The iron condor is one of the most popular options trading strategies used by veteran traders. It’s a directionally neutral strategy that aims to earn options premium from theta decay. The strategy relies on the price of a stock to remain in a tight trading range from the time the trade is opened until the options expiration date. No options trading strategy is perfect and as such it’s important to be aware of the advantages and disadvantages of trading iron condors so you can protect your capital.
Advantages of Trading Iron Condors
Iron condors are considered a more advanced form of options trading As such. it’s important to fully understand the correct way to structure them in order to be profitable. It’s also important to understand their versatility and advantages over other options trading strategies. Below are some of the different advantages of trading iron condors.
- Returns on Iron Condors Can Be Higher
- Directionally Neutral Strategy
- Fixed Level of Risk
- Trade Adjustment Flexibility
- You Receive Credit Instead of Paying a Debit
- Good For Low Volatility Environments
Let’s take a look at these advantages a bit more in depth.
Returns On Iron Condors Can Be Higher
In a flat and low trending market, iron condors can pull in more premium when compared to a single credit spread. Iron condors are double-sided credit spreads and as such receive premium on the put side and the call side when the trade is put on.
Iron Condor Construction
– Sell 1 OTM put ( closer to the price of the stock )
+ Buy 1 OTM put (further away from the price of the stock)
– Sell 1 OTM call ( closer to the price of the stock )
+ Buy 1 OTM call (further away from the price of the stock)
The ability to earn a premium on both sides of the market provides you the opportunity to improve the ROI on your trade.
Directionally Neutral Strategy
A unique advantage to iron condors is the fact that they don’t have a directional bias. They just need the price of the stock to remain within a set trading range by expiration.
By being neutral with the direction in which you hope the stock moves, you diversify your risk and focus on capturing theta decay.
Fixed Level of Risk
Iron condors offer a fixed level of risk. You know the maximum amount you stand to lose the moment you put on your iron condor.
Max Loss on an Iron Condor = The Difference Between the Long Call and Short Call Strike, or the Long Put and Short Put Strikes – Premium Received
To become a profitable trader, it’s extremely important to manage your losses effectively. Trading an iron condor allows you to have a fixed level of risk to protect your capital.
Trade Adjustment Flexibility (Adjusting a Loosing Iron Condor)
Another advantage of trading iron condors is the fact that you can adjust the losing side if the trade turns against you. If the stock price happens to move towards one side of your iron condor, you have some trade adjustment options in order to help you reduce your net loss, or even turn your loosing iron condor into a winning trade.
Below are some of the different options.
- Take a smaller loss by closing out 1 wing of the iron condor
- Close your short put or short call option out
- Roll your iron condor out to a further expiration
- Roll your iron condor further out of the money
These options can help reduce losses on your iron condors and even turn the trade around.
You Receive Credit Instead of Paying a Debit
When you “write” an iron condor you end up receiving credit. One of the biggest advantages of trading iron condors is that you get to benefit from time decay. When you write an iron condor, you end up receiving a credit right away and everyday that the price of the stock remains between your two spreads you keep more and more of your premium.
Good For Low Volatility Environments
Iron condors are best suited for low volatility environments in which the stock stays within a tight trading range. If you have a strong inclination that the price of a stock will begin to consolidate around a certain price range and want to take advantage with a fixed risk strategy, iron condors are very suitable.
Disadvantages of Trading Iron Condors
Although there are advantages to trading iron condors, they do come with some disadvantages. It’s important to be aware of their disadvantages because they may not be suitable for your style of options trading.
Below are some of the different disadvantages associated with trading iron condors.
- Higher Trading Fees
- Iron Condors Can Be Complex
- Limited Profit Potential
- More Ways to Lose The Trade
- Managing Iron Condors Can Be Time Consuming
- You May Have Trouble Getting Fills In Certain Cases
- Iron Condors Carry Assignment Risk
Higher Trading Fees
Since iron condors require 4 options contracts, you will pay more in trading fees than strategies that involve fewer contracts. Most brokers charge anywhere between $0.50 – $0.75 per options contract.
This means that you will pay anywhere between $2.0 – $3.0 or more just to put on an iron condor. If you’re using a commission-free broker you won’t have these fees, but these costs will be baked into the price one way or another.
Iron Condors Can Be Complex
If you’re a beginner in options trading, iron condors may be a bit complex for you. Since they require 4 separate options contracts to construct, an iron condor may be better suited for more experienced options traders.
It’s important to have a good understanding of what types of options contracts are involved in constructing an iron condor before you place one. If you happen to put on an iron condor incorrectly, you can suffer unexpected losses.
Limited Profit Potential
While iron condors have fixed risk, they also have limited profit potential. The maximum amount you will make on an iron condor is the credit you receive from writing it. The limited profit potential associated with iron condors can be a disadvantage when compared to other options trading strategies.
More Ways to Lose The Trade
Since you have two separate trades on opposite ends of the stock price, you have a higher likelihood for one side to lose if a sharp move happens in the stock. Knowing this, in order for an iron condor to be effective, you have to enter it when the stock is likely to stay in a tight trading range.
You should absolutely avoid trading iron condors around earnings announcements and important economic news events.
Managing Iron Condors Can Be Time Consuming
If you get into a situation where one side of your iron condor is losing money, you can adjust your iron condor to further limit your losses or even turn the trade positive.
The problem with this is that you will spend quite a bit of time babysitting the trade and closing out options contracts and opening up new ones. In turn, this will lead to further commission charges and added complexity to the original trade.
You May Have Trouble Getting Fills For Iron Condors
Depending on the stock you are trading, you may have trouble getting fills for your iron condors. There are many different factors that can impact this, including:
- How far out your expiration date is
- How far out of the money you place your strikes
- The liquidity of the stock
- The type of orders you are submitting
Since an iron condor involves multiple options contracts, getting fills won’t always happen automatically or without hiccups. There are however ways to improve your fills when trading iron condors.
Iron Condors Carry Assignment Risk
Believe it or not, there is assignment risk when trading iron condors if you fail to close them before the expiration date.
- If an iron condor expires below your short put strike, you will be assigned 100 shares of stock and have to put up the collateral to purchase 100 shares of stock. (+100 shares)
- If your iron condor expires above the short call strike price, you will be assigned 100 shares of stock short. (- 100 shares)
This happens more often to options traders than most people realized. As such, it’s recommended to close your iron condors at either 50% profit or before the expiration date.
As you can see, there are advantages and disadvantages of trading iron condors. Iron condor can be an extremely useful options strategy when used in the right trading environment. Knowing the risk associated with trading iron condors can help you avoid poor setups and volatile trading environments. Before you begin trading them, make sure you fully understand how each side of the trade is constructed.