What is a short iron condor & how to trade it?

Shore Iron Condor Summary

A short iron condor consists of four options in the form of two short vertical spreads: a short out-of-the-money (OTM) call spread, and a short OTM put spread.
Short iron condors may yield a profit when the stock that the iron condor tracks remains between the short strikes over time. If the stock exceeds the short strikes, the strategy may yield a loss.
Time decay favors short iron condors and can help yield a profit before expiration when covered for a debit less than the initial credit received. If the stock moves quickly though, the directional move can offset time decay and yield a loss prior to expiration.
The max profit for an iron condor is the initial credit received.
The max loss is the spread width less credit received and occurs when the entire call or put side expires in-the-money (ITM).

Short Iron Condor

A short iron condor consists of four options in the form of two short vertical spreads: a short out-of-the-money (OTM) call spread and a short OTM put spread. Short iron condors provide short upside and downside volatility exposure. They can benefit when the stock or ETF the iron condor tracks remains neutral within the range between the short strikes and doesn't experience any sort of sharp upward or downward move in price. 

Short iron condors have a max profit equivalent to the credit received up front when opening the trade. This max profit is realized if all options expire OTM and worthless.

The max loss on a short iron condor can be found by taking the width of the widest spread and subtracting the credit received from trade entry. Iron condors generally have short put and call spreads that are the same width, but if they are not, the max loss is the width of the wider spread. When the underlying breaches the short call or put vertical and the entire vertical closes ITM at expiration, the max loss is defined due to the protection the long option offers against the short option’s risk a few strikes away, as illustrated where the red loss zones flatten in the image below. 

In short, the best-case scenario for a short iron condor is when the underlying remains constant, does not experience sharp upward or downward moves, and remains between the short strikes as expiration nears. Time decay favors premium sellers since it can help yield a profit when covered for a debit less than the credit received prior to expiration as well.

The worst-case scenario for a short iron condor is if the underlying experiences a sharp movement towards or through one of the spreads, in which case the trade can yield losses prior to and/or at expiration. 

Prior to expiration, an ITM short option can be assigned, and the short option contract can convert to 100 shares. In this case, the trade’s risk is still defined because the long option that protects the intrinsic value risk of the short option is still active, even if the short option is converted to 100 shares of long or short stock. The trader can keep the assigned stock position or close it for the current P/L at that time. Alternatively, the trader can perform a covered stock order by closing the assigned shares with the corresponding long option or submit an exercise request to flatten the position, which will likely incur a loss. The OTM long options will expire worthless after the close on its expiration date.

Expiration Risk for Short Iron Condors

A defined-risk vertical spread is no longer a defined risk position if one leg of the spread expires in the money, and the other does not. The risk lies with pin risk on the day of expiration, which is the risk surrounding the uncertainty of where the underlying will close to determine whether an option is in or out of the money.

Options that expire in the money by $0.01 or more are automatically exercised, resulting in the short put option assignment converting to 100 long shares of stock, or the short call option converting to 100 short shares of stock.

In the case of a short put vertical spread, a partially ITM spread will convert to 100 long shares through short put assignment, and the OTM long put option would not get automatically exercised to offset the long shares by selling it.

In the case of a short call vertical spread, a partially ITM spread will convert to 100 short shares through short call assignment, and the OTM long call option would not get automatically exercised to offset the short shares by covering the short shares.

Additionally, any options strategy involving short options may face after-hours risk on the day of expiration. In summary, although the vertical may have expired OTM based on the stock's closing print, an OTM short put option or short call option can become ITM based on any extreme price movement after the market close, resulting in an unexpected assignment of shares. As a result, the investor would assume the risk of 100 shares per contract assigned. The only way to eliminate after-hours risk is by closing any short options positions before expiration.

Due to the risk of getting assigned long shares through a short put, or short shares through a short call, it's crucial to have a plan, like closing or rolling the position before expiration, to avoid this assignment risk, especially when the account does not have sufficient account equity to take on the resulting position. Please visit the Help Center to learn more about Expiration Risk, including more about pin risk and after-hours risk.

Profit & Loss Diagram of a Short Iron Condor

A short iron condor consists of an OTM put credit spread, and an OTM call credit spread, to create a neutral zone of profitability between the short strikes. If all contracts expire worthless, max profit is realized which is equivalent to the credit received up front for opening the trade. If one of the spreads expires ITM, max loss will be realized which is equivalent to the width of the spread less the credit received.

The breakeven zones can be seen in the image below where the green shifts to red and vice versa. This can be calculated by adding the credit received to the short call strike to the upside and subtracted from the short put strike to the downside.

What’s Required For a Short Iron Condor?

Four option contracts: Two short OTM vertical spreads in the same expiration (4 options)

One OTM short call vertical
One OTM short put vertical

Example of a Short Iron Condor

XYZ trading @ $175

Sell to Open -1 XYZ $190 strike call @ $2.00 credit
Buy to Open +1 XYZ $195 strike call @ $0.50 debit

Sell to Open -1 XYZ $160 strike put @$2.25 credit
Buy to Open +1 XYZ $155 strike put @ $0.75 debit

Call vertical credit: $1.50 credit
Put vertical credit: $1.50 credit

Total Collected: $3.00 credit ($3.00 x 100 = $300 total credit)

Time Decay Affect	Works for the seller as time can decay the value of the iron condor.
Max Profit	Total credit received
Max Loss	Upside: Total credit received – [(Spread width) x 100 options multiplier] $300 – [($95 - $85) x 100] = -$700 Downside: Total credit received - [(Spread width) x 100 options multiplier] $300 - [($65 - $55) x 100] = -$700
Breakeven Price (at expiration)	Upside: Long call strike + credit received $85 short call strike + $3.00 = $88 upside breakeven Downside: short put strike – credit received $65 long put strike - $3.00 = $62 downside breakeven
Buying Power Requirement	Max loss = Total credit received – (Spread width x 100)
Account Type Required	US options and futures Margin account

Multi-leg option strategies incur higher transaction costs as they involve multiple commission charges.