Iron condor explained: an options strategy using four options

An iron condor is an options strategy made up of four options on the same underlying, all with the same expiry. It shows a profit at expiry if the price stays within a certain range. Profit and loss are then limited in both directions, but in the example below the possible loss is larger than the possible profit. What calls and puts are is explained in the article Options explained simply: calls and puts by example.

What is an iron condor?

An iron condor combines four options. A put and a call are sold, both with strike prices some distance from the current price. In addition, a put with an even lower strike and a call with an even higher strike are bought. The sold options bring in more premium than the bought ones cost. This surplus is called the net premium, or net credit.

The OIC describes the market view as follows: someone who opens an iron condor ‘is hoping for underlying stock to trade in narrow range during the life of the options’. If the price stays between the sold strike prices until expiry, all four options expire worthless. The premium is then kept in full.

The OIC calls the sold options ‘shoulders’ and the bought ones ‘wingtips’. It lists the strategy as ‘Short Condor (Iron Condor)’. There is also a ‘Long Condor’, in which a premium is paid. This article covers the form in which a premium is received.

Structure: two spreads made up of four options

The same position can be viewed in two ways.

As two spreads. Here, a spread is a combination of two options of the same type, one bought and one sold. (On the exchange, the bid-ask spread, meaning the difference between the buying and selling price, is also called a spread.) Below the current price sits a bull put spread: a put sold and a put with a lower strike bought. Above it sits a bear call spread: a call sold and a call with a higher strike bought.

As a short strangle with wings. A short strangle consists of a sold call and a sold put, both out of the money, that is, without intrinsic value. The iron condor contains exactly these two options, plus one bought option further out on each side. These wings work much like insurance with an excess: they cost premium and, at expiry, only pay out from a certain price onwards.

How to read the payoff profile

A payoff profile shows what a position gains or loses at expiry, depending on the price of the underlying. For an iron condor, the line has a flat plateau in the middle, two slopes at the sides and two flat floors at the outer edges. In the calculator below, the example shows this shape at five points:

1. Plateau between 95 and 105: All four options expire worthless, and the net premium of 2 remains as profit.
2. Lower break-even point at 93: Below 95, the sold put gains intrinsic value. At 93 this amounts to 2 and uses up the premium exactly.
3. Upper break-even point at 107: The same applies on the call side, as a mirror image.
4. Floor below 90: The bought put offsets any further fall, so the loss stays at 3.
5. Floor above 110: On the call side, the bought call takes on this role.

Maximum profit, maximum loss and break-even points

All three calculations apply at the time of expiry:

• Maximum profit = net premium. It arises if the price is between the sold strike prices or exactly on one of them, in the example 2.
• Maximum loss = wing width minus net premium. The wing width is the distance between the sold and the bought option on one side, in the example 95 − 90 = 5. The loss is therefore 5 − 2 = 3. It arises below the bought put or above the bought call.
• Two break-even points. The lower one is the sold put minus the net premium (95 − 2 = 93), the upper one the sold call plus the net premium (105 + 2 = 107).

At expiry, only one side can cost money, because the price cannot be below 95 and above 105 at the same time. If the wings differ in width, the wider one determines the maximum loss arithmetically.

Values from the numerical example above: value of the options at expiry plus the net premium of 2, excluding costs and taxes.

In the example, a possible profit of 2 stands against a possible loss of 3. In general, the possible loss outweighs the possible profit as soon as the net premium is less than half the wing width.

Time and fluctuation change the value before expiry

The three calculations only apply on the expiration date. Before that, the options still have time value, and the value of the position changes continuously.

All other things being equal, time works in the iron condor's favour, because the time value of the sold options erodes. This holds as long as the price is between the sold strike prices. If it is outside them, the position loses value as expiry approaches.

Expected fluctuation works in the opposite direction. Specialists call it implied volatility: the fluctuation that the market derives from option prices. If it rises, time value increases, including on the sold options. All other things being equal, this harms the position. Both effects are measured with indicators: theta for time and vega for fluctuation (negative for an iron condor). What these measures show is explained in the article Option Greeks explained simply.

An iron condor does not have to run until expiry. Exchange-traded options can be traded during their term, so the position can be closed with offsetting transactions in all four options. Each option incurs fees and a bid-ask spread.

How does the iron condor differ from the strangle?

The toggle in the calculator shows a short strangle with the same sold options and premiums. It takes in 3 rather than 2 in premium, and its break-even points are at 92 and 108. Without bought wings, the loss is theoretically unlimited if the price rises and can be substantial if it falls. The iron condor therefore offers less potential profit, but in return a limited loss at expiry. The table compares four strategies that all take in a premium when the position is opened.

Risks and limitations

• Losses are possible: at expiry up to the maximum loss, in the example 3 against a possible profit of 2. Before that, assignment can bring additional losses (see below). The profit remains limited to the net premium, even if the price behaves as hoped.
• Collateral: Anyone who sells options must post collateral (margin). If the cover is insufficient, the securities firm, such as the bank, can issue a margin call or close the position.
• Early assignment: The counterparty can exercise American options on any trading day up to expiry. If this affects a sold option, it is called assignment, and a share position arises. This position can be closed in the market or offset with the matching bought option. In the second case, the shares must be borrowed or financed for one business day. The other half of the iron condor remains in place and can cause further losses. Assignment can also trigger margin calls. For equity options, it is often linked to dividends. According to the OIC, mergers, takeovers, spin-offs or special dividends can completely upset the usual assumptions about early exercise.
• American or European: On the Eurex derivatives exchange, equity options, for example on Nestlé, are generally American-style. Options on the Swiss Market Index (SMI) are European-style, meaning they can only be exercised on the expiration date (as of October 2026).
• Expiry close to a sold strike price: The OIC states: ‘If at expiration the stock is trading near either shoulder the investor would face uncertainty as to whether or not they would be assigned.’ If exercise turns out differently than expected, a share position is left over that carries price risk, for example over the weekend.
• Rising fluctuation and price jumps: If expected fluctuation rises, this works against the position. A large price jump can quickly take the price outside the wings, and at expiry the maximum loss then looms. For background, see the article on how volatility affects option prices.
• Costs and tradability: Four options mean four fees and four bid-ask spreads. Commissions are higher than for a short strangle. In addition, an option cannot always be sold at a reasonable price, and the bought wings can expire worthless.
• Simplified calculation: The calculator and the table only show the value at expiry, excluding costs, taxes and contract size. In its risk brochure of June 2023, the Swiss Bankers Association states that it cannot cover the risks of individual option combinations in every detail.

Conclusion

An iron condor combines two sold options with two bought options further out. It can be viewed as two spreads or as a short strangle with wings. At expiry, the profit is limited to the net premium and the loss to the wing width minus the net premium, in the example 2 against 3. Before expiry, time and expected fluctuation change the value. Early assignment or expiry close to a sold strike price can remove the limit on losses.