Iron Condors are created by combining a Bear Call Spread (short 1 closer to the money call + long 1 further from the money call) with a Bull Put Spread (short 1 closer to the money put + long 1 further from the money put). The expiration months and increments between strike prices for all options should be the same.
An Iron Condor is a delta neutral strategy with positive theta and negative vega. The result is a strategy that profits: a) when the underlying stays relatively flat and remains between the short strikes by expiration; b) with the passage of time; and c) as volatility decreases.
Example of an Iron Condor:
- Bull Put Spread:
Sell 1 XYZ Dec 45 Put @ $0.91
Buy 1 XYZ Dec 43 Put @ $0.60
Net Credit = $0.31 - Bear Call Spread:
Sell 1 XYZ Dec 50 Call @ $1.02
Buy 1 XYZ Dec 52 Call @ $0.76
Net Credit = $0.26
Total Net Credit = $0.57
The maximum loss for an Iron Condor is determined by subtracting the net credit from the distance between the strikes of short and long Calls. In this example there is a $2 difference in strikes for both Credit Spreads.
Maximum loss : $2.00 - $0.57 = $1.43
Thus, maximum loss before commission in the above example = $143.00
Maximum gain = $.57 per contract or 39.8%
Maximum loss occurs when you allow the position to remain open thru to expiration with the underlying closing at/over $52 or at/under $43.
A big plus of this strategy is that due to the positive theta, you make more and more money as each day passes. However, a big challenge of this strategy is that while it is delta neutral the moment you put the trade on, with an upward move in the underlying the net delta turns negative and with a downward move, the net delta turns positive. Therein lies the key to this strategy... you must make adjustments when the delta becomes either too positive or too negative.
