What are the characteristics of this option strategy?
Reverse iron condor spreads are an advanced options structure that combines two vertical debit spreads with a direction neutral, long volatility bias. In this strategy the trader buys a call debit spread above the market and a put debit spread below it, paying a net debit of premium. The maximum loss is that net debit, and the maximum profit is the spread width minus the debit. The reverse iron condor is a risk-defined strategy, meaning there is a predetermined amount of capital that could be lost on the trade if the market moves against the position without the trader taking any extra risk. It needs a large move in either direction before expiration: if the underlying is still sitting between the two long strikes when the options expire, the whole debit is gone.
Is this a bullish, bearish or neutral strategy?
The Reverse Iron Condor Option Strategy is direction-neutral but long volatility. The trader needs the underlying to make a large move, up or down; the entire net debit is lost if the underlying is still between the two long strikes at expiration. This strategy lets the trader take a position on the size of the move without having to be right about its direction. It is the opposite of a standard iron condor, which wants the underlying to sit still.
Is this a beginner or an advanced option strategy?
The Reverse Iron Condor Option strategy is an advanced strategy and is not recommended for beginner options traders. The thought process behind this strategy is complex and requires a deep understanding of options trading and the markets in order to successfully execute this strategy.
In what situation will I use this strategy?
This strategy is best used when a big move is expected but its direction is not, for example around an earnings release, a regulatory decision or a breakout from a long consolidation. Entering when option premiums are cheap keeps the debit small, but the trade still only pays if the underlying actually travels past a breakeven point. Risk is capped at the debit, which is not the same as low risk: the full debit is lost in the single most likely outcome, which is the underlying going nowhere.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The Reverse Iron Condor Option Strategy has a defined maximum loss, the net debit, and a defined maximum profit, the spread width minus that debit. There is no credit collected at the start: the trade is paid for up front. The probability of profit is low, because the underlying has to move past a breakeven point instead of merely staying still, and the reward-to-risk ratio is often less than 1 once the debit is a sizeable share of the spread width. Losing the whole debit is the base case, not the tail case.
How is this strategy affected by the greeks?
The greeks affect this strategy in a variety of ways. Since the Reverse Iron Condor Option Strategy falls in the category of neutral option strategies, the primary greeks that are affected are delta, vega, and theta. Delta measures the change in the option’s price due to a change in the underlying asset’s price, while vega measures the change in an option’s price due to a change in volatility. Theta measures time decay, and because a reverse iron condor is net long options its theta is negative: every day that passes without a large move in the underlying erodes the position's value.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The Reverse Iron Condor Strategy is bought, so a low VIX helps by making the debit cheaper. What it needs afterwards is realized movement: cheap options plus a market that then stays range-bound is the losing combination, not the winning one. Entering when implied volatility is high raises the debit and pushes the breakevens further out, which lowers the odds of the trade paying off.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
There is not much to adjust here, because the trade goes against the trader by nothing happening. The realistic choices are closing early to recover whatever time value is left in the long options, rolling the long strikes closer to the money for a further debit, or buying back the short wing on the side the underlying is drifting toward so that side is no longer capped. Each of those costs more premium and raises the amount at risk, and none of them turns a stalled position into a winner. Adding to a losing position in the hope of a late move simply doubles the debit that is lost if the underlying keeps sitting still.
Where does this strategy typically fall in the range of commissions and fees?
The commissions and fees associated with the Reverse Iron Condor Strategy can vary depending on the broker and the size of the trade. Generally speaking, the strategy is reasonably priced in terms of commissions and fees, especially if the trader is trading multiple contracts at a time.
Is this a good option income strategy?
No. The Reverse Iron Condor is not an income strategy. It is paid for with a net debit, it has negative theta so it loses value every day the underlying does not move, and it only pays off on a large move. Traders normally pair it with breakout or event-driven setups, not with an income program.
How do I know when to exit this strategy?
Most traders close this position for its market value rather than holding it to expiration. The common exits are taking profit once the underlying has pushed past a short strike and the spread is trading near its maximum value, or cutting the trade once the event that was supposed to move the stock has passed and the remaining time value is draining away. Set that time-based stop before entering, because doing nothing costs money every day here.
How will market makers respond to this trade being opened?
Market makers will typically respond to the Reverse Iron Condor strategy by adjusting the quote of the option. This is done in order to offset any gains they may suffer due to the reverse iron condor strategy being opened.
What is an example (with calculations) of this strategy?
Assuming MSFT is trading at $285, an investor can create a Reverse Iron Condor by simultaneously buying and selling four options, consisting of a call debit spread and a put debit spread, with four different strike prices but the same expiration date.
To execute this strategy, the investor would do the following:
Buy one out-of-the-money call option with a strike price of $295 and an expiration date of one month from now, paying a premium of $5 per share.
Sell one out-of-the-money call option with a strike price of $305 and an expiration date of one month from now, receiving a premium of $2 per share. Those two legs are the call debit spread, and it costs $3 per share.
Buy one out-of-the-money put option with a strike price of $275 and an expiration date of one month from now, paying a premium of $4 per share.
Sell one out-of-the-money put option with a strike price of $265 and an expiration date of one month from now, receiving a premium of $1 per share. Those two legs are the put debit spread, and it also costs $3 per share.
The two spreads together are a net debit of $6 per share, or $600 for one contract of each leg, and that is the maximum loss.
The resulting payoff diagram is an inverted condor: the long options sit at the inner strikes nearest the money and the short options sit at the outer wings, so the profit region is outside the range and the maximum loss sits in the middle.
Here’s how the strategy works:
If MSFT's price remains within the range of $275 to $295 at expiration, all four options expire worthless and the investor loses the entire $6 per share net debit ($600 on the position), which is the maximum loss on the trade.
If MSFT's price rises above $295 or falls below $275, the long call or long put starts to pay, and once the stock reaches $305 or $265 the position is at its maximum profit of $4 per share ($10 spread width minus the $6 net debit), or $400 per contract. The short outer options cap that gain but do not create a loss.
The breakevens are $301 ($295 plus the $6 debit) and $269 ($275 minus the $6 debit). MSFT has to clear one of those levels for the trade to make anything at all.
Moving too far is not a risk here. Because each short strike is covered by a long option closer to the money, the loss can never exceed the $6 net debit however far MSFT travels. The risk in this trade is MSFT staying put.
How MarketXLS Can Help?
MarketXLS is a powerful financial analysis and trading tool that can be used to analyze and trade the Reverse Iron Condor Strategy. With MarketXLS, traders can quickly analyze the greeks of their trades and determine the best setup for their strategy. MarketXLS also offers a wide range of built-in option strategies, making it easy for traders to analyze and backtest their strategies before executing them. MarketXLS can be used to quickly automate the entire trading process for the Reverse Iron Condor Strategy, allowing traders to spend more time researching and executing trades instead of manually analyzing them.
Here are some templates that you can use to create your own models
Reverse Iron Condor Spread
Reverse Iron Albatross Spread
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic