Shorting Iron Condors | A simple way to diversify your passive income streams

What is a Short Iron Condor?

A short iron condor strategy is a type of options strategy that involves selling two vertical spreads. The goal is to generate income from the premiums collected and to limit the potential loss on the trade. An iron condor can be used in both bullish and bearish markets, making it a versatile trading tool. Although this strategy works most effectively in a neutral market where the underlying stock price stays in a tight range.

Compared to a long iron condor strategy where the trader is hoping for the stock to make a large move in a certain amount of time.

When Iron Condors Perform Best

There are many scenarios where this options selling strategy works best. Iron condors are optimal when options have high implied volatility. A decrease is IV can allow for options to decay sooner which will help option sellers receive premium faster. High IV market conditions are generally found around earnings and many option traders will take advantage of the iron condor then.

Another time the short iron condor is utilized is when the market trades sideways and stays range-bound with minimal price movement. As long as the stock stays within the middle strike prices of the iron condor that is when an option seller can consistently bring in the full premium.

Important out of the money options

Selling out of the money options is a golden opportunity for traders. That's because there is no intrinsic value in the options but they will have less premium. This gives traders a higher chance of having the options expire worthless. A short iron condor will utilize two credit spreads which will increase the potential profit, the premium received, and lower the maximum loss. This is the beauty of this options trading strategy.

What is a call credit spread

Half of the iron condor is made up of a bear call credit spread. A bear call credit spread is created by selling a call option and buying another call option at a higher strike price for the same expiration date. The goal is to generate income from the premium collected by having the options contracts expire worthless.

Call Spread Example

In the example below, you can see a bear call credit spread was created for the SPY. By selling the $457 and buying the $458 call, we are able to receive a net premium as the time value decays from the spread. This will only happen if the price of the underlying stock stays underneath the breakeven price of $457.36 at the time of expiration. The expiration date of the option below is only 48 hours away which is a very small amount of time value.

The max profit is calculated by the difference in the contract premiums, which happens to be $37 for the net credit received. The max loss is calculated subtracted from the credit received by the difference in the strike prices. This happens to be $63. While risk $37 for $63 doesn't seem attractive that is the whole point of the iron condor, so stay patient as we solve this risk to reward dilemma shown on the profit and loss diagram.

How to receive max profit

Visually we can see the call spread will stay profitable if the stock trades sideways or drops. The current stock price is around 454.20 which is well under our short strike price. Once the price of the underlying crosses the breakeven price of $457.36 that is when this position will start to lose money.

What is a put credit spread

The main caveat of just one credit spread is the risk to reward, for some reason it doesn't make sense to risk $40 to make $20. Over time, just a couple of bad trades can really eat away at overall profits.

So this is the beauty of adding a bear put credit spread to the trade and creating a short iron condor.

As we know at this point, the other half of the iron condor is made up of a put credit spread. A bull put spread is created by selling a put option and buying another put option at a lower strike price. The goal is to generate income from the premium collected by having the options contracts expire worthless.

Put Credit Spread Example

In the example below, you can see a put credit spread was created for the SPY. By selling the $453 and buying the $452 call strike prices, we are able to receive a net premium as the time value decays from the spread. This will only happen if the price of the underlying stock stays underneath the breakeven price of $452.66 at the time of expiration.

The max profit is calculated by the difference in the contract premiums, which happens to be $35 for the net credit received. The max loss is calculated subtracted from the credit received by the difference in the strike prices.

This happens to be $66. Again why is the maximum risk $66 for $34, that just doesn't seem like a smart thing to do! Well, let's finally solve that.

How to receive max profit

Visually we can see the put credit spread will stay profitable if the stock trades sideways or pops. Once we cross the breakeven price of $452.66 that is when this position will start to lose money and result in a possibly maximum loss.

Iron Condor Strike Prices Example

I appreciate you staying patient up until this point because it will make sense now. Combining a call-and-put credit spread will allow option sellers to lower the risk of the trade and maximize the profit. This is because the risk of the trade is greatly reduced from both legs of credit spreads.

Iron Condor Maximum Profit and Risk

Maximum profit: The maximum profit potential increases to $73 because of having two credit spreads.

Maximum Loss: The maximum loss actually decreases because it is the potential profit minus the difference in only strike prices for only ONE credit spread (so $453 strike price -452 strike price -$0.73 net credit = -$27)

You can see in the example below, this is a very neutral position on the stock and the goal is for the stock to trade sideways or expire between the short legs of the put and call credit spreads. This will allow for maximum profit. The max loss will be realized if we have a large move in any direction and we pass the breakeven prices.

How to exit an iron condor with same expiration date

Iron condors can be exited for losses or gains at any time by buying back the position. This would be possible by inputting the exact opposite order as the order placed to open the position. The other option is the let the iron expire out of the money for both credits spreads this would allow for the options to expire worthless, maximum profit to be realized, and commissions saved.

Please understand letting ANY option expire is extremely dangerous because of the chance of assignment. This is worthy of doing research and fully understanding as it can result in major margin calls.

How to maximize this strategy

It's important not to choose iron condors at the extreme ends of the trading range. A lot of iron condor traders will buy iron condors with strikes that are far out from each other, so it can be difficult to make a profit during any one day.

This is because we don't want our iron butterfly position's delta (the exposure) to change too much. If the underlying asset moves in the wrong direction, we could end up with a large loss on our trade

When trading iron condors, it's also important to keep an eye on the implied volatility of the options you're selling. Volatility can increase or decrease over time, so you'll want to make sure that your premiums are still profitable when it changes.

NOTE: iron condors work best in a sideways market, not during times of high volatility or extreme bullishness/bearishness.

Another important thing to note is that iron condor traders should be aware of the commissions they're paying for each trade, as well as any other fees associated with their brokerage account.

Tips for Trading Iron Condors

- When trading iron condors, always use a stop loss order to protect your downside.

- Make sure that you're comfortable with the risk/reward profile of the trade before entering into it.

- Don't choose iron condors at the extreme ends of the trading range.

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