The Iron Condor is a Option strategywhich consists of a total of four options (Legs) and is based on a sideways movement of the market, as well as a downward implied volatility profits. One OTM call option and one OTM put option are sold and another option with a higher/lower strike price is purchased for hedging purposes.
Definition Iron Condor
An Iron Condor consists of a sold Call option (short call) and a purchased call option (long call) with a higher strike price, as well as a sold Put option (short put) and a purchased put option with a lower strike price. All four options have the same remaining term.
So you can think of an Iron Condor like a short strangle, where additional options are bought to limit risk, or like the Combination of a Bear Call Spreads and one Bull Put Spreads. Thus, when the trade is opened, a premium income is generated.
P&L diagram of an Iron Condor
In the profit and loss diagram, you can see that the maximum profit occurs when the underlying quotes between the strikes of the sold options on the expiration date. If the underlying falls below the price level of the purchased put or rises above the price level of the purchased call, the maximum loss occurs.
What to look for when trading an Iron Condor?
An Iron Condor corresponds to a Bull Put Spread and a Bear Call Spread at the same time. The goal is for both spreads to expire worthless or make a profit and be bought back early. The trade is sensitive to changes in implied volatility and has a limited maximum loss, as well as a limited maximum profit, where the maximum loss is usually higher than the maximum gain.
Maximum loss
The maximum loss is equal to the width of the call spread or the width of the put spread (which is usually the same), minus the option premium collected, and arises if the price of the underlying above the base price of the Long calls rises or falls below the strike price of the Long Puts falls.
Maximum loss = width of the call spread (or width of the put spread) - Net Credit
Maximum profit
The Iron Condor achieves the maximum profit if all options expire worthless (i.e. Out Of The Money). This is the case if the price of the underlying on the expiration date has moved between the strike prices of the options sold located.
Maximum profit = Net Credit
Break Even Point
The two break even points are located between the strike prices of the call spread and the put spread, respectively, at the price level where the premium collected (net credit) equals the loss of the option sold.
In case of bullish development:
Break Even Point = Strike Price Short Call + Net Credit
With bearish development:
Break Even Point = Strike Price Short Put - Net Credit