What is an Iron Condor?
An Iron Condor is a neutral strategy that involves selling an out-of-the-money call and put, while buying a further out-of-the-money call and put to limit risk.
- Sell a put option at a lower strike price (e.g., $90).
- Sell a call option at a higher strike price (e.g., $110).
- Buy a put option with a lower strike price (e.g., $80) for protection.
- Buy a call option with a higher strike price (e.g., $120) for protection.
How Payoff Works:
If the stock price stays between the strike prices of the sold options, you keep the net credit received as profit. If the stock price moves beyond the protective strike prices, your losses are limited because of the purchased options.
Corrected Example Payoff Scenarios:
- Initial Setup: You receive a net credit of $300 (for simplicity, assume $3 per share).
- Stock Price = $85:
- Your sold put (strike $90) is in the money, resulting in a $500 loss (since 90 - 85 = $5 per share).
- Your bought protective put (strike $80) ensures no additional loss below $80.
- Net Payoff: You lose $500 from the sold put but gain $300 from the initial credit. Total payoff = -$200.
- Stock Price = $100:
- Both sold options (put at $90 and call at $110) expire worthless.
- Protective options also expire worthless.
- Net Payoff: You keep the full net credit received at the beginning. Total payoff = $300.
- Stock Price = $115:
- Your sold call (strike $110) is in the money, resulting in a $500 loss (since 115 - 110 = $5 per share).
- Your bought protective call (strike $120) limits further losses, so no additional loss above $120.
- Net Payoff: You lose $500 from the sold call but gain $300 from the initial credit. Total payoff = -$200.