The inverse iron condor is also sometimes referred to as an inverse short condor or a long iron condor. This is a volatility-based options strategy that aims to profit from a significant price movement in the underlying asset, either to the upside or the downside, by the time the options expire. It’s the opposite of the more common iron condor, which profits from price consolidation within a defined range.

Core Concept:

The inverse iron condor is constructed by combining four options contracts with the same expiration date but four different strike prices, all equidistant from each other. It involves:

1. Buying one out-of-the-money (OTM) put option with the lowest strike price. This forms the lower protective “wing.”
2. Selling one in-the-money (ITM) put option with a higher strike price. This forms the lower short “body.”
3. Selling one in-the-money (ITM) call option with a lower strike price (equal to the higher put strike). This forms the upper short “body.”
4. Buying one out-of-the-money (OTM) call option with the highest strike price. This forms the upper protective “wing.”

The four strike prices are ordered from lowest to highest. The two middle strikes (the short put and the short call) define the range where the strategy incurs its maximum loss. The two outer strikes (the long put and the long call) limit the potential profit.

Construction Example:

Suppose the underlying asset is trading at $50. A typical inverse iron condor might be constructed with the following options, all with the same expiration date, and a $5 spread between each strike:

• Buy 1 Put Option with a $40 strike price.
• Sell 1 Put Option with a $45 strike price.
• Sell 1 Call Option with a $55 strike price.
• Buy 1 Call Option with a $60 strike price.

Notice the difference from the inverse iron butterfly: the two middle strikes are not the same.

Net Debit:

Establishing an inverse iron condor typically results in a net debit, meaning you pay more to buy the two out-of-the-money options than you receive from selling the two in-the-money options. This net debit represents the maximum potential loss of the strategy (excluding brokerage commissions).

Profit and Loss Profile:

The profit and loss diagram of an inverse iron condor resembles a flattened “M” shape.

• Maximum Potential Profit: Occurs when the price of the underlying asset moves significantly away from the central range (between $45 and $55 in our example) and expires at or beyond either of the outer strike prices ($40 on the downside or $60 on the upside). The maximum profit is limited and is calculated as the difference between the width of the spread between the short and long options on either side, minus the initial net debit. In our example, the width of each “wing” from the short strikes is $5 ($45-$40 and $60-$55). So the maximum profit would be $5 – net debit (on either side).

• Maximum Potential Loss: Limited to the initial net debit paid to establish the spread. This occurs if the price of the underlying asset expires between the two middle strike prices (between $45 and $55 in our example).

• Breakeven Points: There are typically two breakeven points for an inverse iron condor, one below the lower short put strike and one above the higher short call strike. These points are calculated by adding/subtracting the initial net debit from the respective short strike prices. In our example, if the net debit was $2, the lower breakeven would be $45 – $2 = $43, and the upper breakeven would be $55 + $2 = $57. The position becomes profitable if the price moves beyond these points at expiration.

Why Use an Inverse Iron Condor?

• Betting on High Volatility/Large Price Swings with a Wider Profit Zone: Similar to the inverse iron butterfly, this strategy is employed when an investor anticipates a significant price movement but is uncertain about the direction. The wider range between the short strikes compared to an inverse iron butterfly provides a larger window for the price to move before maximum loss is realized.
• Lower Maximum Loss Compared to Buying Strangles with Similar Breakevens: An inverse iron condor can offer similar breakeven points to a long strangle but with a defined and limited maximum loss.
• Defined Risk: The maximum potential loss is capped at the initial net debit paid.

Key Considerations:

• Probability of Profit: While the maximum potential profit is defined, the probability of the price moving significantly beyond the breakeven points by expiration can still be relatively low.
• Time Decay (Theta): Time decay generally works against an inverse iron condor. As the expiration date approaches, the value of the purchased out-of-the-money options will decline if the price hasn’t moved significantly. This erosion needs to be overcome by substantial price movement.
• Volatility (Vega): An increase in implied volatility after the spread is established can be beneficial, as it increases the value of the purchased out-of-the-money options more than it increases the value of the sold in-the-money options. Conversely, a decrease in implied volatility can be detrimental.
• Early Assignment: There is a risk of early assignment on the short put if the price falls significantly below its strike and on the short call if the price rises significantly above its strike, especially close to expiration or if there are dividends involved.

Managing an Inverse Iron Condor:

• Monitoring Price Movement: Closely tracking the underlying asset’s price is crucial. If a significant move occurs, you might consider closing the position to lock in profits.
• Rolling the Spread: If the price approaches one of the outer strikes but hasn’t reached it as expiration nears, you might consider “rolling” the spread by closing the existing positions and opening new ones with different strike prices or expiration dates.
• Adjusting the Strikes: Depending on your outlook, you might adjust the strike prices of the spread if there’s significant time remaining.

Key Differences from an Inverse Iron Butterfly:

• Middle Strikes: In an inverse iron butterfly, the two middle (short) strikes are the same. In an inverse iron condor, they are different, creating a range of maximum loss.
• Profit Potential: The profit potential in an inverse iron condor is generally smaller than in an inverse iron butterfly with the same width between the outer strikes, due to the wider range of maximum loss.
• Probability: The inverse iron condor might have a slightly higher probability of some profit compared to an inverse iron butterfly because the price has a wider range to move out of to become profitable.

In Conclusion:

The inverse iron condor is a volatility-based options strategy designed for investors who anticipate a substantial price swing in the underlying asset but want a wider range of price outcomes where they avoid maximum loss compared to an inverse iron butterfly. It offers a defined risk and the potential for profit if the price moves beyond the breakeven points by expiration. However, like the inverse iron butterfly, it suffers from time decay and requires significant price movement to be profitable. Careful consideration of volatility, time decay, and the likelihood of a large price change is essential when deploying this strategy.