Profitability of the iron condor option strategy depends on two factors: the risk-reward ratio (how much you gain when you win and how much you lose when you lose) and success rate (or win rate or probability of profit – the percentage of trades which end up profitable). While the risk-reward ratio is easy to calculate, estimating the success rate is harder. But it can be predicted, with some degree of accuracy, based on your iron condor setup (mainly the strikes involved), time to expiration, and volatility of the underlying security.
When Iron Condor Is a "Success"
Iron condor, when held to expiration, is profitable when underlying price stays between its two break-even points, and loses when it is outside. The break-even points are easy to calculate:
Iron condor lower B/E = short put strike – initial cash-flow
Iron condor upper B/E = short call strike + initial cash-flow
Typically iron condor is opened when underlying price is between the short put and short call strike (the "middle" strikes). The objective is for it to stay between these two strikes (then we make maximum profit, equal to initial cash-flow), or at least between the two break-evens (then we still make some profit). It is possible to calculate the probability of either.
What Iron Condor Success Rate Depends On
Whether you understand iron condor success rate as the probability of price staying between the strikes (probability of maximum profit) or the probability of price staying between the break-evens (probability of any profit), it depends on the following factors:
- The strikes or the break-even prices
- Current underlying price
- Time to expiration
- Volatility of the underlying security
Generally, iron condor success rate is higher when:
- The strikes or break-evens are further away from current underlying price
- Time to expiration is shorter (price has less time to move into the loss territory)
- Volatility is lower (price moves slower)
Higher Success Rate Is Not Always Better
In trading there are always tradeoffs.
You can possibly increase the success rate if you choose:
- A less volatile underlying (e.g. a broad market index or a utility stock rather than a tech or mining stock)
- Shorter expirations
- Middle strikes further apart
But these also mean that initial option premiums will be lower and risk-reward ratio will be worse. In other words, you will win more often, but less.
In the end, higher success rate does not always mean greater profitability, especially in the long run when you make such trades many times over. Always keep in mind that success rate is not the variable to optimize for. That variable is long term P/L.
Calculating Expected Iron Condor Success Rate
When you know (or estimate – in case of volatility) all the factors which affect success rate, you can predict it with solid level of accuracy (just keep in mind that success rate does not mean that the next one trade wins or loses, but the aproximate percentage of wins over a larger number of trades).
You can plug the inputs (current underlying price, the strikes or break-evens, time to expiration, and volatility) into a probability model, which follows similar logic and makes similar assumptions as the Black-Scholes option pricing model.
This model returns the probability that price will be above a given level (single strike or break-even point) at a given point of time (expiration), based on current price and given volatility.
Then it is easy to combine the probabilities of price being above the individual strikes (or break-evens) to calculate the probability that price will stay within a certain range – the estimated iron condor success rate.
You can find these calculations implemented in the Price Probability Calculator.