Iron Condor

The iron condor consists of constructing both a bull put spread and a bear call spread on the same underlying stock with the same expiration date.

By doing so, you create a trading range that, if the underlying stock stays within, can result in some pretty decent income.

Iron Condor Overview

Specifically, you would write an out of the money put option and purchase a farther out of the money put option to form a bull put). This forms the lower boundary of the condor.

At the same time, you would also write an out of the money call option and purchase a farther out of the money call option to form a bear call. This in turn forms the upper boundary of the condor.

The trade produces a net credit. Actually, since it's formed with both a bull put and bear call, it produces two net credits. The maximum gain is the total amount of net credit received if the share prices finishes between the higher strike price put and the lower strike price call.

If you like the insurance company metaphor we used earlier on the bull put page, you can view the condor trade in similar terms. In this case, you're insuring a specific stock in another investor's portfolio from both increases AND decreases in share price. In effect, you're insuring against moves outside a pre-determined trading range.

As with bull put spreads and bear call spreads, there are three variables involved in this trade:

• Range (strike prices)
• Duration (expiration date)
• Income (net premium)

Iron Condor Example

The XYZ Zipper Company is trading at $30/share.

Earnings season is still two months away and the company hasn't produced a controversy in quite some time. You feel confident that the stock won't stray very far from its current price in the near term.

You consult the stock's option chain and decide to employ an iron condor option trading strategy, setting up both a bull put spread and a bear call spread.

For simplicity's sake, let's assume that you set up both the bull put and bear call portions of the trade at the same time (although that isn't required), and all expiration dates are 30 days away:

• You sell a $27.50 put option for $1/contract and purchase a $25 put option for $0.50/contract (netting you a $0.50 credit).
• You then sell a $32.50 call option for $1/contract and purchase a $35 call option for $0.50/contract (netting you another $0.50 credit).
• Excluding commissions, you receive a net credit of $1/contract, or $100 ($2 in total credits less $1 in total debits).

To realize your maximum gain, you want XYZ to close at expiration anywhere in the $27.50-$32.50 range.

The table below illustrates the possible scenarios depending upon the stock's final share price.

Share Price	Bull Put Portion	Bear Call Portion	Overall
$35.00+	Full Profit	Full Loss (less prem)	Loss Likely
$32.50-$35.00	Full Profit	Partial Loss	Profit or Loss
$27.50-$32.50	Full Profit	Full Profit	Full Profit
$25.00-$27.50	Partial Loss	Full Profit	Profit or Loss
$0.00-$25.00	Full Loss (less prem)	Full Profit	Loss Likely

One other item to note: The bull put and the bear call portions of the trade are not required to be set up at the same time. In fact, many traders who employ this trade will set up one leg initially and then only later, if they feel it's advantageous, will they add the second leg.

Pros and Cons

Here's an interesting question to consider - Which is more risky and which is more rewarding - iron condors or individual bull put and bear call spreads?

The Case For Iron Condors

• Potential to double the premium you would otherwise receive for having set up the single leg spread.
• Potential to receive the same premium you would otherwise receive for having set up the single leg spread (either a bull put OR a bear call) but take less risk by setting the strike prices farther out of the money.
• There's a 100% chance that one side of your iron condor will expire worthless and you'll be able to keep the full amount of the premium received for that spread.
• No additional margin/capital is theoretically required to add a second leg and upgrade a single spread into an iron condor. Since a stock can't close both below your put option strike prices and above your call option strike prices, most options-friendly brokers won't require any additional capital to collateralize the trade. If the difference between strike prices for both the bull put and bear call is $2.50, then no matter what happens, the most you can still lose is $250 (less premium received), not $500. [note: not every brokerage sees it this way, however; some will still require you to collateralize with $500.]

The Case Against Iron Condors

• One very real negative to the iron condor trade is that by betting against specific moves both to the upside AND the downside, you double the ways in which you can lose money. If it's true that one leg is guaranteed to expire worthless, it's also true that there's an increased chance that the other side will be threatened or even breached at some point during your holding period.
• The other big drawback - and the primary reason why I won't trade iron condors myself - is that when the trade goes against you, it can be difficult, if not impossible, to repair.

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