Understanding the Basics
A short iron condor, which is typically used as a neutral strategy, involves four legs and four different strike prices established in a 1/1/1/1 ratio. Unlike traditional condors which can be created using calls or puts, iron condors are created using both calls and puts at the same time.
A short iron condor is a neutral strategy that has a limited loss potential if the underlying security moves sharply in either direction. An iron condor is considered "short" if a net credit is received when it is initiated:
After reaching record new record highs in equities, US markets are finally pulling back with seven out of nine sectors trading lower.
Yet despite this one day pullback, market strength is still in place and we are not looking to buck any trend here or call it a top.
In fact, Russell Rhoads, Director of Education for the CBOE Options Institute, made a great point last night that strategies like butterfly spreads and iron condors tend to unperform the index, especially at time of low volatility.
Moreover, as Rhoads suggested, investors could consider purchasing options at times when volatility is a record low, rather than selling options.
Keep in mindA short iron condor is often used as an alternative for a long condor, except that a short iron condor is initially established for a net credit while the long condor is initially established for a net debit.
The risk and reward profiles, and profit and loss zones of the two strategies are very similar, so the decision of which to use often comes down to which might have a very slight pricing advantage, or whether you prefer to pay a debit (with no margin requirement) or receive a net credit (with a margin requirement equal to the maximum loss).
Iron Condor Example
The XYZ Zipper Company is trading at $30/share.
Earnings season is still two months away and the company hasn't produced a controversy in quite some time.
You feel confident that the stock won't stray very far from its current price in the near term.
You consult the stock's option chain and decide to employ an iron condor option trading strategy, setting up both a bull put spread and a bear call spread.
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