Long iron condor option strategy
In addition, you want the stock price to remain stable, and a decrease in implied volatility suggests that may be the case. If the stock price is approaching or outside strike A or D, in general you want volatility to increase. An increase in volatility will increase the value of the option you own at the near-the-money strike, while having less effect on the short options at strikes B and C. So the overall value of the iron confor will decrease, making it less expensive to close your position.
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Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point. The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract.
There is no guarantee that the forecasts of implied volatility or the Greeks will be correct. Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice.
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The Strategy You can think of this strategy as simultaneously running an out-of-the-money short put spread and an out-of-the-money short call spread. Options Guy's Tips One advantage of this strategy is that you want all of the options to expire worthless.
Options have the same expiration month. Break-even at Expiration There are two break-even points: Strike B minus the net credit received. Strike C plus the net credit received. The Sweet Spot You achieve maximum profit if the stock price is between strike B and strike C at expiration. A long iron condor spread is the strategy of choice when the forecast is for a stock price move outside the range of the highest and lowest strike prices.
Unlike a long strangle, however, the profit potential of a long iron condor spread is limited. Also, the commissions for a condor spread are higher than for a strangle. The tradeoff is that a long iron condor spread has breakeven points closer to the current stock price than a comparable long strangle.
Long iron condor spreads are sensitive to changes in volatility see Impact of Change in Volatility. The net debit paid for a long iron condor spread rises when volatility rises and falls when volatility falls. Consequently some traders establish long iron condor spreads when they forecast that volatility will rise. Since the volatility in option prices tends to rise in the weeks leading up to an earnings reports, some traders will open a long iron condor spread two to three weeks before an earnings report and close the position immediately before the report.
Success of this approach to trading long iron condor spreads requires that volatility rises or that the stock price rises above the highest strike price or falls below the lowest strike. If volatility falls or it the stock price does not move, then a loss will be incurred. If volatility is constant, long iron condor spreads do not show much of a loss until it is very close to expiration and the stock price is within the range of maximum loss. In contrast, long strangles suffer much more from time erosion and begin to show losses early in the expiration cycle as long as the stock price does not move beyond a breakeven point.
Therefore, if the stock price remains in the range of maximum loss as expiration approaches, a trader must be ready to close out the position before a large percentage loss is incurred. Patience and trading discipline are required when trading long iron condor spreads.
Patience is required because this strategy profits from trending stock price movement outside the range of strike prices, and stock price action can be unsettling as it rises and falls around the highest or lowest strike price as expiration approaches. Long calls have positive deltas, short calls have negative deltas, long puts have negative deltas, and short puts have positive deltas.
Regardless of time to expiration and regardless of stock price, the net delta of a long iron condor spread remains close to zero until a week or two before expiration. If the stock price is below the lowest strike price in a long iron condor spread, then the net delta is slightly negative. If the stock price is above the highest strike price, then the net delta is slightly positive.
Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices. As volatility rises, option prices tend to rise if other factors such as stock price and time to expiration remain constant.
Long options, therefore, rise in price and make money when volatility rises, and short options rise in price and lose money when volatility rises. When volatility falls, the opposite happens; long options lose money and short options make money.
Long iron condor spreads have a positive vega. This means that the net debit for establishing a long iron condor spread rises when volatility rises and the spread makes money. When volatility falls, the net debit of a long iron condor spread falls and the spread loses money. This is known as time erosion. Long option positions have negative theta, which means they lose money from time erosion, if other factors remain constant; and short options have positive theta, which means they make money from time erosion.
A long iron condor spread has a net negative theta as long as the stock price is in the range of maximum loss. Consequently, a long iron condor spread loses money from time erosion.
If the stock price moves outside the range of maximum loss, however, the theta becomes positive and the position makes money as expiration approaches.
Stock options in the United States can be exercised on any business day, and holders of short stock option positions have no control over when they will be required to fulfill the obligation. Therefore, the risk of early assignment is a real risk that must be considered when entering into positions involving short options.
While the long options in an iron condor spread have no risk of early assignment, the short options do have such risk. Early assignment of stock options is generally related to dividends.
Short calls that are assigned early are generally assigned on the day before the ex-dividend date, and short puts that are assigned early are generally assigned on the ex-dividend date.
In-the-money calls and puts whose time value is less than the dividend have a high likelihood of being assigned. If the short call in a long iron condor is assigned, then shares of stock are sold short and the long call and both puts remain open. If a short stock position is not wanted, it can be closed in one of two ways.
First, shares can be purchased in the marketplace. Second, the short share position can be closed by exercising the long call. Remember, however, that exercising a long call will forfeit the time value of that call.
Therefore, it is generally preferable to buy shares to close the short stock position and then sell the long call. This two-part action recovers the time value of the long call. One caveat is commissions. Buying shares to cover the short stock position and then selling the long call is only advantageous if the commissions are less than the time value of the long call. Note, however, that whichever method is used, buying stock and selling the long call or exercising the long call, the date of the stock purchase will be one day later than the date of the short sale.
This difference will result in additional fees, including interest charges and commissions. Assignment of a short option might also trigger a margin call if there is not sufficient account equity to support the stock position created. If the short put is assigned, then shares of stock are purchased and the long put and both calls remain open. If a long stock position is not wanted, it can be closed in one of two ways. First, shares can be sold in the marketplace. Second, the long share position can be closed by exercising the long put.
Remember, however, that exercising a long put will forfeit the time value of that put. Therefore, it is generally preferable to sell shares to close the long stock position and then sell the long put. This two-part action recovers the time value of the long put. Again, however, the caveat is commissions. Selling shares to close the long stock position and then selling the long put is only advantageous if the commissions are less than the time value of the long put.
Note, again, that whichever method is used, selling stock or exercising a long put, the date of the stock sale will be one day later than the date of the purchase. The stock position created at expiration of a long iron condor spread depends on the relationship of the stock price to the strike prices of the spread, and there are five possibilities.
The stock price can be below the strike price of the short put, which is the lowest strike price. It can be above the strike price of the short put but not above the strike price of the long put.