LONG IRON CONDOR
Strategy Type: Neutral on direction, but bullish on volatility
# of legs: 4 (Short 1 Lower Strike Put + Long 1 Lower Middle Strike Put + Long 1 Higher Middle Strike Call + Short 1 Higher Strike Call)
Maximum Reward: Lower Middle Strike Price - Lower Strike Price - Net Premium Paid
Maximum Risk: Limited to the extent of net premium paid
Lower Breakeven Price: Lower Middle Strike Price - Net Premium Paid
Upper Breakeven Price: Higher Middle Strike Price + Net Premium Paid
Payoff Calculation: Payoff of lower strike Short Put+ Payoff of lower-middle strike Long Put + Payoff of higher middle strike Long Call + Payoff of higher strike Short Call
Explanation of the Strategy
A Long Iron Condor is a strategy wherein the trader would sell a lower strike Put, buy a lower middle strike Put, buy a higher middle strike Call, and sell a higher strike Call. Each of the option that is traded under this strategy must belong to the same underlying and must have the same expiration. Usually, the lower strike and the lower middle strike Puts are OTM Puts, whereas the higher middle strike and the higher strike Calls are OTM Calls. At the time of initiating this strategy, the underlying price is usually somewhere between the two middle strikes. Usually, all the four options are equidistant from each other. However, this is not a hard and fast rule. Sometimes, traders keep a wider distance between the two middle strikes as compared to that between the outer and the middle strike. Doing so increases the profit potential, but also widens the loss-making zone.
In terms of direction, a Long Iron Condor is a neutral strategy. This is because this strategy can profit either from a down move in the price of the underlying or from an up move. That said, this strategy is bullish on volatility and benefits during times when volatility is rising, and vice versa. This is because the higher the volatility, the higher would be the probability of the position becoming profitable. A Long Iron Condor has two breakeven points: lower and upper. The position is unprofitable as long as the underlying price is within the two breakeven points and is profitable when the underlying price is outside one of the two breakeven points. Both profits and losses under this strategy are limited. Maximum profit occurs when the underlying price falls below the lower strike or rises above the higher strike, while maximum loss occurs when the underlying price gets stuck inside the two middle strikes.
A Long Iron Condor is a net debit strategy. Maximum potential profit under this strategy is usually smaller than the maximum potential loss. As a result, this strategy must preferably be initiated by experienced option traders only. Before initiating this strategy, one must always take into consideration the risk to reward ratio and must initiate only if this ratio is acceptable and worth trading for. Also, as we shall later see, Long Iron Condor has a similar payoff structure as a Short Call Condor or a Short Put Condor. However, there are differences. The major difference is that short Call/Put Condor strategies are net credit strategies, whereas Long Iron Condor is a net debit strategy.
Benefits of the Strategy
This strategy is direction neutral as the trader can profit from either direction, up or down
Maximum loss under this strategy is limited
Rising volatility has a beneficial impact on the strategy payoff
Drawbacks of the Strategy
The cost/risk of this strategy tends to exceed the potential reward
There are chances that the trader could lose 100% of his net investment
When the underlying price is within the confines of the two middle strikes, a decline in volatility would hurt the position
A sharp move below the lower strike or above the higher strike would lead to an opportunity loss as maximum profit potential under this strategy is capped
Time decay would hurt the trader, especially when the position is unprofitable
See that you have a neutral view on the price direction, but you expect volatility to increase sharply once you have initiated the position
Ensure that the strikes are evenly placed. In other words, see that the distance between the lower and the lower middle strike is equal to that between the higher middle and the higher strike
However, sometimes, traders keep the distance between the two middle strikes slightly wider than between the outer and the middle strike to account for a higher profit
The spread between the strikes will be a trade-off between the cost/risk of the strategy and the potential reward
The wider the difference between the adjacent strikes, the higher will be the cost and the risk but so would be the reward, and vice versa
Similarly, the wider the difference between the adjacent strikes, the wider would be the loss-making zone, and vice versa
As this is a neutral strategy that benefits from rising volatility, ensure that you execute this strategy when expiration is far off, as this would give you sufficient time to go right
As the risk/cost tends to be higher than the reward, execute this strategy only when the risk reward ratio is acceptable to you
Ensure there is sufficient liquidity in the underlying that is being chosen to initiate this strategy
Option Greeks for Long Iron Condor
GreekNotesDelta: Delta is at or near zero at initiation. It tends to bottom out below zero when the underlying price is below the lower strike and peak out above zero when the underlying price is above the higher strike. That said, while Delta does become non-zero as the underlying price moves, it does not deviate much from zero. As such, changes in the price of the underlying do not have much impact on this strategy because of the way it is structured.
Gamma: Gamma is positive and is at its highest point in between the two middle strikes. As the underlying price moves away from the midpoint of the two middle strike and approaches either the lower or the higher strike, Gamma tends to move into negative before bottoming out around these extreme strikes.
Vega: Vega is positive and is at its highest point between the two middle strikes, meaning the positive impact of a rise in volatility is the greatestaround the middle strikes. Volatility benefits as long as the position in unprofitable. That said, Vega turns negative when the position becomes profitable, meaning rising volatility now starts hurting the position.
Theta: Theta is negative and is at its lowest point between the two middle strikes, meaning time decay hurts the most around the middle strikes. Time decay hurts the position as long as it is unprofitable. That said, Theta turns positive when the position becomes profitable, meaning time decay now starts benefiting the position.
Payoff of Long Iron Condor
The above is the payoff chart of a Long Iron Condor. Notice that this strategy has an opposite payoff structure as compared to a Long Call Condor or a Long Put Condor. As we can see, maximum loss under this strategy occurs when the underlying price gets stuck within the range of the two middle strikes. On the other hand, maximum gain under this strategy occurs when the underlying price either falls below the lower strike price or rises above the higher strike price. Notice that both maximum loss and gain are known beforehand and are limited. Meanwhile, also notice that the strategy is unprofitable when the underlying price is within the range of the two breakeven points and is profitable when the underlying price moves outside either of the two breakeven points.
Example of Long Iron Condor
Let us say that Mr. ABC has decided to execute a Long Iron Condor strategy on Nifty. The details of the strategy are as below:
Strike price of OTM short Put = 8800
Strike price of OTM long Put = 9000
Strike price of OTM long Call = 9200
Strike price of OTM short Call = 9400
ShortPut premium (lower strike) = ₹50
Long Put premium (lower middle strike) = ₹105
Long Call premium (higher middle strike) = ₹70
Short Call premium (higher strike) = ₹20
Net Debit = ₹105 (105 + 70 - 50 - 20)
Net Debit (in value terms) = ₹7,875 (105 * 75)
Lower Breakeven point = 8895 (9000 - 105)
Upper Breakeven point = 9305 (9200 + 105)
Maximum reward = ₹7,125 ((9000 - 8800 - 105) * 75)
Maximum risk = ₹7,875