Reverse Iron Condor Explained

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Iron Condor

What Is an Iron Condor?

An iron condor is an options strategy created with four options consisting of two puts (one long and one short) and two calls (one long and one short), and four strike prices, all with the same expiration date. The goal is to profit from low volatility in the underlying asset. In other words, the iron condor earns the maximum profit when the underlying asset closes between the middle strike prices at expiration.

The iron condor has a similar payoff as a regular condor spread, but uses both calls and puts instead of only calls or only puts. Both the condor and the iron condor are extensions of the butterfly spread and iron butterfly, respectively.

Key Takeaways

  • An iron condor is typically a neutral strategy and profits the most when the underlying asset doesn’t move much. Although, the strategy can be constructed with a bullish or bearish bias.
  • The iron condor is composed of four options: a bought put further OTM and a sold put closer to the money, and a bought call further OTM and a sold call closer to the money.
  • Profit is capped at the premium received while the risk is also capped at the difference between the bought and sold call strikes and the bought and sold put strikes (less the premium received).

Understanding the Iron Condor

The strategy has limited upside and downside risk because the high and low strike options, the wings, protect against significant moves in either direction. Because of this limited risk, its profit potential is also limited. The commission can be a notable factor here, as there are four options involved.

For this strategy, the trader ideally would like all of the options to expire worthlessly, which is only possible if the underlying asset closes between the middle two strike prices at expiration. There will likely be a fee to close the trade if it is successful. If it is not successful, the loss is still limited.

One way to think of an iron condor is having a long strangle inside of a larger, short strangle (or vice-versa).

The construction of the strategy is as follows:

  1. Buy one out of the money (OTM) put with a strike price below the current price of the underlying asset. The out of the money put option will protect against a significant downside move to the underlying asset.
  2. Sell one OTM or at the money (ATM) put with a strike price closer to the current price of the underlying asset.
  3. Sell one OTM or ATM call with a strike price above the current price of the underlying asset.
  4. Buy one OTM call with a strike price further above the current price of the underlying asset. The out of the money call option will protect against a substantial upside move.

The options that are further out of the money, called the wings, are both long positions. Because both of these options are further out of the money, their premiums are lower than the two written options, so there is a net credit to the account when placing the trade.

By selecting different strike prices, it is possible to make the strategy lean bullish or bearish. For example, if both the middle strike prices are above the current price of the underlying asset, the trader hopes for a small rise in its price by expiration. It still has limited reward and limited risk.

Iron Condor Profits and Losses

The maximum profit for an iron condor is the amount of premium, or credit, received for creating the four-leg options position.

The maximum loss is also capped. The maximum loss is the difference between the long call and short call strikes, or the long put and short put strikes. Reduce the loss by the net credits received, but then add commissions to get the total loss for the trade.

The maximum loss occurs if the price moves above the long call strike (which is higher than the sold call strike) or below the long put strike (which is lower than the sold put strike).

Example of an Iron Condor on a Stock

Assume that an investor believes Apple Inc. (AAPL) will be relatively flat in terms of price over the next two months. They decide to implement an iron condor. The stock is currently trading at $212.26.

They sell a call with a $215 strike, which gives them $7.63 in premium. They buy a call with a strike of $220, which costs them $5.35. The credit on these two legs is $2.28, or $228 for one contract (100 shares). The trade is only half complete, though.

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In addition, the trader sells a put with a strike of $210, resulting in a premium received of $7.20. They also buy a put with a strike of $205, costing $5.52. The net credit on these two legs is $1.68 or $168 if trading one contract on each.

The total credit for the position is $3.96 ($2.28 + $1.68), or $396. This is the maximum profit the trader can make. This maximum profit occurs if all the options expire worthless, which means the price must be between $215 and $210 when expiration occurs in two months. If the price is above $215 or below $210, the trader could still make a reduced profit, but could also lose money.

The loss gets larger if the price of Apple stock approaches the upper call strike ($220) or the lower put strike ($205). The maximum loss occurs if the price of the stock trades above $220 or below $205.

Assume the stock at expiration is $225. This is above the upper call strike price, which means the trader is facing the maximum possible loss. The sold call is losing $10 ($225 – $215) while the bought call is making $5 ($225 – $220). The puts expire. The trader loses $5, or $500 total (100 share contracts), but they also received $396 in premiums. Therefore, the loss is capped at $104 plus commissions.

Now assume the price of Apple instead dropped, but not below the lower put threshold. It falls to $208. The short call is losing $2 ($208 – $210), or $200, while the long put expires worthless. The calls also expire. The trader loses $200 on the position but received $396 in premium credits. Therefore, they still make $196, less commission costs.

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Reference ID: #318471e0-7b13-11ea-9616-f7699f385ccc

Simple Iron Condor Adjustments to Avoid Wiping Out Your Account

Iron Condor Trading looks like the perfect strategy.

A “turn-key” system where all you have to do is put on one trade a month and you’re on your way to instant riches.

Set and forget it. Like an easy bake oven. As long as the market stays within a range then you can earn simple income trading profits.

It’s not that easy.

