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Iron Condor - An Option Trading Strategy

An iron condor is yet another strategy used in the options market by options traders. It is a multi-legged and neutral strategy having limited profit-earning opportunities.

An Iron Condor strategy is made by selling the out-of-the-money bear call spread higher than the current stock price and an out-of-the-money bull put spread below the current stock price having the same expiry date.

The investor may benefit from low volatility, time decay factor, and no or minimal price movement in the underlying asset. Iron Condors are short strangles with options protection, purchased to define the risk in both directions.

Iron Condor strategy from a market perspective:

Iron Condors are a neutral strategy because they did not get affected by the directional bias. A trader begins this strategy when he is sure that the stock price will remain in the specific range and that there will be no effect of implied volatility on the stock. When these expectations are met, only then these strategies be fruitful.

How can I set up an Iron Condor strategy:

A trader can set up Iron Condor by selling a bear call, and a bull put credit spread, both out-of-the-money and having the same expiry date. The amount received by selling both spreads is the maximum profit for a trader. The maximum loss is equal to the spread width minus the credit obtained.

In this strategy, investors are free to sell iron condors at any distance from the current price, and its spread can be anywhere between the short and long options. More premiums can be collected near the strike price to the current price, and the probability of expiring in-the-money will increase.

The broader spread width among the options will result in a high premium collection and also high risk.

Understanding the diagram of the Iron Condor:

A good options trader is one who can identify the strategy from its graph or diagram. If you want to learn what the Iron Condor diagram looks like, read this section carefully.

The diagram of this strategy got this name because it seems like the body and wings of a giant bird. Both profit and losses are predefined. If the trade closes between both the strike prices at expiry, then maximum profit is achieved.

If the price reaches either above or below any one long strike price at the time of expiry, then the trader may face a huge loss. The total amount received above or below the short options is the break-even point in this strategy.

For example: If the Iron Condor strategy is open for Rs. 2, then the break-even points will be Rs. 2 above the strike price of the short call and Rs.2 below the strike price of the put options.

Traders may exit the trade anytime before the expiry. There are various opportunities to profit by exiting the trade, traders can exit themselves entirely from the position, exit only one spread, or buy back the short options. If the cost of new short options bought is less than that were sold, it can also be profitable.

Iron Condor - An Option Trading Strategy

How can I enter the Iron Condor?

Iron condors are made by sell-to-open a credit spread above and below the underlying asset's current price. It is done by selling out-of-the-money and purchasing the farther out-of-the-money options contract.

For example: suppose stock A is currently trading at Rs.100.

A bull put spread can be opened by selling the put option at a strike price of Rs. 95 and purchasing the put options at a strike price of Rs. 90. A bear call spread can be entered by selling a call option with a strike price of Rs. 105 and buying another call option with a strike price of Rs. 110. The above calculations will create a wide iron or Rs.10 and a wings shape having Rs. 5. If a trader receives Rs. 2, then the maximum loss he can incur is Rs. -300, and the highest profit can be up to Rs. 200.

  • Buy-to-open: Rs. 90 put option contract

  • Sell-to-open: Rs. 95 put option contract

  • Sell-to-open: Rs. 105 call option contract

  • Buy-to-open: Rs. 110 call option contract

The spread can be of any width or distance from the current market price. The closer they are, the more credit can be collected, and the probability of closing the trade-in -the-money will be high. The large width between the short and long options will result in an increased premium collection, and the risk associated will be high. If the contracts have enough time to expire, then also, the amount of the premium collected is high, but on the other hand, the chances to earn more will reduce, as there is enough time with the underlying asset to challenge the strike prices.

How can I exit from the Iron Condor?

As seen earlier, Iron Condor can be beneficial if there is minimum price decay, a drop in the volatility, a time decay factor, or may be a combination of all three. Now, if the price of the underlying stock remains within the short options, then this contract will be said to expire worthlessly.

The Iron condor can be exited anytime before the expiry and take advantage of closing the position. The position can be closed completely, exit only one spread, purchase the short options again, etc. if you buy the new short options at a lower price than those sold, then it is a profitable strategy for a trader.

Buying the long options contracts that are above or below the short strike price gives the details of the risk in that position. The maximum loss can equal the spread width minus the credit gain.

If the underlying asset price goes above the long option at the time of expiry, the trade must be exited, as there will be a maximum loss. If any of the short option contracts is in-the-money during the expiry, then there is a risk in the execution of that contract.

Impact of time decay on Iron Condor:

The time decay or theta factor is in favor of this strategy. Every day the time value decreases. Generally, the stock faces a very low movement, and theta will also reduce its value as expiry comes closer.

When the contract price declines, it may attract the investor to buy the options for less money.

Impact of Volatility on the Iron Condor:

The iron condor strategy can be successful when the implied volatility is low. Low implied volatility will reduce the price of the options premium. When the trader initiates this strategy, the volatility is high and gradually decreases as the expiry comes near.

