Short Iron Condor
Risk: limited
Reward: limited
General Description
Entering a short iron condor entails selling (1) lower strike put, buying (1) middle strike put, buying (1) higher middle strike call and selling (1) highest strike call (same expiration month, distance between the two lower legs is equal to the distance between the two upper legs). It's essentially a combination of a lower strike bear put spread and higher strike bull call spread, and it's similar to a short iron butterfly except the long call and put are broken up between consecutive strikes.
(draw a short iron condor risk diagram here)
The Thinking
You're not bullish or bearish, but you do think a big move is coming and along with it, an expansion in volatility. You employ a lower strike bear put spread, which achieves max profitability when the underlying drops (although profitability is capped) and a higher strike bull call spread, which achieves max profitability when the underlying rallies (although profitability is capped). If you are correct, if the stock moves big (preferably above the upper strike or below the lower strike) you'll profit.
Example
XYZ is at $57.50, and your analysis says a big move is coming (earnings or some other big announcement). You buy (1) 55 put for $2.50 and sell (1) 50 put for $0.75 to complete the bear put spread. Then you buy (1) 60 call for $2.50 and sell (1) 65 call for $0.75 to complete the bull call spread. The net debit to enter the trade is $3.50.
Above the highest strike, all puts expire worthless, and all calls expire in-the-money and cancel each other out. As an example, at $65, the 50 put will be worthless ($0.75 profit) and the 55 put will be worthless ($2.50 loss), and the 60 call will be worth $5.00 ($2.50 profit) and the 65 call will be worthless ($0.75 profit). The net of this is a $1.50 profit.
Below the lowest strike, all calls expire worthless, and all puts expire in-the-money and cancel each other out. As an example, at $50, the 50 put will be worthless ($0.75 profit) and the 55 put will be worth $5.00 ($2.50 profit), and the 60 call will be worthless ($2.50 loss) and the 65 call will be worthless ($0.75 profit). The net of this is a $1.50 profit.
Between the middle strikes ($55 and $60), the max loss is suffered. All calls and puts expire worthless, and your loss is equal to the net debit paid to initiate the trade.
The PL chart below graphically shows where this trade will be profitable and at a loss.
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