Well, most of the time it is. Most of the time, the options market overestimates what will happen in the market and the range holds.

When that happens, there’s not much to do. Iron condor trading is boring. And boring is profitable.

Yet there are some times where the market starts to move. And it moves big. Let’s take a look at the risks involved with iron condors and why it’s so important to have an iron condor trading plan before you even put on a new trade.

Want more?

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What’s the Big Deal?

Iron condors are a high odds trade. But with those high odds, it means that the risks are much, much larger than your potential profits.

Here’s an example of a standard iron condor:

See how your maximum risk is much larger than your maximum reward?

Well, yeah. That’s the game. There’s always a tradeoff between risk, reward, and odds. You’re taking larger risk, which means your odds are good.

Your odds are very good. As in you should expect to win over 75% of the time.

The “wins” are easy.

It’s when the iron condor trade gets tested. that’s where things can get a little tricky.

There are some option trading educators out there that will tell you to “set and forget” your iron condors. That the odds will be in your favor so it’s not a huge deal.

Rubbish. Of course it’s a huge deal.

In fact, the “odds” priced into the trade can be a bit misleading. It gets complicated, but just understand that you can have a low volatility market that just moves in one direction, and you’ll get runover.

Trust me. I know this from experience.

It pays to be proactive when trading iron condors. You should focus on active risk management, and have a plan before you even put on the trade.

What’s the best way to adjust iron condors?

It depends on what kind of adjustment you need, what the market is doing at the time, and what kinds of premiums you can get.

Here Are The Risks To Hedge Against In An Iron Condor

There are two things you need to avoid when you are trading iron condors.

The first is avoiding trending volatility.

This is where the market moves constantly in one direction. This happens in bull markets when stock indexes “grind” higher, and in bear markets during crashes.

An example of “trending volatility”

The second thing to avoid is fast movement. If the iron condor hasn’t been active long enough to generate profits, the risk of a fast move can put you in a bad position.

A blowout move can give you a large loss.

Believe it or not.

The “grind higher” is the biggest risk. I know that most traders are always on the lookout for some kind of market crash. but from experience I know that, most of the time, your iron condor will have more risk on the upside.

I talk more about it in this post: The Hidden Risk In Iron Condors

So what can you do? Let’s take a look at some simple adjustments.

Unbalanced Iron Condor

You know what? Nobody is forcing you to have a “plain vanilla” iron condor. There’s a few variations you can use when putting on a new iron condor trade.

The simplest thing to do is don’t sell as many call spreads. This will help to neutralize some of your initial short exposure.

Here’s an example of an Unbalanced Iron Condor:

By going half size on the call side, you can start the trade “delta neutral.” Then, if the market starts to rip higher, you can add more call spreads, or roll the call spreads higher.

If stocks are in a rip-roaring bull market, you can’t afford to start off short, because you will end up with a ton of trending volatility. So consider starting off with some bull call spreads or long calls to hedge your upside.

Embed Long Delta Plays Into Your Trade

Another way to start off truly “delta neutral” is to add another set of options to your iron condor.

These kinds of trades will reduce your time decay profits in exchange for your position not getting blown out by strong movement.

Here are some normal embed strategies:

  • Vertical spreads
  • Cheap OTM Call Buys
  • Ratio (1×2) Buys
  • Kite Spreads

All of these have different tradeoffs depending on what the market is giving us.

One of my more favorite “Embed” trades is a little trickier. it uses VXX puts that give the position an extra “kicker” because of how VXX trades. Learn about this strategy here.

Have An Iron Condor Trading Plan

Iron Condors can almost be completely automated.

It’s a statistically based trade, and you should treat it as such.

What you should do is pick out points where the market has moved enough to require you to adjust the trade.

How do you pick out your adjustment points?

It depends. There’s always a tradeoff here.

If you adjust too late, then you’ll be locking in a loss on a trade.

And if you adjust too early, you’ll feel like an idiot as the market reverses and you lose out on potential profits.

There’s no perfect answer, and there never will be. It’s all about what is most comfortable for you.

Some people use delta bands, where you figure out your maximum directional exposure on a position, and adjust if the market sees a move to a certain level of exposure. This is the one I use the most often.

Other people set alerts when the value of one side of the iron condor gets too high.

Or you could eyeball the chart and look for key levels of support and resistance. I’ll add this in combination with my “delta bands” to best optimize my adjustment areas.

No matter what your plan is, THE POINT IS TO HAVE AN ACTUAL PLAN.

Know where you’ll adjust the iron condor, and if the market hits your level, then adjust.

If you wait too long, you’ll get runover. Again, another mistake I know from personal experience.

Here’s an example of an iron condor trading plan:

Example of An Iron Condor Trade Journal

Roll Your Spreads

Nobody is forcing you to go “all in, all out” on an iron condor trade.

A better way to view iron condors is that they are the combination of two vertical spreads.

When the market moves against you, simply roll one of the verticals closer to the current price of the market. This will reduce the cash needed to be in the trade, reduce some of the directional exposure, and increase the potential for profit.

Example of a rolling iron condor adjustment

You can then roll the losing side of the trade, and the only cost to you is the commissions required with the roll.

