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What is an Iron Condor?

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The Daily Ledger · Markets

She opened an iron condor on the stock, collecting the premium and capping her loss at the width of the wider gap.

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Explained in three depths

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Overview

An iron condor is four option contracts on one stock, all expiring on the same day. Say the stock trades at $100. You sell a put at $95 and a call at $105, then buy a put at $90 and a call at $110. The two you sell sit closer to $100, so they are likelier to finish in the money. Buyers pay you more for them than the two you buy cost you. That difference is yours to keep if the stock closes between $95 and $105. Break past $90 or $110 and you lose $5 a share minus that difference, however far the price runs.
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Overview

Four option contracts, opened at once, on a stock you reckon is going nowhere. That is an iron condor. Two of them are promises you sell, and somebody pays you cash to take them on. Two are cheaper ones you buy, and those cap the damage on a bad day. Net it out and maybe $140 lands in your account today. Guess wrong and that cap still lets you lose up to $260. Then you sit and hope for the dullest month of your life. 😎

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Detail

An iron condor is four option contracts on the same stock, all with the same expiry date. Each one covers 100 shares. Say the stock trades at $100. You sell a put at $95, so a buyer pays you now, and you owe them a dollar a share for every dollar the stock closes below $95. You then buy a put at $90. Below $90 it pays you a dollar a share for every dollar the price falls, matching what the put you sold costs you, so the downside stops there, at $5 a share. You sell a call at $105, so another buyer pays you now, and you owe them a dollar a share for every dollar it closes above $105. You also buy a call at $110. Above $110 it pays you a dollar a share for every dollar the price rises, matching what the call you sold costs you, so the upside costs you the same $5 a share cap. The two you sold have a higher chance of finishing in the money than the two you bought, since $95 and $105 sit closer to $100. That is why buyers pay you more for them than you paid for the two you bought. Say that leaves you $150. Finish anywhere from $95 to $105 and you keep all $150. Finish at $92 or at $108, both three dollars outside the range, and you owe $300, so you are down $150. Past $90 or $110, you owe $500 and are down $350, however far the price goes.
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Detail

An iron condor pays you to bet a stock stays put. Four legs, same day, two sold and two bought. Do the arithmetic and it tells you everything about how the trade is built. Say punters hand you $200 for the two legs you sell, and you pay other punters $60 for the two you buy. Yours fetch more because they sit nearer the money and are likelier to pay out. You are left with $140, and if the stock never breaks out, nobody claims a cent of it. That is your profit ceiling, however dull the month turns out to be. You will hit it plenty, since most weeks a stock does not go far. Now the other end. The legs you buy sit $4 away from the legs you sold, and every contract multiplies that by 100, so $4 means $400. So the ugliest close costs you that $400, less the $140 you already banked. Up $140 when you are right, down $260 when you are wrong, which means four good months in a row hand it all back on the fifth. That lopsided pair of numbers is the trade, not a fault in it. Somebody wanted rid of a risk, and you agreed to carry it. What they handed over is small, because dull months are common and the ugly one is rare. Nobody is giving away free lunches here. 😎

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Analogy

Sam's agency staffs a care home for a quarter, built around 400 to 600 shifts. The home pays him $9,000 up front, and if the quarter lands in range, he pays nothing. Below 400, he pays carers $100 for each shift nobody booked, out of that $9,000. Above 600, he brings in carers at $280 while billing $180, the same $100 lost either way. So he spends $3,000 of the fee on a partner who takes over past 200 shifts on either side and caps his exposure at $20,000. The $6,000 he kept covers part of that, and his worst quarter costs him $14,000. An iron condor works the same way: a fee for staying in range, a cost per unit outside it, and a second position bought to cap how far that cost runs.
Deepest level reached.
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Analogy

You write the weather cover for a vineyard. If the growing season averages between 55 and 60 degrees, nothing happens to the crop, and the premium sits in your account. Come in at 53 and you are paying the grower for fruit that never ripened. It is the same story at 62 on the hot side. So you buy your own cover for anything under 50 or over 65, and the freak year gets a price tag on it instead of a blank cheque. An iron condor splits the same job into four contracts. The two you sell are the cold promise and the hot promise, each earning separately. The two you buy are the cover on each, bought separately too. Same trade, fewer grapes. 😎
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AI explanations may contain errors · Not professional advice

Formal definition — The same term, explained the usual way

An iron condor is a four-legged options position combining a short put spread and a short call spread on the same underlying instrument, with the same expiration date and, in the standard construction, equal distances between the strikes of each pair. The trader sells an out-of-the-money put and an out-of-the-money call, and buys a further out-of-the-money put and call, which produces a net credit because the sold options carry the higher premium. Maximum profit equals that net credit and is realised when the underlying settles between the two short strikes. Maximum loss equals the distance between the strikes of one pair less the net credit, and is reached when the underlying settles beyond either long strike. Because settlement occurs at a single price, only one pair can finish in the money. The position carries positive theta and negative vega, so its value is affected by implied volatility as well as by the price of the underlying before expiration. Positions on American-style options may be assigned early, particularly on short calls before an ex-dividend date, and a settlement price between a short strike and its corresponding long strike can leave the trader holding the underlying. ---

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