Reverse Iron Condor Spread

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Reverse Iron Condor Spread - Introduction



The Reverse Iron Condor Spread is a complex, advanced volatile option trading strategy built upon the foundation of a Short Condor Spread. In fact, the Reverse Iron Condor Spread is the debit spread version of the Short Condor Spread (which is a credit spread). As the name suggests, the Reverse Iron Condor Spread is where you buy an Iron Condor Spread from someone who is betting on the underlying stock staying stagnant. This allows you to profit when the underlying stock moves either up or down quickly.

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Learning the Iron Condor Spread first makes the Reverse Iron Condor Spread easier to understand.

Unlike the Short Condor Spread and the Short Butterfly Spread, the Reverse Iron Condor Spread is a debit spread. This means that it is a strategy which you can execute even if your trading account does not allow you to execute credit spreads.

The Reverse Iron Condor Spread belongs to the family of complex volatile option strategies, similar to the Short Condor Spread, Short Butterfly Spread and Reverse Reverse Iron Butterfly Spread. Each of them has their own strengths and weaknesses but they all have one thing in common, and that is, they all have narrower breakeven points than the basic Straddle / Strangle and a lower maximum loss than a Straddle even though their maximum profit potential is limited. Here is a table explaining the differences:

Short Condor Spread Reverse Iron Condor Spread Short Butterfly Spread Reverse Iron Butterfly Spread
Debit/Credit Credit Debit Credit Debit
Max Profit Highest Higher High Low
Max Loss Low High Higher Highest
Cost of Position NIL High NIL Low
Breakeven Range Wide Widest Narrow Wider


As you can see from the table above, all of the above complex volatile option strategies comes with their own strengths and weaknesses. Option trading strategies are all about trade-offs. There are no single option trading strategy that has the best of all worlds. The Reverse Iron Condor Spread, as a debit spread, has a lower profitability and higher maximum loss than the Short Condor Spread or Short Butterfly Spread, which are credit spreads. Therefore, the Reverse Iron Condor Spread is a complex volatile strategy that you should perform only if your broker does not allow you to execute credit spreads.



When To Use Reverse Iron Condor Spread?


One should use a Reverse Iron Condor Spread when one expects the price of the underlying asset to make a quick break to either upside or downside and is unable to execute credit spreads. One can use this strategy ahead of earnings releases or important releases.

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How To Use Reverse Iron Condor Spread?


There are 4 option trades to establish for this strategy : 1. Sell To Open X number of far Out Of The Money Call Options. 2. Buy To Open X number of Out Of The Money Call Options. 3. Sell To Open X number of far Out Of The Money Put Options. 4. Buy To Open X number of Out Of The Money Put Options.

Sell Far OTM Call + Buy OTM Call + Buy OTM Put + Sell Far OTM Put



Veteran or experienced option traders would identify at this point that the Reverse Iron Condor Spread actually consists of a Bull Call Spread and a Bear Put Spread.

The choice of which strike prices to sell the short legs (trades 1 and 3 above) at depends on the range outside which the underlying stock is expected to break out of. The further away from the money the 2 short legs are, the higher the risk (as the underlying stock needs to move further in order to exit the breakeven range), but the higher the maximum profit would be should the breakeven range be exited. Again, this is a trade-off that all option traders need to decide and accept when trading any kind of option strategies.

The difference between the strike price of the long call option and the long put option determines the range within which the position will result in its maximum loss. The wider the difference, the lower the maximum loss potential. The narrower the difference, the higher the maximum loss potential. Again, another trade-off.

At this point, however, option traders must truly appreciate the level of customisation that the Reverse Iron Condor Spread allows. One could literally pre-determine its maximum profit and maximum risk level in order to attain a position that best suit one's expectations.

Reverse Iron Condor Spread Example

Assuming QQQQ trading at $43.57

Sell To Open 1 contract of Jan $45 Call at $0.60
Buy To Open 1 contract of Jan $44 Call at $1.03
Sell To Open 1 contract of Jan $42 Put at $0.59
Buy To Open 1 contract of Jan $43 Put at $0.85

Net debit = (($1.03 - $0.60) + ($0.85 - $0.59)) x 100 = $69.00 per position

OppiE's Note Contrast this example with the example in Short Condor Spread. These examples were made using the same QQQQ on the same strike price and real values. You will see that instead of getting $34 per position to put on the Short Condor Spread, you actually pay $69 for putting on the Reverse Iron Condor Spread.

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Trading Level Required For Reverse Iron Condor Spread


A Level 3 options trading account that allows the execution of debits spreads is needed for the Reverse Iron Condor Spread. Read more about Options Account Trading Levels.



Profit Potential of Reverse Iron Condor Spread :


Reverse Iron Condor Spreads achieve their maximum profit potential at expiration if the underlying stock expires above the Upper Breakeven Point or below the Lower Breakeven Point. The profitability of a reverse iron condor spread can also be enhanced or better guaranteed by legging into the position properly.



Profit Calculation of Reverse Iron Condor Spread:


Maximum Loss = Net debit.
Maximum Profit Possible = Greatest Difference In Consecutive Strike - Net debit

Reverse Iron Condor Spread Calculation

From the above example :

Maximum Loss = $69.00 per position.

Maximum Profit Possible = ($44 - $43) - $0.69 = $0.31 x 100 = $31 per position.




Risk / Reward of Reverse Iron Condor Spread:



Upside Maximum Profit: Limited

Maximum Loss: Limited to net debit paid



Break Even Points of Reverse Iron Condor Spread:


A Reverse Iron Condor Spread is profitable as long as the price of the underlying stock exceeds the price range bounded by the Upper and Lower BreakEven points.

Upper Break Even Point = Long Call Strike + Net debit

Reverse Iron Condor Spread Breakeven

Net debit = $0.69 , Long Call Strike = $44.00

Upper Breakeven Point = $44.00 + $0.69 = $44.69.


Lower Break Even = Long Put Strike - Net debit

Net debit = $0.69 , Long Put Strike = $43.00

Lower Breakeven Point = $43.00 - $0.69 = $42.31.


In this case, the Reverse Iron Condor Spread position in our example is profitable as long as the QQQQ close outside $42.31 to $44.69 at option expiration day.

OppiE's Note Notice that the Breakeven Range of an Reverse Iron Condor Spread ($2.38 range) is also wider than that of a Short Condor spread ($2.36 range).




Advantages Of Reverse Iron Condor Spread:



:: Typically has a narrower breakeven range than a straddle or strangle.

:: Maximum loss and profits are predictable.

:: Able to profit whether the stock moves up or down.

:: Can be used by option traders who cannot use credit spreads.

:: Higher maximum profit potential than a Reverse Iron Butterfly Spread.



Disadvantages Of Reverse Iron Condor Spread:



:: Lower profit and higher loss than the Short Butterfly Spread or the Short Condor Spread.

:: Potential loss is much higher than the potential gain.

:: Has a wider breakeven range than a Reverse Iron Butterfly Spread.



Adjustments for Reverse Iron Condor Spreads Before Expiration :



1. If the underlying asset has gained in price and is expected to continue rising, you could close out all the put options and transform the position into a Bull Call Spread.

2. If the underlying asset has dropped in price and is expected to continue dropping, you could close out all the call options and transform the position into a Bear Put Spread. Such transformations can be automatically performed without monitoring using Contingent Orders.


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