Iron Condor for the newbie

nx109 · May 21, 2012

Hello ET,

I'm new to all this but I've been reading about options and now I need to interact and ask some questions since it's getting pretty complicated.

Long Iron Condors create a net credit (at least they should), but I'm not clear on a few points. This means that the options I sell are more expensive than the once I buy, thus depositing $ in my account. However, if I let all 4 of the legs expire, that means that this cash will stay in my account with 100% certainty.

Is this correct?

From what I was reading, the authors somehow seem to explain that this cash (credit) will only stay in my account if the price finishes in the price range designated by the options combo, but I don't see how that could be true, so please, by answering the above question you'll clear things up for me.

If it is correct, that means that the only "threat" after selling options is that you get a margin call in case you have too many positions and they are all negative at the exact same time, right? If you never get the margin call, you have safely earned that money, right?

Cheers

nx109 · May 22, 2012

To simplify the question:

Let's say I have a Bear Credit Spread (Bear Call Spread). Now, first my account gets net credit, and then I wait for expiration. If at expiration, the price is higher than the mid-point, that means if I closed the position, I would be at a net loss.

However, if I let my Short Call expire OTM, it is worthless so I loose nothing, while, at the same time my Long Call is ITM and that would mean - I'm net positive?

That's almost like 0% risk free money. What am I missing here, somebody please explain.

Thanks.

Strangler · May 22, 2012

An iron condor is selling an OTM call spread and an OTM put spread. To answer your question I'll just focus on the call side.

Example:
- Stock is at $100.
- You sell a 105 call and buy a 110 call.
- You receive a credit (let's say $2).

Expiration Scenarios:
- Stock is lower than $105. Both options expire worthless, you keep the full $2.
- Stock is higher than $110. Both options are in the money. You are on the hook for $5 (diff between strikes). So you took in $2, paid out $5, for a net loss of $3.
- Stock is between $105 and $110 (let's say $107). The 110 call is worthless, but the 105 call is in the money by $2, so you have to pay $2 to buy it back. So you took in $2, paid out $2, for a net breakeven.

So in this example your max gain would be $2, your max loss would be $3. Hope that helps.

AAAintheBeltway · May 22, 2012

No, you've got them all mixed up.

Rather than agonize over explanations here, you should get any decent options book, which will have profit and loss graphs for each specific position.

Trust me, there is no free lunch in options, no matter what anyone tells you. If there was a risk-free guaranteed profitable position, don't you think the hedge fund guys or market makers would arbitrage it to death?

nx109 · May 22, 2012

Quote from Strangler:

- Stock is higher than $110. Both options are in the money.

Wait what? That's what got me confused. I thought that if the price went above $110, that would mean that the short call would be OTM, just like a long put would. That's what's confusing me. Are you saying that price above $110 makes a long put OTM and a short call ITM ?

Thanks for the great answer, it cleared up almost everything except for that little confusion I have.

Quote from AAAintheBeltway:

Rather than agonize over explanations here, you should get any decent options book, which will have profit and loss graphs for each specific position.

I agree, I might go for a book, but for now I'm using the OptionsOracle app which lets me visualise the PnL for all kinds of spreads really nicely. I just get confused with the core logic sometimes.

diaoptions · May 22, 2012

Try and visualize this chart. Stock is at $45.00.

Sell 50 Call and Buy 55 Call for $50.00 credit.
Sell 40 Put and Buy 35 Put for $50.00 credit.
Total Credit $100.00.
Maximum gain $100.00 if stock is between $40.00 and $50.00 at expiration.
Maximum loss $400.00 if stock is below $35.00 or above $55.00 at expiration.

Strangler · May 22, 2012

Quote from nx109:

Wait what? That's what got me confused. I thought that if the price went above $110, that would mean that the short call would be OTM, just like a long put would. That's what's confusing me. Are you saying that price above $110 makes a long put OTM and a short call ITM ?

I think you are getting confused by short vs. long. Calls and Puts are either in the money or out of the money. Makes no difference if you are short or long.

A call is in the money if the stock price is HIGHER than the call strike price. A put is in the money if the stock price is LOWER than the put strike price. Simple as that.

nx109 · May 22, 2012

Quote from Strangler:

Calls and Puts are either in the money or out of the money. Makes no difference if you are short or long.

A-ha! Right... I was just thinking about it and it makes sense. I was confused by reading somewhere that "short calls are the same as long puts", except they're not. Thanks for that.

Strangler · May 22, 2012

Quote from nx109:

A-ha! Right... I was just thinking about it and it makes sense. I was confused by reading somewhere that "short calls are the same as long puts", except they're not. Thanks for that.

You were likely reading something about "equivalent positions". In options there are different strategies that produce the same risk-reward profiles, these are called equivalent positions.

Example:
- Long 100 shares of stock + short call = short put

This does not mean that stock, calls, and puts are all the same instrument. It just means that these 2 strategies will have the same risk-reward characteristics.

Whistlingleaf · May 23, 2012

Take my advice and don't do it.

As a noob options trader the last thing you should be trading are ICs.

The market has been too volatile over the past few years as big money pushes up and down too fast in short time frames.

I know the allure of making 10% a month sounds good on paper and I'm sure you'll find someone selling a book or a website saying how easy it is to make money on ICs, but ask around and talk to actual traders - if anyone has said they've made money consistently on ICs in the past few years I'd be shocked.

The tricky part is knowing what to do when a position moves against you and as a newbie you're really going to have a difficult time ~ panic, roll out, sell for loss, pray for reversion, add more - it's not easy to decide.

You're better off doing longer directional plays (debit spreads) IMO - read my posts in the bull call spread thread if you want more.

If you're going to do it anyway - don't risk more then 10% of your money in one month.

If you're going to go hog wild - send me half your money - in 12 months when you're busto with the first half - I'll give you the other half back. Promise.