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On Options

# Long Iron Condor Spreads: Understanding the Basics

Learn how long iron condor spreads can be used as a breakout strategy when you expect a stock or ETF to move sharply in an uncertain direction.

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A long iron condor, which is considered a breakout strategy, involves four legs and four different strike prices established in a 1/1/1/1 ratio. Unlike traditional condors which can be created using either calls or puts, iron condors are created using both calls and puts at the same time.

A long iron condor is a breakout strategy that has a limited loss potential if the underlying security stays more stable than expected. An iron condor is considered "long" if there is a net cash outlay required to initiate it:

• Sell one put with the lowest strike price
• Buy one put with a higher strike price
• Buy one call with a higher strike price
• Sell one call with the highest strike price

Figure 1 – Basics of a long iron condor spread
Source: Schwab Center for Financial Research.

The options chosen for a long iron condor should all have the same expiration date and the strike range between the first and second leg should be the same as the strike range between the third and fourth leg. Like many option strategies, the maximum gain, maximum loss, and breakeven points can all be calculated at the time of order entry.

## How to calculate price levels for a Long Iron Condor

Assuming stock XYZ is trading at 219.60, the following formulas will allow you to calculate the maximum gain, maximum loss, and upper and lower breakeven prices on any long iron condor trade.

Example of a 10-point long iron condor spread:
Sell 10 XYZ Dec 210 puts @ 5.40
Buy 10 XYZ Dec 220 puts @ 10.25
Buy 10 XYZ Dec 230 calls @ 5.70
Sell 10 XYZ Dec 240 calls @ 2.92
DR (Debit) = 7.63 (+5.40 – 10.25 – 5.70 + 2.92)
MG (Maximum Gain) = 2.37 (second strike - first strike - ML x number of spreads) or \$2,370 (Occurs beyond the outside strike prices)
ML (Maximum Loss) = 7.63 (Debit paid x number of spreads) or \$7,630 (Occurs between the second and third strike prices)
Upper BE (Breakeven) = 237.63 (third strike + ML)
Lower BE (Breakeven) = 212.37 (second strike - ML)

Or, you can simply allow StreetSmart Edge to do the calculating as shown below.

Figure 2 – Calculating maximum gain, maximum loss and breakeven for a long iron condor trade
Source: StreetSmart Edge®

Once you know these important values, consider drawing them on an actual price chart to help you visualize the trade. You’ll probably want to include the outside strike prices of 210 and 240 (max gain levels) and the upper and lower breakeven levels of 212.37 and 237.63. A convenient way to do this is to use the support and resistance lines, which are typically used for technical analysis, to illustrate the breakeven and max loss levels. Use the resistance line tool (red line) for the inner breakeven lines, and the support line tool (green line) for the outer max gain levels as illustrated below:

Figure 3 – Breakeven thresholds
Source: StreetSmart Edge®

The snapshot of the chart above was taken on January 13, 2015 with the February long iron condor having about 39 days until expiration. If XYZ is between 212.37 and 237.63 at the February option expiration, this trade will be unprofitable. The maximum loss will be reached if XYZ is between 220 and 230 at expiration. This trade will be profitable if XYZ closes above 237.63 at expiration, with the maximum profit of \$2,370 occurring at any price above 240. Likewise, the trade will also be profitable if XYZ closes below 212.37 at expiration, with the maximum profit of \$2,370 also occurring at any price below 210.

As you can see, a long iron condor spread requires a fairly substantial move to be profitable, whereas the maximum loss occurs anywhere between the two middle strike prices, 220 to 230 in this example. In this example, XYZ has to move up more than 18.03 points (237.63 – 219.60), or down more than 7.23 points (219.60 – 212.37) to end up profitable.

## Keep in mind

A long iron condor is often used as a substitute for a traditional short condor, except that a long iron condor is initially established for a net debit while the short condor is initially established for a net credit.

The risk and reward profiles, and profit and loss zones of the two strategies are very similar, so the decision of which to use often comes down to which might have a very slight pricing advantage, or whether you prefer to pay a debit (with no margin requirement) or receive a net credit (with a margin requirement equal to the maximum loss).

## Conclusion

A long iron condor is a breakout strategy—appropriate when you expect the underlying security to experience a sharp move higher or lower, but you are uncertain which direction. This four-legged strategy, created using both calls and puts, has four different strike prices and is established with the same contract quantity for each leg. A long iron condor has a limited loss potential if the underlying security stays more stable than expected and you saw how you might select strike prices for long iron condor spreads.