“Iron Condors” are another very common spread among individual traders in CME Group’s options markets.  These spreads build upon the strangle that we talked about last time, in that they involve executing a strangle, but with additional options on the “wings” that limit the downside risk of the position.  Another way to look at an Iron Condor is that it is constructed by simultaneously selling (buying) an out-of-the money (OTM) Put spread and an OTM Call spread.  Therefore, the maximum profit and loss of the position is known, or defined, at the time of execution.  

A short iron condor involves selling both an OTM Call and Put spread.  Because this strategy consists of two short spreads, it results in a net collection of premium and realizes its maximum profit if the underlying price, at expiration, remains between the short Call and short Put strikes.  

A long iron condor involves buying an OTM Call and Put spread and comes with the opposite P&L characteristics, though the max profit and loss is still known at the time of execution.  

All else equal, because a short iron condor involves selling premium and is “short volatility”, a speculative short iron condor realizes its max profit when the market moves less than the market is pricing in.  

For our example, we looked at CME’s Gold Options market.  At the time we constructed our hypothetical Short Iron Condor position, Gold futures were trading at around 2,442.  Therefore, we constructed the following position, using out of the money Call and Put spreads that had 27 days until they expired:

Sell 1 2,410 Put (out of the money) @ 26.2 | Delta 36

Buy 1 2,395 Put (further out of the money) @ 20.5 | Delta -31

Sell 1 2,470 Call (out of the money) @ 30 | Delta -40

Buy 1 2,485 Call (further out of the money) @ 25 | Delta 35

As you can see, this hypothetical position results in a net credit of 10.7 points and, because the contract multiplier for Gold options is 100, the dollar value of the premium collected on this trade is $1,070.  

In the three images below, we show the P&L profile (at expiration) of this strategy from three different perspectives.  

- The top image shows the overall P&L of a short Iron Condor at expiration.  As you can see, the Max Profit ($1,070) is realized when the price at expiry is between the short options positions and the Max Loss ($430) occurs with large price moves to the upside OR downside. 

- The middle image below shows the Strangle element of the Iron Condor in the gray shaded area.  We extended the line in RED to show that the impact that the “Long Wings” has on the strategy relative to the Strangle.  A Strangle has the potential for unlimited loss whereas the Iron Condor caps the loss due to the long options.  

- The lower image shows the short Put and short Call spreads that comprise a Short Iron Condor.  By themselves, if all else is kept constant short Put and Call spreads have a directional bias, but when combined in an Iron Condor, the max profit, at expiration, is realized when the price moves less than what was priced in. 

However, because option pricing is multi-dimensional, several different elements can impact the value of the position between the time of execution and the expiry.  To illustrate this, we used CME’s options calculator to change the hypothetical volatility and time to expiration to demonstrate what the resulting theoretical value of the position would be.  

Implied Volatility (IV) (Vega)

To illustrate the impact that IV has on this position, we decreased it for each option by 3% and held everything else constant (futures price, days to expiry etc).  This resulted in the following change in theoretical value:

2395 Put declined from 20.5 to 14.1

2410 Put declined from 26.2 to 18.8

2470 Call declined from 30 to 22.4

2485 Call declined from 25.1 to 17.8

Even though each of the four options declined in theoretical value, the short options in this position, that had higher Vega values, declined by more than the long options and the overall value of the position declined from 10.7 points to 9.3 points.  Therefore, because this position was “net short volatility” the theoretical impact to the P&L resulting from this change in implied is 1.4 points, or $140. 

Time Value (Theta)

Next, we returned IV to its original values and simulated the passing of 2 weeks, holding all else constant.  This resulted in the following changes to theoretical value:

2395 Put declined from 20.5 to 10.5

2410 Put declined from 26.2 to 14.8

2470 Call declined from 30 to 17.6

2485 Call declined from 25.1 to 13.3

Similar to the hypothetical decrease to volatility, the passage of time results in the theoretical decline in the value of all four options.  Again, because this hypothetical position was “net short Theta”, the value of the short options declined more, relative to the long options and the theoretical impact to the P&L would be positive 2.1 points, or $210.  

Concluding, the Iron Condor can be an effective strategy for a trader who believes the underlying price will move more, in the case of a long Iron Condor, or less, in the case of a short Iron Condor, than the options market is pricing.  Further, because it is a “risk-defined” strategy, the max profit or loss is known at the time of execution.