The iron condor strategy is one the most versatile options trading strategies out there that has over a 70% probability of success.
If you trade it correctly…
You see, there is so much misinformation out there on the internet about the iron condor that is flat out wrong.
Dooming you for failure...
That's why I want to show you how to correctly use the iron condor options strategy so you can add it to your trading toolbox and generate consistent trading profits, just like I do.
Let's dive in.
The Short Iron Condor Fundamentals
What could iron condors possibly have in common with options trading?
Well it turns out that some options traders came up with the “iron condor” to describe one of the best options trading strategies, especially for beginners and for those with smaller trading accounts.
You must be wondering what this strategy is and how it works…
So let's dive in.
Iron condor strategy basics
The iron condor strategy is a defined risk options trading strategy that benefits from non-movement in the price of the underlying stock price.
One question I always get from newer options traders is how you can possibly make a profit without getting the stock price direction to move in your favor.
The answer is because this strategy takes advantage of other factors like time decay and volatility contraction to make money.
This is because the iron condor is a short premium strategy where you are a net seller of option premium.
So, when you initiate this strategy, you are actually receiving cash upfront.
You don't actually get to keep that cash unless several factors work in your favor, which I'll get to later in this post.
The components of an iron condor spread
Here are the building blocks for the iron condor spread.
- Sell 1 out of the money put option
- Buy 1 further out of the money put option
- Sell 1 out of the money call option
- Buy 1 further out of the money call option
If you're familiar with vertical spreads like credit spreads, you'll quickly notice that an iron condor is just the combination of a short call credit spread and a short put credit spread.
This is what that looks like on a profit and loss diagram.
So, with a neutral strategy like this, you want the stock price to stay between your two short strikes that you are selling (B & C).
Then, with cooperation from the stock price, you can take advantage of time decay and volatility contraction.
Iron condor time decay
As you saw in the previous section, you are a net seller of options when you use the iron condor strategy, meaning you collect premium upfront for initiating the trade.
This means that you have positive theta decay.
Time works for you when you use this strategy.
You can be completely wrong on the direction of the stock price, but as long as the stock price stays with your predefined range, you will make a profit.
This is because everyday that goes by, the value of the options that you sold decreases day after day.
So, after enough time had passed, you'll be able to buy back your short options for a cheaper price than what you had bought it for, profiting off the difference.
This is also the reason why the iron condor options strategy is such a high probability strategy (greater than 70%).
Time passing is given, so as long as the stock price stays within a range, you will make a profit using this strategy.
Iron condor IV environment
Using the iron condor spread in the right implied volatility environment is crucial.
Getting this wrong can destroy your odds of success.
Here's a quick primer on implied volatility.
When implied volatility is high, options prices are also high. When implied volatility is low, options prices are also low.
Implied volatility is the “extra dimension” to the price of an options contract that many beginner traders miss.
So, if you remember, the iron condor spread is a premium selling strategy.
If you are selling something (no matter what it is) you want to sell it for the highest price possible.
As I just explained, high options prices occur when implied volatility is high.
Thus, the prime opportunity to use the iron condor is when implied volatility is high.
Now, understanding when implied volatility is actually high is out of scope of this post, but you can check out a post I made just about this topic.
Time Decay and Implied Volatility
Time and volatility are two components that go into determining the price of an options contract. We can measure the effect of time and implied volatility on the price on an option by looking at theta and vega, which are two of the option "Greeks".
How to profit from an iron condor
So now let's bring what I've show you so far all together and summarize how you can profit from the iron condor spread.
- You need non-movement from the price of the underlying stock. As long as the stock price stays between your short strikes, you will make a profit on this strategy
- You need time to pass. Since the iron condor spread is a positive theta strategy, you make money on the trade everyday that passes.
- You need to initiate the iron condor in high implied volatility environments and wait for a volatility contraction. Doing this will let you sell expensive options that will quickly decay when implied volatility contracts.
Put these three factors in your favor and you have a winning strategy on your hands that will make you options trading profits, which is why we are all here.
How To Calculate Iron Condor Metrics
Now let's get into the nitty-gritty and learn how you can calculate a few important iron condor metrics.
The ones I'll show you are how to calculate an iron condor's maximum profit, maximum loss, break even price, and probability of profit.
Let's do it.
How to calculate an iron condor's maximum profit
Calculating an iron condor’s maximum profit potential is actually quite easy.
All you have to do is check what the initial credit you collected when you initiated the trade.
Here’s an example.
Let’s say you sell the following iron condor:
- Sell 1 100 strike put
- Buy 1 95 strike put
- Sell 1 125 strike call
- Buy 1 130 strike call
You put on this package for a $1.35 credit (in options terms). In dollar terms, this equates to $135.
This is your maximum potential profit on the trade since that’s all you are collecting.
How to calculate an iron condor’s maximum loss
Calculating your maximum potential loss on an iron condor trade requires a little bit of math.
