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.