• Long a deep OTM (out of the money) put.
• Short a slightly-OTM put.
• Short a slightly-OTM call.
• Long a deep OTM call.

<Risk chart of iron condor retrieved from IB’s Trader Workstation>

One way to look at a iron condor is that this is a short strangle inside a long strangle.

Iron condors are directionally-neutral strategies. Opening a iron condor could be a strong trade if betting on the price action to stay in a tight trading range because of positive market gamma conditions. One key approach for this would be to open iron condors above the Volatility Trigger™.  More specifically, it can be used to set up a pinning strategy with defined risk at a major key level such as Absolute Gamma.

Advanced: Strategy and Customization

A iron condor collects a credit, which is income over time on the position–in exchange for accepting risks and obligations that are characteristic of short options. Generally, opening a iron condor is a way to short IV (implied volatility) with limited risk; therefore it is usually centered around the current underlying price so that it is a minimally directional bet. A sharper way to short volatility however would be a short straddle. A short straddle is going to have a lower win rate but it will lose less from extreme moves.

Some traders prefer to lean into the turns with short strangles by writing the short put at a higher strike price if the underlying price has already been crashing, or to write the short call at a lower strike price after it has already been melting up; the idea of doing this is to bet on a reversal soon while also collecting a higher credit.

In order to approach a iron condor dynamically, it makes sense to devise a system of mechanics that focuses on deltas rather than fixed strike distances. This keeps you in touch with probabilities and it also adjusts for skew imbalances and the relative implied range of implied volatility. Focusing on equivalent deltas on both sides is a way to keep the position more balanced because otherwise skew will have one side with a more expensive premium than the other at the same fixed strike difference. Either way, as a credit, the trader can be patient with the price, writing well above the ask for more edge if there is a fill.

Absolute Gamma: Absolute Gamma is the strike with the largest total gamma. It can be treated as a strong support/resistance level and a magnet. It is also normal for this level to be near an inflection point like Zero Gamma rather than near the far edges of the trading range. 

credit: In an option strategy, there is a credit received from the time decay (theta) of short options or credit spreads. This is the premium which you receive and the counterparty pays for the opportunity to hold the position. The one receiving the credit gains income until the option expires but takes on risks which can lead to losses and be significant if from an open-ended position.

credit spread: In an option strategy, a credit spread is one that has a net credit received from short options that is greater than the cost paid on the long options. This means that there is no upfront cost of the trade (known as a debit) but there are risks (and obligations) which can lead to losses. This is also how short options work, but what a credit spread does is buy one or more options to reduce some of the risk. For any short option strategy, there is going to be obligations and assignment risk. The way assignment risk works is that short option holders can be assigned shares at any time; this risk becomes greater when an option is in-the-money and near expiration. In exchange for taking on risk, the option holder pays a premium as the counterparty. This premium gradually decays the value of the option over time as it is paid out. This time decay is measured by a first-order Greek known as theta.

defined risk: In an option strategy, if risk is defined then it is structured so that it has a max loss (capped total loss on a trade) rather than potentially unlimited loss.

delta: A first-order Greek that measures the sensitivity of an option's price to directional movement in the underlying security. Factoring out nonlinear dynamics, the instantaneous value of one delta is worth one share of a stock. This means that if the option on a stock is 40 delta, such as a 40 delta long call or a 40 delta short put, then instantaneously it has the same profit/loss dynamics of being long 40 shares. 

edge: An edge in trading is a competitive advantage but not one that guarantees a profit. It can be any method, idea, or tool which helps to outperform randomness. One way to interpret an edge is that it has a positive expectancy, which means that it would prevail as net profitable after many (ideally hundreds or more) occurrences. A single losing trade can be a good trade the majority of the time and a single winning trade can be just lucky without an edge. The bottom line is that if you have edge in your trading then you have a positive expected value, where you should come out on top if your trading size is managed well enough that no single trade causes too much loss and allows for many attempts.

gamma: A second-order Greek which compares changes in delta (directional exposure) to changes in the underlying. In general, gamma means the acceleration of directional exposure. Gamma is also one of the main properties of an option: All long options are long gamma. In a way, gamma is thought of as the magic of options because the size of directional exposure (delta) increases as it is right about direction (therefore increasing profits), and it decreases when it is wrong about direction (therefore decreasing losses). But the cost for this magic is time decay. The connection to market makers is that when they are long gamma (market gamma is positive) then they trade against the direction of the trend to lock in profits after they have favorable moves with increased size thanks to gamma. This is why positive market gamma tends to create an environment of reduced or reducing realized volatility (smaller overall price moves).

IV (implied volatility): The expected percentage range over a year with 68.3% confidence. This is based on options pricing at one standard deviation. Long options benefit from increases in implied volatility and short options benefit from decreases in implied volatility. In general, when implied volatility increases it means that the expected percentage range is getting larger. When implied volatility is applied to lengths of time other than one year, then this is called the expected move.

pinning strategy: A pin is a thesis or a condition where prices tend to stick in a narrow range. A pinning condition is usually linked to high gamma levels in the market. The Absolute Gamma strike is a normal place for a pin to occur. The phenomenon of a pin is how a security is drawn to a specific price as it nears expiration. Technically, when approaching an expiry and when close to an option’s strike, the increase in market gamma creates dealer hedging activity which causes the stock to gravitate back to the pinned strike; dealer hedging is the rebalancing of market maker books to neutralize their risk.

skew: Volatility skew is the difference between implied volatility amounts of different options strikes on the same date. Implied volatility is the expected percentage range over one year–based on option prices–with 68.3% confidence. Skew is one of the main edges to look for in an options trade, especially on vertical spreads (all options are on the same date). Sometimes it is a penalty dragging down a good trade, but it is nonetheless important to understand the extent of how much it can challenge a trade if knowingly accepting to take the opposite side of a skew advantage.

strangle: A vertical option strategy which is long an OTM (out of the money) put and long an OTM call at different strikes (long strangle) or that is short an OTM call and short an OTM put at different strikes. Like a straddle, a strangle is a way to trade volatility. Long strangles have less accuracy and less cost than long straddles; short strangles have more accuracy and more risk than short straddles.

strike: The price that an option is based on. A long call will expire worthless if the price of the underlying security finishes underneath the strike price, and a long put will expire worthless if the underlying finishes above the strike price.

VT (Volatility Trigger™): The VT is our proprietary indicator which detects the level below which we expect bearish feedback loops (chain reactions) to start kicking in. Above this level we expect bullish flows that lead to relatively lower market volatility. Underneath the VT, realized volatility (the expected percentage range over a period of time based on historical data with 68.3% confidence) is modeled to expand significantly. In the Equity Hub™, a similar calculation is used for what is called the Hedge Wall. 

writing: We say “write” when a trader sells an option to open a new position. Simply saying “to sell” an option is unclear, as that could mean either selling-to-close or selling-to-open a new position. The most common example of writing is the covered call strategy, which is buying 100 shares in a stock and then selling-to-open a short call on that same stock. In general, writing is to accept an obligation, and there is time-decay income in exchange for that risk (as well as the risk of assignment which is being delivered shares that can create a jump in directional risk).