Iron Condor Maximum Loss Calculation
Take the width of one side of the spread and subtract your initial credit collection.
Here’s an example:
Let’s us the same iron condor that we set up in the previous section.
The width of one side of the spread is $5, since the difference between 100 and 95 is 5. The difference between 130 and 125 is also 5.
But we only need to take one side of the iron condor, not both. This is because it is impossible for you to lose on both sides, since the stock price cannot be in two places at once.
So, here’s how that looks:
$5 spread width minus $1.35 credit collected = $3.65 maximum loss
$3.65 (in options terms) or $365 in dollar terms is the most you could potentially lose for this iron condor setup.
This is because the iron condor strategy is defined risk, so you know going into the trade what you could potentially lose if things go south.
How to calculate an iron condor’s break even price
An iron condor spread has two break even prices because you can potentially lose to the downside on the put credit spread or to the upside on the call credit spread.
Let’s go through how to calculate your break even prices.
Break Even Price
Your break even price is the stock price at which you would neither make nor lose any money on the position.
To calculate your break even price to the downside, take your short put strike and subtract the initial credit collected.
To calculate your break even price to the upside, take your short call strike and add the initial credit collected.
Here’s an example on how to calculate the break even price for the example iron condor we’ve been going through.
- Sell 1 100 strike put
- Buy 1 95 strike put
- Sell 1 125 strike call
- Buy 1 130 strike call
Your short put strike is 100, so subtract 1.35 from that and you get a price of 98.65.
Your short call strike is 125, so add 1.35 to that and you get a price of 126.35.
So, with this iron condor example, your two break even prices are $98.65 and $126.35.
As long as the stock price stays between those two points, you’ll make a profit.
If at expiration, the stock price lands on either $98.65 or $126.35, you won’t make any money, but you won’t lose any money also.
How to calculate an iron condor’s probability of profit
There’s a quick, back of the hand method for calculating probability of profit, which I’ll show you in this section.
There’s also a more complex mathematically way of calculating probability of profit that involves probability distributions and some calculus, which is out of scope for this post.
The good news is that this calculation is already calculated for you in most trading platforms.
Let’s go through the easy way to calculate an iron condor’s probability of profit.
You take 1 minus the ratio of your initial credit collected to the width of the spread.
So, for our example iron condor, this means that you take 1 minus 1.35 divided by 5.
(1.35 is the initial credit collected and 5 is the width of the spread)
The result is .73. To convert this into a percentage, simply multiple by 100.
So, your probability of profit with this iron condor example is 73%.
Real Life Iron Condor Example
Okay, now we got all the theory out of the way for the iron condor.
Next, I’d like to show you a real life iron condor example, so you can really see how this type of strategy works.
I’ll even show you screenshots of the iron condor setup in my tastyworks trading platform.
Let’s get started.
Real life iron condor example in Facebook stock
I’ve constructed an iron condor in Facebook stock to go through all the concepts we’ve gone through so far with a real example.
Here’s the exact setup:
Here are the exact strikes I used for this example:
- Sold 1 130 strike put option
- Buy 1 125 strike put option
- Sold 1 155 strike put option
- Buy 1 160 strike put option
Here’s what that looks like on a profit and loss diagram:
The market on this particular iron condor is $1.52 or $152 in dollar terms, which also is the maximum potential profit on this trade if the stock price stays in between my break even points.
Like we’ve learned before, the maximum loss on this trade is the width of the spread minus the credit collected.
So, in this case the maximum potential loss is $3.48 or $348 in dollar terms.
The two break even points in this example are $123.48 and $156.52. As long as the price of Facebook stays between those two prices, this trade will make a profit.
Outside of those two break even points, this trade will be a loss.
A few other things to note about this trade is that a delta of -2, which means that you are short two shares of Facebook (so you want the price of Facebook stock to go down a little bit).
But for all intents and purposes, a delta of -2 is as neutral as you can get.
Additionally, this iron condor example has a theta of 3.1. This means that as each day passes, this spread will profit 3.1 in pure time decay, all else being equal.
Lastly, you’ll notice that the tastyworks trading platform automatically calculates your “POP”, which stands for your probability of profit.
In this example, the iron condor has a 63% probability of making one penny or more.
It’s important to note that if you use the back of the hand calculation, you’ll get around 70% probability of profit.
The calculation the trading platform uses is the more complex formula that takes into account implied volatility and standard deviations, so the two methods of calculating probability of profit will be slightly different.
Despite the difference, the quick and easy calculation is still good for approximating your probability of profit.
How To Trade The Chicken Iron Condor
So, there’s been a lot of talk lately about the chicken iron condor.
I want to use this section to explain the difference between a standard iron condor and a chicken iron condor.
It’s the same strategy, it just has a few tweaks to the strike placement for earnings trades.
Let me explain.
What are chicken iron condors?
Chicken iron condors are a variation on the iron condor spread.
