Ask the Institute

DATE: March 25, 2013

QUESTION:

Can you explain how an Iron Condor option strategy is constructed?

ANSWER:
An Iron Condor is a 4-part option strategy. Anytime you hear the word "iron" in the name of an option strategy, it means that both calls and puts are used in the strategy. An Iron Condor is constructed by combining an out-of-the-money bear call spread and an out-of-the-money bull put spread.

If a trader wanted to construct an Iron Condor position on XYZ stock because they believe it will continue to trade near $115 through option expiration in April, they could first sell the 120/125 bear call spread. Specifically, they would sell the 120-strike call for 1.60 per share and buy the 125-strike call for .60 cents for a net credit of $1 per share for the bear call spread. Simultaneously, they would then sell the 110/105 bull put spread. Specifically, they would sell the 110-strike put for 1.50 per share and buy the 105-strike put for .50 per share. So, a net credit of $1 per share is also received for the bull put spread. The result is a 105/110/120/125 Iron Condor established for a net credit of $2 per share. To learn more about Iron Condors, view this week's segment of "Ask the Institute."