Iron Condors: Selling Options for a Trading Range

We recommend a lot of iron condors every week, so I thought it would be a good idea to write about the strategy more often. Consider this the first of many pieces on the option trader’s favorite way to sell volatility without being right about direction.

An iron condor is involves the selling of two out-of-the-money (OTM) vertical spreads, one an upside call spread and the other a downside put spread. The basic idea is that you are not sure which direction the given stock or index is going to trade, but you are pretty sure of what range it might trade within, and thus you can comfortably sell option spreads around that range.

Here’s a recent example from the ONN Trading Ideas that assumed the SPDR Gold ETF (GLD) was likely to trade between $103 and $120 into January:

Iron Condor Part I: Bull Put Spread –

• Sell the January 103 put for $1.02 per contract
• Buy the January 102 put for $0.86 per contract
• Net credit of $0.16 per spread

Iron Condor Part II: Bear Call Spread –

• Sell the January 120 call for $1.47 per contract
• Buy the January 121 call for $1.30 per contract
• Net credit of $0.17 per spread

Overall credit for the spread: $0.33 (or $33)

Profit/Loss Details:

Maximum profit: $0.33 (the total premium collected) minus commissions.

Maximum risk: $0.67 (the difference between put or call strikes minus the premium collected). Return on risk is approximately 49% for this strategy.

Upper breakeven price: $120.33 (the strike of the sold call plus the total premium).

Lower breakeven price: $102.67 (the strike of the sold put minus the total premium).

The key with any iron condor is being willing to pick a trading range you feel confident about for a given time period and then being willing to sell both spreads simultaneously around that range. Some traders like to sell call spreads near the top of the expected trading range and then sell the put spreads near the bottom of the expected range to get the most option premium income possible. This way of building the iron condor one spread at a time as the stock, index, or ETF moves around can have advantages.

But it also assumes that you can time the market’s movement. And this goes against the basic approach of the condor that says we don’t know if, when, or where the market will move around in that range—or even if it might defy our expectations and go through the short strike of the spread we have sold.

In this sense, by selling both spreads at once (which can usually be done for one commission on all four option legs) we capture a good chunk of premium and actually lower our overall risk to an adverse price movement.

Here’s what the risk/reward profile of the spread at expiration looks like on the OptionsHouse Profit/Loss Calculator:

This graphic representation of potential profit and loss gives you a mental picture of what you are trying to accomplish with this spread. You can see the area of profit you capture if the GLD stays within $103 and $120. And you can also see how you begin to give back some of that profit if the ETF passes through either of those strikes, and how losses accumulate past the breakeven points of $102.67 on the downside or $120.33 on the upside.

The beautiful thing about this winged spread is that you can’t lose on both ends of the range. The stock, index, or ETF you are trading can’t go through both spreads at expiration. You can be exposed to an unrealized loss if volatility rises and the price you would have pay to buy the spread back rises. But you are always free to buy back any side of the iron condor if conditions change and you feel the potential reward doesn’t warrant the risk.

Keep in mind, I’m just using this spread as an example and I can’t know if it is appropriate for your experience, goals, and risk tolerance. What I recommend every aspiring iron condor trader do is use the OptionsHouse Trading Tools, like the P&L Calculator and the Probability Calculator, to experiment with iron condor ideas you might have.

Building them and dissecting them is so easy, it’s really the ideal way to practice and get used to all the risk/reward dynamics of these versatile option strategies. If you don’t have an OptionsHouse trading account, sign up for a free virtual account where you can place the trades and see how they evolve in real-time with all the profit/loss exposures marked continuously.

In the Trading Ideas section of ONN, we recommend two or three iron condors per week. Keep an eye on them and before you consider trading them, plug them into the OptionsHouse tools to make sure you fully understand their dynamics. If you have any questions about iron condors, send them to me at kcook@onn.tv. And, as always…

“Mind the Risk, Bank the Profits!”