Alright. Hey everyone. This is Kirk here again at Option Alpha and in this video, I’m going
to go through iron condor breakeven prices, yes, because there are multiple breakeven
prices for iron condors. Take your time with this video, but I promise you, if you watch
all the way through, you’re going to get a lot out of this and how to understand, how
to calculate these breakeven prices for iron condors. The first thing that we’re going
to do is start with a simple payoff diagram. This is a simple payoff diagram structure
that we can use for our iron condor. Now, remember that an iron condor has this payoff
structure. It has four pivot points. I don’t know why they call it an iron condor, but
they do. Maybe it looks like a flying bird. But essentially, it pivots at four different
places and this is really how we start building the framework around calculating the breakeven
points. It pivots at four different places which send the iron condor payoff diagram
up through the breakeven point right here, and then this is your potential profit zone
in here, but then another breakeven point and pivot point sends the iron condor payoff
diagram down through this breakeven point here. This is why we say that it has two breakeven
points. We’ve got the breakeven point here, breakeven point one essentially, and then
we’ve got this one here which is breakeven point two. And you do have to calculate both
because this is how we determine the probability of success or how wide the position is or
basically, our range that we’re looking for the stock to trade in before expiration.
To build out this iron condor, again, what you need to understand is the different prices
of the contracts that you had bought and sold the entire way through. We’re going to go
through this in very simple fashion, so that you understand exactly how it works. Let’s
assume right now for the sake of argument, that the stock we’re trading this on is
trading at $100 even. The stock is trading right here, right in the middle of our iron
condor position and we just simply want to take a position where we assume that the stock
is going to go generally sideways between now and expiration. In this case, what we
might do is we might sell a put option here, so I’ll just put –1P for put option and
this will be a put option that we sell at the 95 strike price. That’ll be the strike
price of that particular point. This is where it pivots on the payoff diagram. Then on the
put side, we have to buy another put option to give ourselves defined risk in case the
stock really starts tanking. And so, here, we’re going to buy a put option, so we’ll
say +1 for a put option which is P and then this is going to be at the 90 strike. We’ll
just give this a 90 strike here and you can see on the put side now, we have a $5 wide
spread. On the call side, we’re going to do the same general principle and process,
except with call options. We’re going to sell one call option here. We’ll do this
at the 105 strike price on the call side. And then notice that we have to go even further
out to buy our long call option contract here, so we’ll say +1C and we’ll do this contract
here at $110.
Now, this is a pretty even and balanced iron condor, and I did this on purpose because
I want to make sure you guys understand exactly how to calculate these breakeven prices, although
even if you have sides of the iron condor that are uneven, say the 105 and the 115 or
the 105 and the 106, you can still use the same process to calculate breakeven points.
In our case here, we have a $5 wide spread on the put side and a $5 wide spread on the
call side. Now, what we need to do is we need to figure out the prices of each of these
particular sides to the iron condor or each of these individual contracts. We’ll start
up here with the short put option that we sold. Let’s say that we sold this put option
for $2.35. This is the price that we collected for selling this one 95 strike put option.
On the call side, let’s assume that we sold this one strike call option at 105 for $2.80.
We collected these premiums. This is the starting point that gives us the total premium that
we’ve collected so far. However, we use some of those premiums to purchase these outside
wings or these outside legs to give us defined risk. Let’s assume for this example, that
we bought the one 90 strike put option down here below for $2 and we bought this one call
option at 110 strike for $2 as well. This just makes the math a little bit easier for
us, although I do make it a little bit complicated, so you actually have to do these calculations.
You can’t do them in your head necessarily. You can do them through a scratch paper if
you want to as well.
Now that we have the prices of all the individual contracts, now what we can do is we can total
up each side. And this is how I do it. I total up each side of the spread, and then that
gives me my total credit, and I use that total credit for the purposes of calculating the
breakeven price. I’ll do this over here, so you guys can see this, but in this case,
we have our put side spread and we have our call side spread. On the put side spread,
we had sold this 95 strike put for $2.35, but we had used some of that premium to buy
the 90 strike put, so our net credit that we collected was still $.35. That was the
net credit that we collected on the call side or I’m sorry, on the put side, was still
a $.35 net credit. On the call side, our short 105 and our long 110 call, we had sold the
105 for $2.80, we bought the 110 for $2, so that means that we still collected a credit
of $.80 on the call side. Let me just make this a little bit better for you since my
writing isn’t that good when I write 8s. Make it a lot easier for you to understand.
There we go. Now, we have our credits for each individual side. We have our put spread
side and our call spread side, and our total credits that we have now collected on this
position, our $1.15. Now, this is really important because this $1.15 here is very helpful for
not only determining what our potential profit is which is here. This is our max profit,
$1.15. That’s the difference between all of these different contracts in here. But
this is going to be used to calculate breakeven one and breakeven two here. And so, what we’re
going to do now is we’re going to use the $1.15 credit and we’re going to calculate
breakeven price one. We’re just going to put over here BE1, so that we can go through
the calculation together.
Now, to calculate breakeven point one, we basically take the short put option strike
price which is $95, so we take $95, and we subtract the credit that we had received on
our total iron condor position. 95 strike put option, we subtract the total credit received,
and you actually can visually see this here. This is the way I always think about it, is
that when you see the strike price at 95, in order to get to the breakeven point here
which is further out on the payoff diagram, you actually have to subtract and go backwards
down the payoff diagram. That’s how I know and that’s how I usually remember that I
take the 95 strike option here, and I subtract the credit received which is 115, and when
I subtract the 115, that leaves me with breakeven’s price number one or breakeven point number
one at 93.85. That is our first breakeven point there. 93.85 is our first breakeven
point. Now, to calculate breakeven point number two, so BE2, we basically are going to do
the same thing, just in the opposite direction with the call option. We take the strike price
of our short call option here which is 105, and notice that we have to travel up the payoff
diagram to get to breakeven point number two, so instead of subtracting the credit that
we received, we actually add the credit that we received of $1.15. $1.15 here gives us
a breakeven point number two of 106.15. That is our second breakeven point.
And that’s essentially how you do it. It’s really not any more complicated than that.
As you start going through calculating breakeven points on iron condors, it does get a lot
simpler as you start doing it over and over again. I really encourage you to draw it out
like this if you want to on a scratch piece of paper or on an iPad, something where you
can actually start doing these calculations. And we deliberately did not make this really
easy with round numbers here. I wanted to make it a little bit more difficult, so that
you understood exactly how all these calculations work. But again, just as a reminder, to calculate
the first breakeven point on an iron condor, you take the strike price of your short put
option contract, you subtract the credit received. That gets you your first breakeven point.
The second breakeven point, you take the strike price of your short call option contract and
you add the credit received. That gets you your second breakeven point here. And now,
we know that ideally, we want this stock to trade anywhere between 93.85 and 106.15 between
now and expiration, and if it trades between 95 and 105 which is our two strike prices,
we know that we make our total max profit here of $1.15 by expiration. Hopefully this
helps out. As always, if you have any questions at all on this or anything else options related,
let us know and until next time, happy trading.