Iron Condor
Categories: Derivatives
Options give you the right, but not the obligation, to buy or sell some underlying asset at a set price at some point in the future. So...you might purchase an option to buy 100 shares of NFLX at $400 per share, with the option expiring in a month.
The two most basic option contracts are the put and the call. The put is a bet that the underlying asset (the stock or the commodity or whatever) will go down in price. The call is a bet that the underlying asset will go up.
Okay, that info takes care of the basic background on options...now on to the Iron Condor.
Think of it this way: if one option contract is good, then a bunch of options working together must be great. Right? It’s like assembling the Avengers, if Iron Man and Thor were derivative contracts instead of superheroes.
Some of these combos are popular enough to get their own names. Iron Condor is one of those (also maybe Iron Man's cousin).
The Iron Condor is made up of four options. The strategy seeks to take advantage of a lack of volatility in a stock. When you set up the Iron Condor, you're hoping the stock moves sideways in a narrow range, ending the expiration period as close as possible to where it started it.
The structure involves two calls and two puts. You sell one call and buy one call, while simultaneously selling one put and buying one put. All the strike prices for each of the contracts are different, though the expiration for all four is the same.
All four contracts are also out-of-the-money, forming wings spreading out from the current stock price. So the pair of calls would have strike prices above the target price, while the pair of puts would have strike prices below. Usually, the stock prices are staggered in equal gaps.
An example Iron Condor for NFLX might go like this (with NFLX trading at $400 at the time you set up your Iron Condor):
Sell 100 NFLX calls, with a strike price of $420 and an expiration in May.
Buy 100 NFLX calls, with a strike price of $410 and an expiration in May.
Sell 100 NFLX puts, with a strike price of $390 and an expiration in May.
Buy 100 NFLX puts, with a strike price of $380 and an expiration in May.
You earn cash by selling the puts and calls. You have to spend some of the money you earn by buying the other puts and calls. But the idea is to bring in more than you shell out. The calls and puts you buy act as hedges in case the stock suddenly makes a big unexpected move. You make money by selling the options.
Your hope is that the stock holds steady. if all the options expire out of the money (if NFLX ends May at $405, for instance), you get to keep the money you earned by selling the puts and calls (minus expenses). Your worst case scenario would be if the stock made a big move. Then you have to use the options you bought to cover the options you sold...the ones where you owe something to other investors who might exercise their options.