Know Your Greeks

This is a little more advanced, so bear with me.

There will be times where certain kinds of adjustments work better than others. If volatility is running high, it’s much more difficult to hedge to the downside because premiums are so expensive, so you have to look at spreads.

The most important thing to ask yourself when adjust iron condors is.

“What risk do I need to get rid of?”

The biggest one will be your directional risk, your delta. And hedging that risk will always come at a cost, so your job is to find the best strategy that minimizes that cost, and to make sure that the hedge doesn’t hurt too much if the market reverses back to the mean.

One more thing to understand here.

You Don’t Have to Hold Your Iron Condor Adjustments to Expiration

Again, nobody is forcing you to have a “fixed” position in an option trade. If the market is moving against you, go out and buy some protection, and if the market moves big against you again, close out the hedges for a profit and then roll the trade.

This took me way too long to realize. Because many times I would put on a hedge and hold onto it too long, and then it stopped being effective.

Being a little more aggressive with your risk management is what will get you the sustainable iron condor trading edge you need.

Consistency Is Everything

Most of the time, iron condors are an easy trade. You get in, you get out, you take your profits.

Your long term success comes in knowing what to do in case things go against you.

Have a plan ahead of time, know the best kind of adjustment for what the market is giving you, and be aggressive with holding onto your hedges.

If you do this, you’ll build aggressive and sustainable returns in the options market through iron condor trading.

Want more?

Get Your FREE Iron Condor Toolkit.
You’ll see live case studies, free training videos, and my Iron Condor Lifecycle Journal.
Yours, free, today.

Iron Condor

The Strategy

You can think of this strategy as simultaneously running an out-of-the-money short put spread and an out-of-the-money short call spread. Some investors consider this to be a more attractive strategy than a long condor spread with calls or puts because you receive a net credit into your account right off the bat.

Typically, the stock will be halfway between strike B and strike C when you construct your spread. If the stock is not in the center at initiation, the strategy will be either bullish or bearish.

The distance between strikes A and B is usually the same as the distance between strikes C and D. However, the distance between strikes B and C may vary to give you a wider sweet spot (see Options Guy’s Tips below).

You want the stock price to end up somewhere between strike B and strike C at expiration. An iron condor spread has a wider sweet spot than an iron butterfly. But (as always) there’s a tradeoff. In this case, your potential profit is lower.

Options Guy’s Tips

One advantage of this strategy is that you want all of the options to expire worthless. If that happens, you won’t have to pay any commissions to get out of your position.

You may wish to consider ensuring that strike B and strike C are around one standard deviation or more away from the stock price at initiation. That will increase your probability of success. However, the further these strike prices are from the current stock price, the lower the potential profit will be from this strategy.

As a general rule of thumb, you may wish to consider running this strategy approximately 30-45 days from expiration to take advantage of accelerating time decay as expiration approaches. Of course, this depends on the underlying stock and market conditions such as implied volatility.

Some investors may wish to run this strategy using index options rather than options on individual stocks. That’s because historically, indexes have not been as volatile as individual stocks. Fluctuations in an index’s component stock prices tend to cancel one another out, lessening the volatility of the index as a whole.

The Setup

  • Buy a put, strike A
  • Sell a put, strike B
  • Sell a call, strike C
  • Buy a call, strike D
  • Generally, the stock will be between strike price B and strike price C

NOTE: Options have the same expiration month

Who Should Run It

Veterans and higher

When to Run It

You’re anticipating minimal movement on the stock within a specific time frame.

Break-even at Expiration

There are two break-even points:

  • Strike B minus the net credit received.
  • Strike C plus the net credit received.

The Sweet Spot

You achieve maximum profit if the stock price is between strike B and strike C at expiration.

Maximum Potential Profit

Profit is limited to the net credit received.

Maximum Potential Loss

Risk is limited to strike B minus strike A, minus the net credit received.

Ally Invest Margin Requirement

Margin requirement is the short call spread requirement or short put spread requirement (whichever is greater).

NOTE: The net credit received from establishing the iron condor may be applied to the initial margin requirement.

Keep in mind this requirement is on a per-unit basis. So don’t forget to multiply by the total number of units when you’re doing the math.

As Time Goes By

For this strategy, time decay is your friend. You want all four options to expire worthless.

Implied Volatility

After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices.

If the stock is near or between strikes B and C, you want volatility to decrease. This will decrease the value of all of the options, and ideally, you’d like the iron condor to expire worthless. In addition, you want the stock price to remain stable, and a decrease in implied volatility suggests that may be the case.

If the stock price is approaching or outside strike A or D, in general you want volatility to increase. An increase in volatility will increase the value of the option you own at the near-the-money strike, while having less effect on the short options at strikes B and C. So the overall value of the iron confor will decrease, making it less expensive to close your position.

Check your strategy with Ally Invest tools

  • Use the Profit + Loss Calculator to establish break-even points, evaluate how your strategy might change as expiration approaches, and analyze the Option Greeks.
  • Use the Probability Calculator to verify that strike B and strike C are approximately one standard deviation (or more) away from the stock price.

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