Trading iron condor with options explained


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The subject line of the email you send will be "Fidelity. To profit from a stock price move up or down beyond the highest or lowest strike prices of the position. A long iron condor spread is a four-part strategy consisting of a bear put spread and a bull call spread in which the strike price of the long put is lower than the strike price of the long call.

All options have the same expiration date. In the example above, one 95 Put is sold, one put is purchased, one Call is purchased and one Call is sold, so the four strike prices are equidistant. However, it is normal for the distance between the long call and long put to be greater than the distance between the long and short options of the same type. For example, an Bear Put Spread might be combined with a Bull Call Spread to create a long iron condor in which trading iron condor with options explained distance between the strike prices of the long options is 15 points while the distance between the strike prices of the bull and bear spreads are 5 points.

A long iron condor spread is established for a net debit, and both the potential profit and maximum risk are limited. The maximum profit potential is realized if the stock price is above the highest strike or below the lowest strike at expiration. The maximum risk is realized if the stock price is trading iron condor with options explained to or between the strike prices of the long options on the expiration date, in which case all options expire worthless.

Given that there are four options and four strike prices, there are multiple commissions in addition to four bid-ask spreads when opening the position and again when closing it.

The maximum profit trading iron condor with options explained is the maximum value of the bear put spread or the bull call spread less the net debit paid for the position. In the example above, the bull and bear spreads have a maximum value of 5. The maximum profit, therefore, is 2. There are two possible outcomes in which the maximum profit is realized.

If the stock price is below the lowest strike price at expiration, then the calls expire worthless, but both puts are in the money. With both puts in the money, the bear put trading iron condor with options explained reaches its maximum value and maximum profit.

Also, if the stock price is above the highest strike price at expiration, then the puts expire worthless, but both calls are in the money. Consequently, the bull call spread reaches it maximum value and maximum profit.

The maximum risk is the debit paid for the strategy plus commissions. A loss of this amount is realized if the stock price is equal to or between the strike prices of the long options on the expiration date, in which case all options expire worthless. There are two breakeven points.

The lower breakeven point is the stock price equal to trading iron condor with options explained strike price of the long put minus trading iron condor with options explained net debit paid. The upper breakeven point is the stock price equal to the strike price of the long call plus the net debit paid.

A long iron condor spread trading iron condor with options explained its maximum profit if the stock price is above the highest strike or below the lowest strike on the expiration date.

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 trading iron condor with options explained 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 trading iron condor with options explained 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 trading iron condor with options explained 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 trading iron condor with options explained 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 trading iron condor with options explained 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 trading iron condor with options explained a long put, the trading iron condor with options explained 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.

It can be between the strike prices of the long put and long call. It can be above the strike price of the long call, but not above the strike price of the short call; or it can be above the trading iron condor with options explained price of the short call, which is the highest strike price.

If the stock price is below the strike price of the short put lowest strikethen both puts are in the money and both calls are out-of-the-money. In this case both calls expire worthless, but the short put is assigned and the long put next higher strike is exercised. As a result, stock is purchased at the lowest strike and sold at the next higher strike.

As a result, the maximum profit is earned, but no stock position is created. If the stock price is above the strike price of the short put but not above the strike price of the long put, then the short put and both calls expire worthless, but the long put is assigned. The result is that shares of stock are sold short and a stock position of short shares is created.