The reverse (short) iron condor is a limited risk, limited profit trading strategy that is designed to earn a profit when the underlying stock price makes a sharp move in either direction.
|Reverse Iron Condor Construction|
|Buy 1 OTM Put|
Sell 1 OTM Put (Lower Strike)
Buy 1 OTM Call
Sell 1 OTM Call (Higher Strike)
To setup a reverse iron condor, the options trader buys a lower strike out-of-the-money put, sells an even lower strike out-of-the-money put, buys a higher strike out-of-the-money call and sells another even higher strike out-of-the-money call. A net debit is taken to enter this trade.
Maximum gain for the reverse iron condor strategy is limited but significantly higher than the maximum possible loss. It is attained when the underlying stock price drops below the strike price of the short put or rise above or equal to the higher strike price of the short call. In either situation, maximum profit is equal to the difference in strike between the calls (or puts) minus the net debit taken when initiating the trade.
The formula for calculating maximum profit is given below:
Maximum loss for the reverse iron condor strategy is also limited and is equal to the net debit taken when entering the trade. Maximum loss occurs when the underlying stock price at expiration is between the strikes of the long call and the long put. At this price, all the options expire worthless so the trader is left with nothing except a loss equal to the initial debit taken.
The formula for calculating maximum loss is given below:
There are 2 break-even points for the reverse iron condor position. The breakeven points can be calculated using the following formulae.
Suppose XYZ stock is trading at $45 in June. An options trader executes a reverse iron condor by selling a JUL 35 put for $50, buying a JUL 40 put for $100, buying another JUL 50 call for $100 and selling another JUL 55 call for $50. A net debit of $100 is taken upon entering the trade.
Suppose if XYZ stock is still trading at $45 on options expiration in July, all 4 options expire worthless. Since the trader had taken a debit of $100 on entering the trade, he suffers a loss of $100. This is also his maximum possible loss.
If XYZ stock is instead trading at $35 on expiration date, only the long JUL 40 put option expires in the money. This JUL 40 put option is worth $500 and therefore the trader's profit is $400 after deducting the initial $100 debit. A similar situation occurs when the underlying stock trades at $55 on expiration date. In this case, only the long JUL 50 call option expires in the money and it is also worth $500.
To further see why $400 is the maximum possible profit, let's examine what happens when the stock price falls below $35 to $30 on expiration date. At this price, both the JUL 35 put and the JUL 40 put options expire in-the-money. The short JUL 35 put has an intrinsic value of $500 while the long JUL 40 put is worth $1000. Selling the long put for $1000 and buying back the short put for $500 still leaves the trader with a net $500. Subtracting the initial debit of $100 taken, his profit is still $400. A similar situation occurs when the stock trades above $55 with the call options.
Commission charges can make a significant impact to overall profit or loss when implementing option spreads strategies. Their effect is even more pronounced for the reverse iron condor as there are 4 legs involved in this trade compared to simpler strategies like the vertical spreads which have only 2 legs.
If you make multi-legged options trades frequently, you should check out the brokerage firm OptionsHouse.com where they charge a low fee of only $0.15 per contract (+$4.95 per trade).
The following strategies are similar to the reverse iron condor in that they are also high volatility strategies that have limited profit potential and limited risk.
The converse strategy to the reverse iron condor is the long iron condor. Long iron condor spreads are used when one perceives the volatility of the price of the underlying stock to be low.
The reverse iron condor spread belongs to a family of spreads called wingspreads whose members are named after a various flying creatures.
Your new trading account is immediately funded with $5,000 of virtual money which you can use to test out your trading strategies using OptionHouse's virtual trading platform without risking hard-earned money.
Once you start trading for real, all trades done in the first 60 days will be commission-free up to $1000! This is a limited time offer. Act now!Click here to open a trading account at OptionsHouse.com now!
Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]
If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]
Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]
If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPSÂ® and why I consider them to be a great option for investing in the next MicrosoftÂ®.... [Read on...]
Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]
As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]
Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]
To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]
Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]
Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]
Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]
In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]
Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]
Risk Warning: Stocks, futures and binary options trading discussed on this website can be considered High-Risk Trading Operations and their execution can be very risky and may result in significant losses or even in a total loss of all funds on your account. You should not risk more than you afford to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Information on this website is provided strictly for informational and educational purposes only and is not intended as a trading recommendation service. TheOptionsGuide.com shall not be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon.