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An Iron Condor describes a combination of four options. With this combination, investors can speculate on stagnation or moderate fluctuations of stock prices within a certain range up or down. The aim is to earn money from the premium income for selling options.
The name Iron Condor describes a curve in the profit and loss chart. It is the result of the composition of a Bear Call Spread (Vertical Call Spread) and a Bull Put Spread (Vertical Put Spread) and thus results from four different options. It is therefore a synthetically produced position.
In practice, the Iron Condor option strategy is often based on indices, because these by their nature have lower volatility than many individual stocks.
Creation of an Iron Condor
So how is an Iron Condor formation formed? First of all, an out of the money call option is sold (call short). The exercise price should be at the upper end of the expected fluctuation range within which the share price may move in order not to fall into the loss zone.
An out-of-the-money put option is sold for the lower limit of the fluctuation range (put short).
The investor can collect a corresponding option premium for each of these two sales.
The problem that now arises is that, contrary to expectations, the share price overshoots the expected fluctuation margin, resulting in high losses.
In order to limit the risk of an uncontrolled loss, the call short and the put short are hedged with a counter position.
To hedge the call short, a call long option with a slightly higher exercise price is therefore purchased at a lower premium. To hedge the put short, a put long option is accordingly purchased at a slightly lower strike price and a lower option premium.
Advantage of the Iron Condor strategy
Premium income generated from short positions is reduced by the premiums paid for long positions. However, a premium profit remains in the total.
The original fluctuation margin for the share price on which the speculation was based is reduced slightly. However, there is still sufficient scope within which fluctuations in the share price can occur.
On the other hand, the risk of loss has been limited to a fixed maximum loss by adding the call long and the put long.
Example for the formation of an iron condor
Let’s assume a share price currently stands at €50. An investor thinks that the price will not rise or fall by more than 10% in the near future. The expected fluctuation range should therefore be between €45 and €55. Overall, the fluctuation margin should be a good 20%.
The investor now first buys a call short position on the shares at an exercise price of € 57.5 and receives a premium of € 1.46 per share. This means that he can earn € 146 per 100 shares for the call short option.
At the same time, he sells a put short option at a strike price of € 43. In return he receives a premium of €1.61 per share. For 100 shares, he can therefore receive €161 for the put short option.
In total, the investor can therefore earn €305 by selling the call and put options.
Hedging with an Iron Condor
To hedge the position, he now buys suitable counter positions with a call long and a put long. In this way, he can limit the resulting loss if the share price fluctuates more strongly upwards or downwards than expected due to an unforeseen event, such as the publication of quarterly figures or sudden takeover rumours.
He therefore buys a call long at an exercise price of €60. An option premium of €0.95 per option is paid. For one hundred shares, this corresponds to a total price of €95.
To hedge the put short, a put short option is purchased at an exercise price of €41. An option premium of €1.15 per share must be paid for this. For 100 shares 115 € are to be paid thus.
For the two long options, a total of €210 must therefore be paid. If the premium income of €305 is now taken into account, a positive balance of €95 remains.
The risk of loss is considerably reduced with this construction. In concrete terms, a maximum loss is achieved in the event of strong fluctuations beyond the expected range.
Read my other articles about options:
- Bear Call Spread Options Strategy
- Bull Put Spread – Earn Money With Puts And Limit Risk
- Butterfly Spread Options Strategy
- Definition Of Option Price/Option Premium
- Earn Money With A Covered Call Options Strategy
- How to exercise Options
- How to use the Standard Deviation for Options Trading
- Iron Condor – Profit From Low Price Fluctuations
- Options Trading Tutorial for beginners
- Options vs. Futures – Two Different Types Of Futures Contracts
- Options vs. Warrants – 4 Differences
- Protective Put – Hedging Of Equity Positions
- Simple Trading Strategies for Options
- Term structure options
- What are options? – Explained Simply And Quickly
- What is a Long Call in Options Trading?
- What is a Long Put in Options Trading?
- What is a Short Call in options Trading?
- What is a Short Put in Options Trading?
- What is delta in Options Trading? – The Most Important Key Figure
- What is Historical Volatility in Options Trading?
- What is the Gamma in Options Trading?
- What is the Implied Volatility Of Options – Important Or Not?
- What is the Theta in Options Trading?
- What Is The Vega Of An Option?