Chicken Iron Condors
A chicken iron condor is a type of iron condor where you bring your strikes closer to the current stock price to collect a higher credit.
The reason it is called a “chicken” is because you are bringing in your short strikes of the spread closer to the stock price.
So, what does this do?
If you bring your short strikes closer to the stock price, you end up collecting more premium because you are closer to the current stock price.
The trade off is a lower probability of profit. Hence, you are playing “chicken” with the stock price.
(Remember, you want the stock price to stay in between your two short strikes)
When you bring your short strikes closer to the stock price, there is a smaller window for the stock price to trade in for you to be successful.
How to setup a chicken iron condor
To setup a chicken iron condor, you bring your strike closer to the stock price up until the point where you are collecting 50% of the width of the spread.
So, let’s say you are selling a $3 wide iron condor.
You can bring your strikes closer to the stock price up until you are able to collect $1.50 in credit, since that is 50% of $3.
If you remember our back of the hand probability of profit formula, if you collect 50% the width of the spread, then your probability of profit is 50%.
Why trade the chicken iron condor?
On the surface, you may question why anyone would want to use the chicken iron condor since the probability of profit is so low (only 50%).
The trade off for a lower probability of profit is less risk and higher return.
One good situation for a chicken iron condor is if you are doing an earnings trade.
Earnings trades are binary events, meaning after a company releases its earnings report, the stock price can quickly move in a big way in either direction.
Since, these types of trades are a flip of a coin, sometimes it’s just better to sacrifice your probability of profit for a lower maximum potential loss and higher maximum potential profit.
This way if you’re right, you make more profit. And if you’re completely wrong (which if you’re wrong on an earnings trade, you’re probability really wrong) you end up losing less using this variation.
What's The Difference Between An Iron Condor And An Iron Butterfly?
The iron condor and iron butterfly are two very similar strategies.
And beginner traders always get confused on the difference between the two.
So, let’s use this section to answer that question.
How are iron condors and iron butterflies different?
So, as we’ve learned in this post, an iron condor spread is a short put credit spread below the current stock price and a short call credit spread above the current stock price.
The result is a profit and loss diagram that looks something like this:
As you can see, the two short strikes (red tiles) are situated on different strike prices.
On the other hand, an iron butterfly has the two short strike situated on the same strike price, typically at the current stock price.
Otherwise the composition of the options contracts that make up the iron condor and the iron butterfly are essentially the same.
Here’s what the iron butterfly looks like:
So, with the iron condor, you have a much wider range for the stock price to float around and still make a profit.
This means a higher probability of success in exchange for a lower profit potential.
With the iron butterfly, you are bringing your short strikes all the way to the current stock price. This makes your range of profitability much smaller, lowering your probability of success.
The trade off here is that you have a much higher profit potential.
What situations to use iron condor vs iron butterfly
When should you use one strategy over the other?
That’s a really open ended question and depends on many factors like your own risk tolerance and conviction on the stock price staying in a range.
If you want to be more aggressive because there’s either really high implied volatility or you think the stock price is not going anywhere, the iron butterfly is probability a better choice.
This is because you’ll make a larger profit if you turn out to be right on your prediction.
If, on the other hand, you think the stock price might move around some, an iron condor might be better.
This is because an iron condor spread has a larger range for the stock price to move around for you to be profitable. But you might not make as might profit this way.
How To Trade Iron Condors For A Living
We’ve been through a TON of helpful information about the iron condor options trading strategy.
What does this all boil down to?
Ideally, you can use this strategy to generate consistent income month after month so that you can trade iron condors for a living.
Let’s dive in.
What does it take to trade iron condors for a living?
The math and the theory work. It’s statistically proven that a high probability options strategy like the iron condor strategy works and makes profit over time.
The question is do you have the discipline and dedication to stay mechanical and see each of your trades through, even if you have a string of losing trades?
Even though this strategy has a high probability of success, you will still have losing trades.
In fact, you can even have a month long rut of losing trades just as you can flip a coin 10 times and get all heads.
With that being said, here are a few trading tips to help you stay mechanical when trading the iron condor for a living that will set you up for success.
- Only use this strategy in high implied volatility environments
- Make sure you have at least a 60% probability of success
- Close your trades at 50% of maximum profit
- Ride out losing trades until expiration
- Keep your position size small relative to your account size
- Avoid selling cheap options (less than $0.50 of value)
- Only use chicken iron condors for earnings trades
- Stay mechanical to let the math and probabilities work itself out
In my years of experience in the markets trading options, all it takes is to follow these few simple trading tips.
The traders who become successful are able to follow the mechanics and believe the math, probabilities, and statistics that back up the iron condor.
If you are able to do that, you will be able to trade iron condors for a living.
Now It's Your Turn
Now I’d like to hear from you.
Anything you think I missed?
Did I miss anything on the iron condor strategy that you think is important to remember?
Or maybe you have a question about something I talked about.
Either way, let me know by leaving a quick comment below, right now.