed a Short Iron Condor strategy, you must first determine at which
price the underlying stock will most probably NOT be trading at the expiration date.
This is the price that will be in between the two middle strike where you purchase the
puts and calls options. Next sell a lower strike put option and a higher strike call option
of the same expiration date. These two short options help to reduce the cost of the two
long options.

A Short Iron Condor is typically a bet on the volatility expansion. Verdict of law suit,
product announcement, earning or economic reports do have a tendency to move the
stock price sharply up or down.

The maximum profit will be earned, at the expiration date, when the underlying stock
moves beyond one of the breakeven points in either direction.

The maximum loss will occur when the underlying stock close in between the two middle
strike prices at expiration day.

This is a net debit trade as you are paying the premium for both the puts and calls
spreads. The risk is that the stock is trading range bound or the move is not big enough
to push the stock price beyond the breakeven point during the trading time frame,
forcing both the puts and calls debit spread to decay in value. Therefore it is preferably
to use this option trading strategy with at least 3 months left to expiration so as to give
yourself more time to be right.

An Iron Condor strategy is a good strategy to deploy in your arsenal of trading


strategies. You should pick the strike price and time frame of the Short Iron
Condor according to your risk/reward tolerance and forecast outlook of the underlying
stock. Having the patient to wait, knowledge to apply and discipline to follow
through the option trading strategies with appropriate risk-reward parameters is
important to your long term success in option trading.

Related Strategies

Short Call Condor Long Strangle Long Iron Condor


Sideway Strategy Volatility Strategy Sideway Strategy

4
Limited Risk Limited Risk Limited Risk
Limited Profit Unlimited Profit Limited Profit
Credit Trade Debit Trade Credit Trade
Same risk profile Unlimited profit Opposite risk profile
as Short Iron potential but higher of Short Iron
Condor cost compare Condor
to Short Iron
Bear Call Spread + Bull Put Spread +
Condor
Bull Call Spread Bear Call Spread
Long Call + Long
Put