Iron Condor Adjustments to Help Avoid Big Losses

Iron condors allow traders to potentially profit from sideways movement in the stock market. Each iron condor is a four-legged options trading strategy that limits your losses while presenting some upside. While iron condors can benefit short traders, options can get exercised at any time. If one of the iron condor’s options gets exercised early, the strategy can expose you to big losses. Understanding how iron condors work and knowing which adjustments to make along the way can help you manage your positions better and potentially avoid significant losses.

What Is an Iron Condor?

An iron condor is an options trading strategy that involves two puts and two calls. You can set up an iron condor with the following options:

• Buy one put that is out of the money
• Sell one put that is near or at the money
• Sell one call that is near or at the money
• Buy one call that is out of the money

These options all have different strike prices but the same expiration date. Adjusting the strike prices impacts your maximum profit and loss from the iron condor. You can opt to create an iron butterfly instead if you sell one call and one put with the same strike prices.

You typically need a higher level options enabled brokerage account to trade iron condors. It’s not an options trading strategy that everyone can access. Contact your specific brokerage to find out more information. 

Why Would You Need to Adjust an Iron Condor?

An iron condor may profit when the market moves sideways and reaches its max loss when the underlying stock’s price moves sharply in either direction at expiration. The long call and long put theoretically protects you from the unlimited losses of a short call or put. This protection can save you from significant losses, but the person holding onto your short call or put can exercise it early. If someone exercises your short call or put early, it can expose you to potential losses greater than the theoretical max loss of the short iron condor. 

If the options trader with the contract you shorted exercises it early, you will suddenly lose your downside protection. Assume the calls of your iron condor are the following:

• Short call with a $150 strike price
• Long call with a $160 strike price

If the stock price exceeds $160, the gains from the long call and losses from the short call cancel each other out. But if the stock reaches $165 per share, and the person exercises your short call, you lose money on that option. Even if the stock price falls back to $150 per share before expiration, you won’t profit from the iron condor This also creates a short stock scenario that must be covered by either buying the 100 shares from the market, or exercising the long call but forfeiting any time value left.

How to Adjust an Iron Condor

Options traders have several strategies to adjust iron condors to help mitigate the chance for significant losses or recover if the stock price moves back to the shorted option’s strike price. These are some adjustments worth considering limit your upside if the stock’s price continues to move sharply in the same direction. 

1. Pick Further Out Expiration Dates

You can keep all of your strike prices but adjust the expiration date on your options. Picking further out expiration dates may potentially increases your maximum profit and gives the stock’s price more time to return between the strike prices of your short call and short put. This is generally called rolling an option.

However, keep in mind that rolling options involves closing an existing position and realizing gains or losses, while also opening a new position. Rolling options doesn’t ensure a profit or guarantee against a loss. You may also end up compounding your losses and you also give the stock more time to move in an unfavorable direction. Iron condors that expire in several months also experience less volatility than weeklies.

2. Make the Long Call and Put Strike Prices Closer to the Money

A large gap between a short option and a long option’s strike prices increases how much you can lose. Swapping your long call and put for ones with strike prices closer to the money will minimize your maximum loss. However, this strategy requires a longer premium payment and reduces your potential upside. Keep in mind that rolling options involves closing an existing position and realizing gains or losses, while also opening a new position

3. Move the Long Call and Put Further Out of the Money

This options strategy increases your potential maximum losses since the gap between the strike prices expands. However, you also increase your potential maximum gain. Some traders have enough risk tolerance to increase their risk in exchange for a greater upside.

4. Exit the Iron Condor Early

You don’t have to wait until your options expire to leave an iron condor. Exiting an iron condor before expiration lets you lock in gains or minimize losses. It may make sense to exit an iron condor early if you have a net gain or to help limit further losses and a major event looms. Earnings reports, economic data and Federal Reserve meetings can cause significant price movements, potentially affecting iron condors.

While exiting an iron condor early locks in gains or losses in some cases , you miss out on the maximum gain (or lose). You will have to pay premiums to exit the short call and put. You will receive premiums for exiting the long positions, which can help compensate for the premium paid on the other options.

5. Create a Stop Loss

A stop loss is a type of order that minimizes how much you can lose from an iron condor. You can set a stop-loss price that places an order to exit s the position when an options contract reaches a specific price. This strategy can help reduce your losses while you are away from your computer, but options prices are volatile. It’s possible for an option to fall slightly below the stop-loss price, trigger an exit and then gain value shortly after you have exited the iron condor.

6. Buy Back a Short Option to Close the Position

You don’t have to exit the entire iron condor. If the short call has lost value, short positions to lock in profits and leave open position. If you buy back a short call to close the position, your long call’s potential growth will not get canceled out by the short call anymore. However, you will lose some of the premium to close the position.

7. Exit One of the Spreads

An iron condor consists of two spreads: a call spread and a put spread. Depending on how the stock’s price moves and what you feel comfortable with, it may make sense to exit one of the spreads. You can possibly lock in profits with one part of the condor and preserve the other part of it. A trader who believes the stock price will increase may consider taking profits on the bull put spread. The bear call spread will benefit from a declining stock price and will no longer get canceled out by the put spread.

Exiting one of the spreads means paying a premium to close the position. You reduce your potential gains from the spread, and the stock price can also move in an unfavorable direction. However, if you get out of the right spread and keep the other spread intact, you can end up potentially increasing your gains and minimizing your downside.

Modifying Your Strategy As You Go

An iron condor lets the trader realize a premium right away, but the stock’s movements determine whether your iron condor makes a profit. Adjusting your strategy to help minimize losses and lock in potential gains can improve your options trading results. Market conditions constantly change, and the strategy you use today may not be the best choice next week. Knowing how the market is moving and keeping your risk tolerance in mind may yield better returns.

Frequently Asked Questions