The (Short) Iron Condor Spread is my all-time favorite spread when I think the market will trade within a fairly small range for the near future. It is a little complicated, but worth the effort to learn.
With a name like this, it's got to be a great spread. I know what a condor is, but I wouldn't recognize a short one if I saw it, and I've never seen an iron one - all the condors I know have feathers.
If you really want to impress your friends, you can tell them you own a Short Iron Condor Spread, or wow them even more by saying you also are long a strangle and short another strangle which is more in the money. Or you can say you have a bear call spread and a bull put spread, or else a short vertical call spread and a short vertical put spread. They all mean the same thing, but who really cares what they call them?
The Iron Condor spread involves the simultaneous purchase of a put and a call for the same expiration month (usually only one or two months of remaining life), and the sale of a put and call for that same month but at a strike price which is closer the to current stock price than the options you purchased.
The result is that you end up with two vertical spreads, one of which uses calls at the higher strikes (called a bear call spread) and puts at the lower strikes (called a bull put spread) with all positions in the same expiration month. The number of call spreads is equal to the number of put spreads, and the increment between the strike prices is the same for both spreads.
Typically, an iron condor spread is sold rather than bought (so it should really be called a short iron condor spread). Since both the puts and calls which are sold have a higher value than those being purchased, it is a credit spread. It is placed when the investor believes the underlying stock will end up inside of a certain range of prices. If it does, all four options will expire worthless and the investor will pocket the original credit she received when originally placing the spread.
The iron condor is so named due to the shape of the profit/loss graph, which loosely resembles a large-bodied bird. In keeping with this analogy, traders often refer to the inner (short) options collectively as the "body" and the outer (long) options as the "wings".
The word Iron is used (for no apparent reason that I have been able to find) to describe a spread where one part of the overall position is a spread at strike prices above the current price of the underlying stock and the other part of the overall position is at strikes below the current price of the stock. An iron butterfly is another example of using iron in this manner.
Six reasons to love Short Iron Condor Spreads:
- The stock can go up, down, or stay flat, and you can still make a profit.
- Exceptional profits are possible every month
- Extreme flexibility is possible in creating a comfortable risk level
- You can precisely determine your maximum potential loss (or gain) before you make the investment
- If the stock closes anywhere in a broad range at expiration, a guaranteed pre-determined profit is made
- You only have to wait a maximum of 30 or 60 days to learn how much you have made or lost.
One reason not to like Short Iron Condor Spreads:
- You can lose your entire investment in less than 60 days.
For this reason, the best way to carry out the iron condor strategy is to be willing to take a small loss at times because it eliminates the possibility of incurring a larger loss, and only investing a portion of your capital at one time. Theoretically, if you only risk half your capital at one time, you will never run out of money to invest.