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The Iron Condor is a strategy used for trading in options. It combines two other tactics, a bull put spread and a bear call spread, meaning the investor holds a total of four positions in the same financial asset, such as a company stock. The name of the Iron Condor comes from the shape of a graph showing the effect of a change in the asset's market price on the investor's overall profit or loss.
The basis of the Iron Condor is options trading. This involves an investor paying an agreed fee up front that buys him the right to buy or sell an agreed quantity of a financial asset at an agreed price on a set future date, regardless of what the market price for the asset is on that date. The investor will hope to correctly guess the future price movement, and then buy or sell the asset as required to profit from the difference between the agreed price and the prevailing market price. As the deal is an option, the investor does not have to go through with the agreed transaction if the market price has gone against him. This is a significant benefit, usually reflected in the initial fee the investor pays to set up the deal.
Some investors use more sophisticated tactics with options, such as a spread. This involves setting up two options deals that cover the same asset, but contrast with one another. For example, an investor might set up an option to buy an asset at a low price, while also selling another trader the option to buy the same asset at a higher price. Exactly if and how the investor goes on to make or lose money depends on the asset's price movement. The key is that the money he paid to set up one deal will be different than the money he received in setting up the other deal. This is because one option is more likely to turn out to be profitable than the other.
There are a total of four possible ways to combine two options in a spread strategy. A spread can be described as either a call spread or put spread, depending on whether the investor's own option to buy carries a higher price than the option to buy that he offered to the other trader. A spread can also be described as either a bull spread or a bear spread, depending on whether the investor profits from the market price of the asset rising or falling. This thus creates the bull call spread, the bull put spread, the bear call spread and the bear put spread.
The Iron Condor combines two of these spreads — the bull put spread and the bear call spread. This means the investor sets up four options, all for the same asset. The name comes from the fact that a graph showing the trader's potential profit or loss starts out flat as the asset price rises, then increases through to a profitable level before flattening out again, and decreases back to a loss-making level before again flattening out. The name is derived from the way this shape resembles a large winged bird such as the Iron Condor.