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06/15/2011

Iron Condor Spread Strategies: Timing, Structuring, and Managing Profitable Options Trades


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Iron Condor Spread StrategiesThe purpose of this essay is to improve your ability to trade iron condor option spreads. Iron condors have become a very popular spread type among active options traders, but there is little detailed or quantitative information available about the best way to employ these spreads. As participants in the crash of 2008 and the intense bull market of 2010 can attest, the static “set-it-and-forget-it” method with which some novice traders approach iron condors does not produce ideal results. In the following, I will consider the circumstances in which it is appropriate to enter a condor spread, key techniques and considerations when structuring spreads, and will present some backtested historical returns for a few strategy variations.

What Is An Iron Condor?

Because this is not an introductory-level text, I will not dwell on the basics of options, option greeks, or implied volatility. As a refresher for traders not regularly employing this spread type, recall than an iron condor has the following structure:

1 bought XYZ Month1 call struck at K4

1 sold XYZ Month1 call struck at K3

1 sold XYZ Month1 put struck at K2

1 bought XYZ Month1 put struck at K1

Each option or leg of the position should be on the same underlying asset and in the same expiration cycle. The numbered strike prices K1-4 signify that each option in the list should have a different strike price; typically, out- or near-the-money (OTM/NTM) options are used, rather than at- or in-the-money options. The price of the underlying asset should be somewhere between K3 and K2 (for example, between the strikes of the two short options).1

Configured in this way, the nearer-to-the-money sold options will have higher prices than the long options, such that the trade will be opened for a net credit. If the underlying asset is between the strike prices of the two sold options at expiration, the trader retains the full credit received. If the underlying expires above the strike of the long call or below the strike of the long put, the maximum possible loss for the trade is incurred; if the underlying at expiration is somewhere between the short and long puts or the short and long calls, the precise profits or losses at expiration will depend on the asset price relative to the strike prices of those options. Novice traders should develop an understanding of how to find the break-even points for the spread, how to determine the maximum possible loss, and so on.

When to Trade an Iron Condor

It is important to realize that an iron condor options spread is no more a “strategy” than buying a share of stock, selling short a futures contract, or purchasing a U.S. Treasury bond are strategies. These are all merely financial transactions. They rise to the level of strategies only after there is some thesis in place that justifies each transaction. Just as a value investor would not buy shares of stock without first gaining knowledge about the nature of the company, its balance sheet, and so on, an options trader requires some information before an iron condor spread can be justified. In other words, there are certain situations inwhich an iron condor spread will be appropriate.

Jared Woodward, Excerpted from Iron Condor Spread Strategies: Timing, Structuring, and Managing Profitable Options Trades


1. Throughout this text, I am discussing “short” iron condors—spreads in which the higher-priced options are sold, generating a net opening credit. It is possible, of course,to take the other side of such a trade, buying a strangle and selling another strangle with strikes further OTM to reduce the cost of the first. This approach is less common, but the same general points made here will apply (inversely) to the long condor. Excerpted from Iron Condor Spread Strategies: Timing, Structuring, and Managing Profitable Options Trades by Jared Woodard (FT Press Delivers Insights for the Agile Investor).


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