Traders frequently jump into options trading with little or no knowledge of options strategies. These lead to unwanted risks and losses. When you know your basics and tricks very well, there is hardly any room for mistakes. Iron condor strategy is one of the commonly-used option trading strategies. In this article, we are going to cover everything you need to know about the iron condor option strategy.
There is a myriad of options trading strategies. Some possess higher risks while others limit your risks. Iron condor strategy is one such options trading strategy that limits your risks. It is a trading technique that helps a trader take the upper hand in low volatility market conditions. So, let us get to know the iron condor options strategy better.
What is the iron condor strategy?
The iron condor strategy consists of two puts i.e. one long and one short, and two calls i.e. one long and one short. So, it consists of four strike prices and all with the same expiration date. Traders make investments with the expectation that prices will go up. But, it’s not the case always. With options trading and more specifically iron condor, you can make money when the markets do not really move. So, the iron condor makes the maximum profit when the underlying asset closes in between middle strike prices at expiry. Hence, the aim is to gain from the low volatility in the underlying asset.
When combined with judicious money management, the iron condor option strategy option time premium selling, implied volatility, and probability on the trader’s side. So, to construct an iron condor what you have to do is first, you need to sell an out-of-the-money put and then sell an out-of-the-money call. Next, you have to buy a further out-of-the-money put and then again buy a further out-of-the-money call.
So, as you can see above, the iron condor strategy uses four legs of trading. This includes both bear put spread and bear call spread. Therefore, the long put’s strike price is lower than the long call’s strike price.
Iron condor strategy example
Let us consider that an organization is trading at Rs.50 in April. Note that all the options have 100 shares lot size. Here’s how you can execute an iron condor strategy:
- You buy one May put option with a strike price of Rs. 40 (at a cost of Rs. 50)
- You buy one May call option with a strike price of Rs. 60 (at a cost of Rs. 50)
- You sell one May put option with a strike price of Rs. 45 (for a price of Rs. 100)
- You sell one May call option with a strike price of Rs. 55 (for a price of Rs. 100)
So, we can say that your overall profit is Rs.100. This is because for options sold you received Rs.200, and then for the option bought, you paid Rs. 100.
Now, suppose at expiration, the underlying stock closed between Rs.45 and Rs.55. Let us consider Rs.50. Then:
Option 1- It would expire worthless, as it gives you the opportunity to sell it at Rs.40 instead of Rs.50.
Option 2- This would also expire worthless because it gives you the right to buy at Rs.60 instead of Rs.50.
Option 3- It would expire worthless as it gives the trader to sell at Rs.45 instead of Rs.50.
Option 4- Expires worthless since it gives the trader the right to buy at Rs.55 instead of Rs.50.
So, one in all, you will be left with the initial profit of Rs.100 if you follow the iron condor strategy in this scenario.
Types of Iron Condor
A trader can opt for two positions while using the iron condor strategy. In both positions, the strategy uses balanced buying and selling of the involved puts and calls. Basically, a trader covers both sides of the underlying asset with long and short calls and puts. So, the trader covers every position by buying and selling OTM calls and puts, each respective to one another.
Long Iron Condor Strategy
A long iron condor strategy is used when a trader is expecting low volatility in the underlying asset. A bear call spread is employed by the trader on the call option side, selling a call with a lesser strike price and then purchasing a call with a comparatively higher strike price. On the other hand, the trader employs a bull put spread on the put option side, buying a put with a lesser strike price and then with a higher strike price, he sells the put. Note that the strike prices of the call option are both OTM above the price of the underlying asset, while the put options strike prices are both OTM below the price of the underlying asset.
Short Iron Condor Strategy
A short iron condor strategy is used when a trader is expecting low volatility in the underlying asset. This type of iron condor is just the contrary of a long iron condor. As usual, a trader employs a bear put spread and bull call spread. He sells a put with a lower strike price and then buys a put option with a higher strike price. He sells a call option with a higher strike price and buys a call option with a lower strike price. The call option strike prices are both OTM above the price of the underlying security, while the put options strike prices are both out-of-the-money below the price of the underlying security.
Whether a trader uses a long iron condor or a short iron condor all the options have the same expiration.
How to take off?
Iron condor option strategy sounds complicated and you do need some time to learn and practice. But, if you choose the right online course to learn iron condor strategy you learn efficiently and make consistent profits.
Elearnmarkets is offering a comprehensive course on iron condor strategy “Master Iron Condor with Adjustments” where you learn how to select the correct strike prices, basics of the iron condor, margins and adjustments, and right implementation. With this course, you will master the art of implementing iron condor strategy without taking too much risk. The course contains recorded explanation videos, step-by-step explanations, backtesting results for a year, all these while focusing on practical aspects of trading in the iron condor strategy.
Iron condor strategy is used by traders for making profits from options trading. Though it involves risks, when the risks are managed systematically, traders are able to cut down their risks. As you have already seen, traders can significantly make handsome profits when the asset’s price is non-directional. Iron condor can be confusing, but if you opt for the right online course and learn all the fundamentals, it will be a cakewalk for you.