I think of Iron Condors as vehicles to be used when premiums are juicy and/or our outlook on the underlying instrument (in most cases, ETFs) is for sideways consolidation.

An Iron Condor is a four-legged spread involving four different options strikes all in the same expiration series. This trade has defined risk and is essentially the combination of a short call vertical spread and a short put vertical spread. What this means in practice is that you’re short both an out-of-the-money call and an out-of-the-money put, and you’re protected with an even further out-of-the-money (and cheaper) call and put. The sum total of debits and credits received from all four legs will add up to a credit which equals the “premium” in the trade. This premium represents the maximum you stand to gain in this trade if you were to do nothing and hold this position to expiration and the underlying closes somewhere between your two short strikes. If the underlying expires with either your short call or short put in-the-money, then the most you stand to lose is the dollar difference between your short and long options minus the credit you received at trade initiation.

The orange line above displays what your profits would be at expiration, whereas the blue line shows you where your P/L would be today at various points along the x-axis of stock prices (this blue line will slowly converge in curve to the orange line as we get closer to expiration). As you can see from this graph, your goal is for the underlying to settle into a nice comfortable range between your short strikes — which you can notice graphically are where your orange expiration profits line starts sloping down (bad).

In Practice:

I like to trade Iron Condors in indices and ETFs (SPX, IWM, SPY, QQQ, for example) due to lesser risk of sudden large gap down moves, and I particularly like to trade them when volatility is relatively high. In this environment, options prices will be more expensive which means I can better protect myself by either taking in a higher premium for the trade (which moves my breakeven levels further away), or setting my short strikes further away and enjoying greater likelihood of the short options expiring out-of-the-money (worthless).

Once in an Iron Condor trade, I don’t seek to be actively trading around it, though I do keep an eye on it if sudden moves take place or if an extending trend brings prices close to my short strikes. If I find myself in a situation where price is starting to trend to one of my short strikes, I’ll look to make an adjustment to the position. The common adjustment I’ll make is to close out the short vertical on the winning side of the trade for a small debit, then re-establish a new credit spread (same distance between short and long option) a little bit closer to market action. The net result of these two trades will be a credit, which will be added to the credit I established at the beginning of the trade which in effect reduces the total risk I have in the position. I generally will only do this once. After that, I’ll just ride with the hand I’m dealt.

Meanwhile, at all times that I’m in the trade, I’ll keep a resting limit order working in the market to close the trade at any time that my profit target is hit. Generally, in trades where no adjustments were made, I like to close the entire position at a price that is equal to one-half of the total premium collected, letting me keep the other 50% as profit (minus commissions, obviously). If this were a position that I had to make an adjustment in to protect myself, I might then be more aggressive in taking profits. In this case, I’ll often be happy closing the trade for a debit equal to 75% of the total credits received (initial trade credit plus additional credit from adjustment).

Either way, I do not like to hold these trades to expiration. Once you can close your position for 50% of the premium you collected, you’re tempting the Trading Gods by greedily trying to hold for more gains. The risk-to-reward ratio begins to severely work against you. You’ll often be holding out for that extra dime of profits while still holding a full dollar of risk. I don’t like those numbers.

Don’t be greedy with Iron Condors. They are wonderful spreads that give you plenty of wiggle room to be wrong, but don’t take that for granted. Take your profits and run. Keep your win percentage high in these trades.