Although the volatility or vega is challenging to predict, it will be helpful if you know its impact on the price of the options.

How can I adjust the Iron Condor?

Traders can adjust the iron condor by extending the trade's time or by rolling any spread up or down based on its movement. When traders adjust the iron condor, they bring in more credit, which leads to high profit, reducing the maximum risk or loss and widening the break-even points.

The probability of the profit reduces when the iron condor's width narrows.

In order to maintain your risk profile, it is necessary that a trader should keep the lot size and expiry date the same as before.

If a trader feels any one side is making a loss at the time of expiry, then the trader has two choices to make a profit; roll out the position to some later expiry date or roll one credit spread in the direction of the stock price.

Traders can also close the entire position and reopen it again for some later expiry date. If by doing so, traders receive some credit, then the break-even point will be extended to the amount received as a premium.

If one side feels challenged, the other side can be rolled towards the stock price, which will bring an additional credit.

For example: If the stock is currently traded at a lower price, then Rs. 105 and Rs.110 call spreads can be closed, and new spreads can be bought having the lower price. This might narrow the width of the Iron Condor but will also gain additional credit to offset the risk on the overall position.

  • Buy-to-close: Rs. 105 call options spread

  • Sell-to-close: Rs. 110 call options spread

  • Sell-to-open: Rs. 100 call options spread

  • Buy-to-open: Rs. 105 call options spread

If by making this adjustment, traders get the additional credit of Rs.1, then the maximum profit will increase by Rs.100 per contract, and the maximum loss will reduce by Rs. 100 per contract. The break-even point of the put options spread will increase by the amount equal to the credit received.

Iron Condor - An Option Trading Strategy

Opposite to the above situation, if the stock is trading higher than the current price, then R. 95 and Rs. 90 put credit spread can be closed or exited, and a new spread should be bought at a higher price. By doing so, the width spread of the iron condor might get narrow, but the overall risk on the position will be reduced due to the additional credit gain.

  • Sell-to-close: Rs. 90 put options spread

  • Buy-to-close: Rs. 95 put options spread

  • Buy-to-open: Rs. 95 put options spread

  • Sell-to-open: Rs. 100 put options spread

Iron Condor - An Option Trading Strategy

If by making these adjustments, the trader gets an additional credit of Rs. 1, then the maximum profit potential will rise by Rs. 100 per contract, while the loss will get reduced by Rs. 100 per contract. The break-even point for this call spread will increase to the amount equal to the credit received.

Iron Condor - An Option Trading Strategy

If there is a significant move in the underlying asset's price, then this Iron condor can be converted into the Iron butterfly strategy. To enter into the iron butterfly, the trader has to close one spread and move the short strikes toward the same price.

When the Iron Condor is turned into the Iron butterfly, it may have the highest potential to make a profit, and te risk is very low, but the range to make the profit will get narrower than that of Iron Condor

  • Sell-to-close: Rs. 90 put options spread

  • Buy-to-close: Rs. 95 put options spread

  • Buy-to-open: Rs. 100 put options spread

  • Sell-to-open: Rs. 105 put options spread

Suppose by making the above adjustments; traders can get an additional Rs.2 credit. In that case, the maximum potential to profit will rise by Rs. 200 /contract. The maximum loss is reduced by Rs 200/contract. The break-even point for the not adjusted spread will increase by the amount received as credit.

How to roll the Iron Condor?

Like every other strategy, Iron Condors can be rolled out to a later expiry date to increase the potential profit on that trade. As we know, time decay helps the options seller. Let's say the expiry date is coming near, and the position does not look profitable; then, it is advised to close the original position and reopen it again for any other future date.

This will lead to extending the time and will also make break-even points broader.

For example: The Iron condor has Rs. 105 and Rs. 110 call spread and Rs. 95 and Rs. 90 put spread expiring in June, and have gained Rs 2 as premium; then the entire iron condor can follow the order close-to-buy and can enter into the new Iron Condor by following the Sell-to-open (STO) order for July.

While doing this, if the trader gets the credit of Rs.1, the maximum potential to make a profit will increase by Rs. 100/contract, and the maximum loss will reduce by Rs. 100/ contract. The new break-even points, in this case, will be Rs. 92 and Rs. 108.

Iron Condor - An Option Trading Strategy

How to hedge the Iron Condor?

The best method to hedge the iron condor can be rolling the less risky spread into the direction of the price movement of the underlying stock.

For example: if the stock price is moving high and challenging the bear call spread, then the initial bull put spread can be closed and opened again at the price closer to the current stock price.

By doing so, the amount received as credit will rise, and also, if the stock price keeps on moving high, the bull put spread will still make a profit, while the bear call spread might be losing money.

So, this was all about the Iron Condor options strategy, do share with us how useful you found this information. If you need help understanding it more deeply, you may contact us via the number provided or email stating your query.


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