The iron condor is a popular option trading strategy used by both individual investors and money managers. As a trading strategy, the condor uses two vertical spreads. A call spread and a put spread. These two vertical spreads have four different strikes and the same expiration.
Some core features of the trading strategy include;
1. One call spread and one put spread with the same expiration day and on the same instrument.
2. Four out of the money options.
3. The call spread and the put spread have equal width.
4. The underlying asset is often included in the broad-based market index such as NDX, RUT or the SPX. You can also choose your iron condor position on smaller indexes or individual stocks.
5. Buying of the iron condor occurs once you sell the call or put spreads. The cash that you collect is the maximum profit for the specific position.
How does the strategy work?
The strategy works on the assumption that the underlying index of the security will remain in a narrow trading range from the time you open the particular position to the time the position expires.
When the expiration period arrives, if all the options are out-of-the-money, they are worthless. You keep every penny less the commission that you collected when buying the position.
Sometimes, you may have to close the position before the expiration arrives and sacrifice a portion of the profit. This ensures that you minimize your losses and lock in profits.
The iron condor is a good trading strategy when perfectly executed. Just like any other trading options , it has its risks. To minimize these risks, you have to keep in mind how much you can afford to loose, and your options in case the market takes unexpected twists.
Knowing this will help you plan your trading style in a way that will shield you from potential losses.