For instance, with an iron butterfly, one option will almost always be in the money (ITM). However, it comes with a higher risk than the iron condor because the breakevens are worse. This is because it collects more extrinsic value premiums upfront. Meaning, that they are playing against any strong movement of the stock price.Īt first glance, the iron butterfly appears to be the preferred choice. Also, both bets are on low realized volatility. Both of these options trading methods are made up of four options with the same expiration date. However, it often has lower breakevens than the iron condor. Because of the credit gained upfront, this arrangement has a bigger maximum profit. Conversely, the iron butterfly uses at-the-money (ATM) put and call credit spreads with the short put and call on the same strike. However, the iron condor employs out-of-the-money (OTM) put and call credit spreads to generate a range of profitability.
The iron condor and the iron butterfly share the same components. In any scenario, the trade still has a limited payout with equally limited risk. For example, if both of the middle strike prices are higher than the underlying asset’s current price, the trader anticipates a slight increase in its price by expiration. By using multiple strike prices, the strategy can be made to lean bullish or bearish. This results in a net credit to the account when the trade is executed. Because both of these options are further out of the money, their premiums are smaller than those of the two written options. The options that are further out of the money (OTM) are called the wings. 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, the maximum loss occurs. To calculate, reduce the loss by the net credits obtained, then add commissions to determine the overall loss for the trade. It amounts to the difference between the long call and short call strikes, or the long put and short put strikes. The amount of premium or credit received for initiating the four-leg options position is the maximum profit for an iron condor. The maximum risk is defined as the spread width minus the credit obtained. The spread credit that results sets the maximum profit for the trade. Each, however, has the same expiration date. As a result, this strategy comprises four distinct option contracts on the same stock. The short iron condor is formed by combining two vertical spreads – a bull call spread and a bear put spread. An iron condor might be thought of as a long strangle inside a larger, short strangle-or vice versa. The approach seeks to capitalize on a decrease in implied volatility in the options as well as time decay. In other words, stocks that do not see major price fluctuations in either direction. They work well for stocks that are projected to have moderate volatility. Iron Condors are risk-defined, neutral strategies with limited profit potential.
This is only possible if the underlying asset closes between the middle two strike prices at the expiry date. Ideally, the trader would like all of the options to expire worthlessly. However, limiting the risk also restricts the potential profits. This is because the high and low strike options, called the wings, protect against significant moves in either direction. The iron condor strategy limits upside and downside risk. The condor and the iron condor are both extensions of the butterfly spread and the iron butterfly. However, instead of only calls or only puts, it uses both calls and puts. The iron condor has a similar reward as a standard condor spread. In other words, the idea is to profit from the underlying asset’s low volatility and pocket the premiums as profit. A net credit indicates that the four options contracts brought in more money than the investor had to payout.Īs an options trading strategy, a short iron condor gets the most profit when the underlying stock closes at expiry between the middle strike prices and all four options expire worthlessly. However, it is more commonly used as a short Iron Condor, where the transaction generates a net credit. The strategy can be built as a long Iron Condor, where the trade generates a net debit. Each of the options has a different strike price but the same expiration date. It is made up of two call options (one long and one short) and two put options (one long and one short). Share on Digg Share What Is an Iron Condor Options Strategy?Īn iron condor is the combination of a bullish and bearish vertical spread on the same underlying asset.
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