Hey everyone. This is Kirk here again at Option Alpha and in this video, I want to walk through how to calculate the maximum profit that you can make on an iron condor trade. And again, iron condors are a little bit more complicated only because they have more legs attached to them. But if you go through it very slowly, it’s actually fairly easy to see how you can generate money and what the max profit is with an iron condor position. The first thing that we’re going to do is we’re going to use this structure for a payoff diagram and we’re going to build out our iron condor payoff diagram. It looks like this. This is a very simple iron condor shape. You can see here, we have four points at which the payoff diagram pivots, and naturally, you can see that the payoff for this particular iron condor, the profit range is everything inside of this shaded box, so everything above this zero barrier, and what we’re trying to figure out is what is that amount, how do we determine what that amount is. Well, remember, with an iron condor, you’re basically selling a call option and selling a put option as the first legs or the inside strikes, so in this case, we sell one C for call option, let’s say $105 strike price, and we might also sell one P for a put option at a $95 strike price. Now, this is assuming that the stock is probably trading somewhere in between this range, and for the sake of this video, we’ll assume the stock is trading right at about $100 a share, and so, we just want to build an iron condor payoff diagram that potentially profits if the stock trades anywhere between our strike prices or our breakevens by expiration.
Now, to build out an iron condor, you still need the outside wings or the outside legs where you’re going to buy some options on either end. In this case, we’re going to buy a call option at say the $110 strike price. Buy one C for call option at $110 and buy one P for put option at an even lower strike price. Let’s say this one is at $90. Now, we have the structure of our iron condor and now, we can start to figure out what the profit is by going through and figuring out what the prices are on each of the individual contracts that we either purchased or sold. For the sake of this video, we’re going to assume a very simple math here to make it easy, but let’s assume that we sold the one put option here at the 95 strike for a premium of $2.50 and we bought this one put option at the 90 strike for a premium of $.50. This gives us a total premium on the put side here of $2 that we collected net. The net premium that we collected on this side was $2. The difference between selling this contract at $2.50 and buying this contract for $.50, we’re still left over with a total credit on this particular put spread side of $2. On the call side, let’s assume that we sold this one strike call option for $3 and let’s assume that we bought this 110 strike call option for $2.50. Maybe the calls were a little bit more expensive generally than the puts, and so, as a result, we had to pay some higher premiums for this call spread side. Still, the net result is that the difference between these contracts on the call spread side was we still collected a net credit of $.50. We sold the 105 call for $3, we used pretty much all of that premium to buy the 110 strike call option for protection, and what was left over was a total credit on the call spread side of $.50.
Now, this is the way that I like to think about it. I like to do the calculations on both sides. You can also do them by adding together these two amounts and subtracting these two amounts together here. In this case, you would get $2.50 plus $3 is $5.50, you subtract the total here which is $3, you still end up with the same $2.50 in the center. Now, what we do is we take this amount here on the call spread side, this amount here on the put spread side, we add them together and we end up with a total potential profit of $2.50 as the center or middle point of our iron condor payoff diagram. Now, what’s really cool about this is that you can take that $2.50 and very easily calculate the total risk on the position which we’ll do in another video for iron condors, but again, this is a really easy way to determine how much money you can make on an iron condor payoff diagram. And you’ll notice here that the payoff is capped. We can’t make any more money than the $2.50 that we’ve collected, and that’s assuming, of course, that the stock closes between our breakeven points here which we’ve calculated in other videos. As always, hopefully this makes sense and it helps out. If you have any other questions about iron condors or anything else trading related, please let us know and until next time, happy trading.
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