Reverse Iron Condor

The Reverse Iron Condor Setup

Assume XYZ Corp is trading at $100. To establish a Reverse Iron Condor, you would:

• Buy a put option with a lower strike price, say $95, for $3.
• Sell a put option with an even lower strike price, say $90, for $1.
• Buy a call option with a higher strike price, say $105, for $3.
• Sell a call option with an even higher strike price, say $110, for $1.

All options have the same expiration date, a few months out.

Who Should Consider It

The strategy is ideal for traders who anticipate large price action in the underlying asset but are unsure of direction. It caps the maximum risk at the net cost of establishing the positions while offering opportunities to make money from large movements.

Strategy Explained

In a Reverse Iron Condor, the trader is speculating on volatility. The hope is the stock moves far enough so that one of the spreads (either the bull put or the bear call) goes all the way into the money by expiration. The bought options (the $95 put and the $105 call) are the positions that profit from large movements, while the sold options (the $90 put and the $110 call) cover the buys and cap the maximum gain.

Breakeven Process

There are two breakeven points for this strategy, one for each potential direction the stock can move:

• Upper breakeven point: Higher strike of the purchased call + net premium paid.
• Lower breakeven point: Lower strike of the purchased put - net premium paid.

As an example, if the net premium paid is $4 ($3 + $3 - $1 - $1), the breakeven points would be $109 ($105 + $4) if the price goes up, and $91 ($95 - $4) if the price goes down.

Sweet Spot

The sweet spots for this strategy are when the stock price at expiration is above the highest strike of the call spread or below the lowest strike of the put spread. This maximizes the value of one of the spreads while the other spread is worthless or approximately worthless.

Max Profit Potential

The maximum profit for a Reverse Iron Condor is limited by the difference between the strikes of the winning spread minus the net premium paid. As an example, if the stock finishes below $90, the put spread realizes maximum value, which is $5 ($95 - $90), and the maximum profit would then be $1 ($5 - $4).

Max Loss

The maximum loss is limited by the net premium paid to enter the trade. In this example, the maximum loss would be $4, which occurs if the stock price finishes between the strikes of the purchased options ($95 and $105) at expiration.

Risk

The main risk is that the stock does not move far enough to make up for the cost of the net premium paid, and the premium is lost.

Time Decay

Time decay (theta) is generally not favorable to this strategy as it needs a large move to be profitable. Without a large move as the expiration date nears, the value of the long positions erodes.

Implied Volatility

Increased implied volatility is preferable when entering the trade as it raises the premium of the options and the likelihood of larger price movements. Decreasing volatility can lower the chances of hitting the breakeven points.

Conclusion

The Reverse Iron Condor is a strategic trade for traders anticipating high volatility without a strong directional bias. It provides a defined risk/reward profile, which makes it an attractive choice for risk management while profiting from large market movements.