What it means
The structure has four legs on the same underlying share and the same expiry date. You sell a put below the current price and buy a further out put beneath it, then sell a call above the current price and buy a further out call above that.
Selling the two inner options brings in more premium than the two outer options cost, so the trade opens with a net credit. That credit is the maximum profit, earned in full if the share price finishes anywhere between the two options you sold.
The two bought options are the reason the strategy is popular with cautious traders. Without them, an unexpected move could produce almost unlimited losses, whereas the outer options fix the worst case at a known, modest amount from the moment the trade is placed.
Iron condors suit markets that are quiet or range bound, and they lose money when prices break out sharply in either direction. They also benefit from time passing, because options lose value as expiry approaches and the seller of an option gains from that decay.
The nuance that catches people out is the reward to risk shape. A typical iron condor wins often but wins small and loses rarely but loses several times more, so a single badly managed breakout can wipe out many months of collected premiums.
In practice
Real-world examples.
Example
A trader expects a large index to drift sideways through a quiet summer and places iron condors each month with strikes roughly 5% either side of the current level. Eight of ten months produce the full credit, and two breakout months take back most of the year's gains.
Example
A treasury team at a listed company is barred from directional speculation but sells iron condors on a broad index within a strictly limited notional cap, purely to earn premium from a portfolio the board has agreed to keep static. The capped loss on each position is what makes the policy acceptable to the audit committee.
Example
An experienced investor closes an iron condor early for a $0.60 per share cost after collecting $2.00, banking $1.40 with two weeks left rather than risking a late move for the final portion of the credit.
Think of it
“Iron condor profits if price stays in a range-selling a narrow strangle, buying a wide one.
Formula
Calculation
Maximum profit = net premium received; maximum loss = width of one spread - net premium received
Consider a share trading at $100 with options expiring in six weeks, each contract covering 100 shares. The trader sells a $95 put and buys a $90 put, then sells a $105 call and buys a $110 call, collecting a net premium of $2.00 per share, which is $200 per contract.
The width of each spread is $95 - $90 = $5, or $500 per contract. Maximum loss is therefore $500 - $200 = $300 per contract, which occurs if the share finishes at or below $90 or at or above $110.
The break-even points are $95 - $2 = $93 on the downside and $105 + $2 = $107 on the upside. So the trade keeps the full $200 if the share finishes between $95 and $105, breaks even at $93 or $107, and loses the maximum $300 outside $90 to $110.Case study
Seen in the real world.
This is a fictional illustration rather than a real account. Larkfield Capital, an invented boutique fund, ran a systematic iron condor programme on a single index, placing 200 contracts a month with strikes about 6% either side of the market and collecting an average net credit of $210 per contract, or roughly $42,000 a month.
For eleven months the strategy behaved exactly as modelled, producing around $420,000 of premium against occasional small losses. The invented risk report described the approach as low volatility, which was accurate but misleading, because the losses were simply rare rather than small.
In the twelfth month the index fell 9% in four sessions, every position breached the lower strike, and the maximum loss of $290 per contract on 200 contracts cost $58,000 in a single expiry. The illustrative lesson was not that the strategy was flawed but that a win rate above 90% says nothing useful unless you also size the rare loss.
Watch out
Common mistakes.
- Judging the strategy by its high win rate rather than by expected value, since a run of small wins can be erased by one capped but much larger loss.
- Placing the sold strikes too close to the current price to earn a fatter credit, which sharply raises the chance of the range being breached.
- Forgetting that the maximum loss is per contract, so a position of 200 contracts carries 200 times the loss shown on a single trade ticket.
Questions
People also ask.
Is an iron condor a hedge?
No, it is an income strategy that profits from a lack of movement, and it adds risk to a portfolio rather than protecting it.
What happens if only one side is breached?
Only the breached spread produces a loss, and the collected credit from the untouched side reduces the damage, so the worst case is the width of one spread less the net credit.
When should the position be closed early?
Many traders close once they have captured most of the available credit, since holding for the last portion means accepting most of the remaining risk for a small extra gain.
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