Long Iron Condor

 

Description

 

The Long Iron condor is a strategy for stocks that are rangebound.

 

A variation of the Long Iron Butterfly, it is in fact the combination of a Bull Put Spread and Bear Call Spread.

 

The combination of two income strategies also makes this an income strategy. Traders often will leg into the Long Iron Condor, first trading a Bull Put Spread just below support, and then as the stock rebounds off resistance, adding a Bear Call Spread---thereby creating the Long Iron Condor.

 

Ideally the stock will remain between the two middle strikes with the maximum profit occurring if the options expire between these.

      

Ideally all these options will expire worthless and you get to keep the credit. 

 

Steps to Trading a Long Iron Condor

 

     1. Buy one lower strike (OTM) put.

 

     2. Sell one lower middle strike (OTM) put.

 

     3. Sell one higher middle strike (OTM) call.

 

     4. Buy one higher strike (OTM) call.

 

All options share the same expiration date for this strategy

 

For this strategy, you must use both calls and puts. A Long Iron Condor is the combination of a Bull Put Spread and a Bear Call Spread. The short put strike is lower than the short call strike. Remember that there should be equal distance between each strike price, while the stock price should generally be between the two middle strikes.

  

Market Opinion 

 

Neutral. You expect little movement in the stock.

 

P/L

 

 

 

 

 

 

When To Use

 

Use this strategy when you believe the stock will have low volatility, and you are looking to enhance income.

 

Example

 

XXXX is trading at $27.50 on April 11, 2011.

Buy May 2011 20 strike put for $0.25.

Sell May 2011 25 strike put for $1.25.

Sell May 2011 30 strike call for $1.30.

Buy May 2011 35 strike call for $0.35.

Net credit from premiums sold-premiums bought = $1.95

 

Benefit

 

The benefit is that, for low cost, you can profit from a rangebound stock with capped downside risk.

 

Risk vs. Reward

 

The risk is the difference between any two strikes minus your net credit. The reward is the net credit you receive.

 

Net Upside

 

Net credit received.

 

Net Downside

 

The difference between adjacent strikes minus net credit.

 

Break Even Point

 

Break even up: middle short call strike plus net credit.

 

Break even down: middle short put strike minus net credit.

 

Effect Of Volatility

 

Increased volatility would have a negative effect on this position.

 

Effect Of Time Decay

 

Positive when the position is profitable, and negative when it is not profitable. The stock is profitable when you buy it, so from then on time decay erodes the value of the position.

 

Alternatives Before Expiration

 

You can close out this position just before expiration by unraveling in two-leg segments.

 

Alternatives After Expiration

 

Close out the trade by buying back the options you sold and selling the options you bought.