Iron Condor Briefly Defined

An Iron Condor is an option spread trade constructed from two other separate spread trades–a bull put spread and a bear call spread.

It is essentially a bet that a stock won’t trade either above or below specified levels during a set period of time. If the stock closes at expiration within that range, the trader retains his or her maximum gain, which can be very lucrative on a ROI basis and for such a short period of time.

Like any option trading strategy, there are pros and cons to trading the iron condor.

Advantages

1. Double Premium. By far, the biggest advantage is the opportunity to collect twice as much premium as you would setting up only a single bull put spread or single bear call spread position.
2. A Single Safer Premium. You could also take a more conservative approach and choose to receive the same total net premium available on either a single bull put or bear call spread position. You theoretically take less risk (by setting the strike prices farther away from the current share price) and receive the same amount of money.
3. Guaranteed Maximum Gains on One-Half the Trade. Because the stock can’t simultaneously close both below the bull put strike price and above the bear call strike price, one of those legs is guaranteed to expire worthless, ensuring your maximum profits on that portion of the trade.
4. Double Leverage at Half the Price. Along the same lines, because the stock can’t close both below the low end of the range and above the high end of the range, an options-friendly broker will only require you to collateralize half the trade. Because you can’t sustain a loss on both the bull put and the bear call, your maintenance requirement (for options-friendly brokers) will be for the equivalent of just one of those trades.
5. Flexibility. Option trading, by its very nature, is flexible. That is also true with the iron condor. In the case of a big move in the share price of a stock on which you’ve constructed an iron condor, the underwater short option can be bought back for a loss and the corresponding long option allowed to remain open. If the stock continues its directional move, the long option will increase in value, offsetting and even potentially reversing the loss.

Disadvantages

1. Two Ways to Lose Instead of One. Because you’re betting that a stock won’t breach a specific trading level in either direction, you have essentially doubled the ways in which you can lose money.
2. Big Potential Losses. While your maximum potential gains on a ROI basis can be very lucrative, your maximum potential losses on a ROI basis can be much larger. If the stock makes a large, unexpected move in either direction, you will most likely sustain significant losses of the capital at risk.
3. Invites Over Leveraging. Because the required capital to set up a single iron condor is so little (the difference between the strike prices within either the bull put or bear call spread multiplied by 100 less the net premium received), and because that number won’t change throughout the holding period, it’s very easy to set up more iron condor positions than may be prudent.

Conclusion:

Iron condors can produce some tremendous rates of return. But they are definitely not without risk. Investors are advised to conduct additional and thorough research and consider all the risks involved before employing this strategy.