10/12/2009 10:36 am EST

Focus: OPTIONS

In previous articles, I have described a textbook example of an iron condor. In this article, I will pick up where I left off and focus on defining the main difference between the I.C. (iron condor) and condor spreads.

It is my belief that studying the iron condors first and completely separately from the condor spreads makes the understanding of the condor spreads later so much easier. Therefore, let us briefly review the I. C. from the previous example/article without any charts or pictures. Once again, an iron condor is composed of a bear call and a bull put, both being the vertical credit spreads.

Iron Condor Entry

IWM \$73.91 on 06-03-2008

Bear Call

BTO + 1 June 76 call @ - 0.69 (debit)
STO - 1 June 75 call @ + 1.11 (credit)
Max P (Profit/Reward) = + 0.42 (credit)
Max L (Loss/Risk)
(The formula for the max loss is the width of the call strike spread minus the credit received for the bear call.)
Max L (76 strike minus 75 strikes = one; 1.00 - 0.42 of the credit = 0.58)
Max L = 0.58

Bull Put

BTO + 1 June 70 put @ - 0.29 (debit)
STO - 1 June 71 put @ + 0.41 (credit)
Max P (Profit/Reward) = + 0.12 (credit)
Max L (Loss/Risk)
(The formula for the max loss is the width of the put strike spread minus the credit received for the bull put.)
Max L (71 strike minus 70 strikes = one; 1.00 - 0.12 of the credit = 0.88)
Max L = 0.88

I.C. combined credit is 0.54 (or \$54.00) The amount comes from the credit from the bull put, which was 0.12, plus the credit from the bear call, of 0.42.

The maintenance that should be held by the broker should be the greater of the two max losses, which would be the one on the bull put.

Iron Condor at Expiry

IWM \$72.55 on 06-20-2008

Figure 1 below visually presents the facts that both the Bear Call as well as the Bull Put have expired worthless; therefore, allowing us to keep the maximum premium of \$54.00 without paying any additional commission.

NEXT: Three Major Differences Between I.C and Condor Spreads

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Now, in this second segment of the article, I will explain the three major differences between the condor spreads and the I.C.

• The first difference between the two is that the condor spreads are made up of the same class of options, either all call options or all put options. The reverse side of condors is the I.C., which, by its default, consists of both calls and puts. Hence, in the future, when you hear some trader mentioning an I.C. trade, there is no need for clarification as to which option class the trader used, for both were utilized. Nevertheless, if the condor spread is mentioned, the question remains: Was it a call condor spread or a put condor spread? The adjectives do make a big difference when it comes down to option trading.

• The second difference between the I.C. and condor spreads is that the sold (or short) I.C. is basically a credit spread, which is not the case with the sold (or short) condor spreads. Generally, they end up being a debit spread.

• The third difference between the two is that usually (key word) the sold I.C. is composed of OTM options, whereas the condor spread could be composed of ITM options.

In conclusion, I have completed my explanation of a textbook example of an iron condor by focusing on the mathematical side of it. I have also described the three main differences between the I.C. and the condor spreads. Once again, be a net seller of premium at any given time, especially in the market conditions that we currently have.