Long Iron Condor Option Strategy

The long iron condor is an advanced options strategy designed to take advantage of minimal price movement in the underlying asset, much like the long iron butterfly. However, unlike the iron butterfly, the long iron condor uses out-of-the-money (OTM) call and put options at different strike prices, creating a wider range for the underlying asset to remain within at expiration. The goal is to profit from a stable, range-bound market with limited risk and defined reward. This strategy is most effective when the investor anticipates low volatility and expects the price of the underlying asset to stay within a specified range.

Introduction

The long iron condor strategy involves four different options:

  • Long call at a lower strike price

  • Short call at a higher strike price

  • Short put at an even lower strike price

  • Long put at a higher strike price than the short put

All of the options are typically out-of-the-money options. The strategy combines elements of both a bull put spread and a bear call spread, resulting in a position that benefits from low volatility and small price movements. The trader profits when the underlying asset stays within a defined price range, which allows the short options to expire worthless and the long options to retain their value.

The maximum risk in this strategy is limited to the net premium paid to establish the position, while the maximum profit occurs when the underlying asset’s price is near the middle strike price at expiration.

What is a Long Iron Condor?

A long iron condor is a four-legged strategy where the investor holds:

  • A long put with a lower strike price

  • A short put with a higher strike price

  • A short call with a higher strike price than the short put

  • A long call at an even higher strike price

These positions create a profit zone that relies on the underlying asset remaining between the middle strike prices of the short put and short call. The long options (both calls and puts) help offset the cost of the short options, thereby reducing the net premium paid for the entire position.

For example:

  • Buy 1 XYZ (Month 1) 90 put

  • Sell 1 XYZ (Month 1) 95 put

  • Sell 1 XYZ (Month 1) 105 call

  • Buy 1 XYZ (Month 1) 110 call

Here, the long iron condor position is set up with four options:

  • A long 90 put (lower strike)

  • A short 95 put

  • A short 105 call

  • A long 110 call (higher strike)

Additional Considerations

The strategy profits when the price of the underlying asset is between the short put strike price (95) and the short call strike price (105) at expiration. The investor will incur a loss if the price moves significantly beyond the range of the short options, as this would make both the long and short options lose value, offsetting the potential profit.

Unlike the long iron butterfly, the long iron condor benefits from a wider price range for the underlying asset, making it more flexible in its potential for profitability. However, it is still a neutral strategy, and profits are maximized when the price of the underlying asset stays within the price range of the short options.

The long iron condor is a defined-risk, limited-reward strategy, which means the investor knows both their maximum loss and maximum profit upfront.

Example Scenario

Consider stock XYZ, which is currently trading at $100. The investor believes that XYZ will stay within a narrow price range but is uncertain about the direction. The investor decides to enter a long iron condor position, setting up the following options:

  1. Buy 1 XYZ (Month 1) 90 put for $2.00

  2. Sell 1 XYZ (Month 1) 95 put for $3.00

  3. Sell 1 XYZ (Month 1) 105 call for $2.50

  4. Buy 1 XYZ (Month 1) 110 call for $1.50

In this case:

  • The total premium received from the short positions (95 put and 105 call) is $3.00 + $2.50 = $5.50.

  • The total premium paid for the long positions (90 put and 110 call) is $2.00 + $1.50 = $3.50.

  • The net credit (profit) for entering the position is $5.50 – $3.50 = $2.00.

Profit and Loss Analysis

Maximum Profit:

The maximum profit occurs if the price of the underlying asset is between the strike prices of the short call and short put at expiration. In this scenario, the maximum profit is the net premium received for the position, which is $2.00. This profit is realized when the underlying asset’s price is between $95 and $105 at expiration. At this point, the short options (put and call) will expire worthless, and the long options will retain their value.

  • Max Profit = Net Premium Received
    In this case:
    = $2.00 (not including commissions and fees)

Maximum Loss:

The maximum loss is limited to the difference between the strike prices of the long and short options minus the net premium received. This occurs if the underlying asset's price moves significantly outside of the price range between the short options. In such cases, the long options will offset some of the loss, but the loss is still capped.

  • Max Loss = Difference between the strikes of the long options and short options – Net Premium Received
    In this case:
    = ($95 – $90) or ($110 – $105) – $2.00
    = $5.00 – $2.00
    = $3.00 (not including commissions and fees)

Breakeven Points:

The breakeven points are calculated by adding and subtracting the net premium received from the strike prices of the short options.

  • Upper Breakeven = Short Call Strike Price + Net Premium Received
    = $105 + $2.00
    = $107.00

  • Lower Breakeven = Short Put Strike Price – Net Premium Received
    = $95 – $2.00
    = $93.00

The underlying asset needs to remain between $93 and $107 at expiration for the investor to break even. If the price falls below $93 or rises above $107, the position will result in a loss.

At-A-Glance Summary

Strategy: Long Iron Condor
Alternative Name: Iron Condor
Pre-Requisite Strategy Knowledge: Long Put, Long Call, Short Put, Short Call
Legs of Trade: 4 legs
Sentiment: Neutral (price range-bound)
Example:

  • Buy 1 XYZ (Month 1) 90 put

  • Sell 1 XYZ (Month 1) 95 put

  • Sell 1 XYZ (Month 1) 105 call

  • Buy 1 XYZ (Month 1) 110 call
    Max Potential Profit (Gain): Net Premium Received
    Max Potential Risk (Loss): Difference between the strike prices of the long and short options – Net Premium Received
    Breakeven Points:

  • Upper Breakeven: Short Call Strike Price + Net Premium Received

  • Lower Breakeven: Short Put Strike Price – Net Premium Received
    Ideal Outcome: Underlying asset’s price remains between the short call and short put strike prices (at expiration)
    Early Assignment Risk: Early assignment risk applies to the short options (put and call). If one of the short options is exercised, the trader may need to adjust or close the position to avoid losses.

Risks and Risk Mitigation

The primary risk of the long iron condor strategy is limited, as the potential loss is capped at the difference between the strike prices of the long and short options minus the net premium received. However, the risk of significant price movement in either direction is still present.

The key to success with the long iron condor is having an accurate outlook on the price range of the underlying asset. If the price of the asset moves outside the range defined by the short options, the position will result in a loss. Investors may mitigate risk by monitoring the price of the underlying asset as expiration nears. If the asset approaches the upper or lower end of the defined range, traders may consider closing or adjusting the position to reduce losses.