Long and Short Iron Condor: All You Need to Know

Just like Straddle and Strangle, there is another non-directional strategy that is gaining popularity in the Indian markets. Iron Condor has been used widely ever since the market regulator changed margining rules.

While Straddle and Strangle are two-legged strategies, Iron Condor is a four-legged strategy, combining call and put vertical spreads. The combination of bullish and bearish vertical spreads around where the market is trading creates an Iron Condor.

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The Iron Condor gets its name from the wide-winged Condor and is a delta-neutral strategy.

Iron Condors are of two types – Long Iron Condor and Short Iron Condor.

In both cases, the trader will need two call options and two put options for its construction.

The call options, one long and one short, will have different strike prices but the same expiry date and the same underlying asset. Similarly, the two put options, one long and one short, are at different strike prices but all with the same expiration date and the same underlying asset. 

A Long Iron Condor is a net debit trade, while a Short Iron Condor is a net credit trade. 

Let’s look at the two strategies and their construction closely. 

Long Iron Condor 

This is a net debit strategy, which means that the net inflow and outflow of the four options is a debit. In other words, the trader pays money to create the strategy.

A Long Iron Condor strategy is created by buying the two inner strike options (out-of-the-money) and selling the two outer strikes (deep out-of-the-money). 

A Long Iron Condor is functionally the opposite of a Short Iron Condor. 

This strategy is in play when the trader expects volatility to increase and a large move in prices in either direction.

Construction 

A Long Iron Condor is created by four options – two on the call side and two on the put side. 

All options are out-of-the-money (OTM).

The chart below shows the payoff diagram of a Long Iron Condor.

The following four steps create the strategy 

Selling a 17800 Put at 30

Buying a 18200 Put at 74.8

Selling a 19400 Call at 26.4

Buying a 19000 Call at 108.2

Notice that the Long Iron Condor is created by combining the Put spread and the Call spread.

The strategy has been created on Nifty monthly options with 29DEC2022 as the expiry date. 

The strategy will be in loss if the market stays between the two strike prices where options are sold.

It will be profitable only if the market moves beyond the breakeven on either side.

The strategy has defined risk and defined profitability.

Despite four legs being used, the strategy requires Rs 37,204 as margin.

Calculations

The calculation of breakeven and maximum risk, and maximum profit is a multi-step process. 

Calculating the net debit of the strategy: 

In our case, it will be 30+26.4-74.8-108.2=126.6

(All debit legs are deducted from credit legs)

Net Debit in value = 126.6 X 50 (lot size) = Rs6330

This is the maximum loss in the strategy 

Maximum profit in points = 273.4 

Maximum profit in Rs = 273.4 X 50 = Rs 13,670

Lower breakeven =17,800+273.4=18074

Upper breakeven = 19000+126.6=19126.6

Conclusion

The Long Iron Condor strategy is created in a rising volatility environment. 

The strategy is also used when the trader expects a large price movement. 

The Long Iron Condor is a net debit strategy. 

It is a risk and reward-defined strategy. 

The Long Iron Condor is created by combining a Call Debit Spread and a Put Debit Spread.

Time decay works against the strategy; hence a sharp burst in price is needed in either direction for it to be profitable. 

It is a delta-neutral strategy with the theta, or time decay, working against it

Short Iron Condor

A Short Iron Condor is also a four-legged strategy. In functionality, it is the opposite of a Long Iron Condor.

This is a net credit strategy, which means that the net value of the long options outflow is smaller than the short options inflows.

The Short Iron Condor strategy, which is widely used by intraday and positional traders, is profitable when the market expires within the sold strikes, at which point all the four option legs expire worthlessly.

Short Iron Condor strategies are also delta-neutral strategies and have a defined loss and defined profit. Because its risk is defined, the strategy does not take too much margin to create.

The ideal time to create a Short Iron Condor strategy is when volatility is high and traders expect a volatility crush. The strategy is widely used by traders who take the earnings trade when implied volatility is close to its peak, just ahead of the results.

The two long options that are further away define the wings of the Short Iron Condor. 

They are purchased as insurance and act to restrict loss in the strategy.

Strangle traders convert their strategy into Short Iron Condor by buying the insurance, which also helps them to bring their margin requirement substantially lower.

Construction 

A Short Iron Condor is created by four options – two on the call side and two on the put side. 

All options are out-of-the-money (OTM).

The chart below shows the payoff diagram of a Short Iron Condor.

The following four steps create the strategy 

Buying a 17800 Put  at 30.8

Selling a 18200 Put at 76.15

Buying a 19400 Call at 25.95

Selling a 19000 Call at 108.1

Notice that the Short Iron Condor is created by the combination of the put spread and the call Spread

The strategy has been created on Nifty monthly options with 29th December as the expiry date.

The strategy will be at a loss if the market moves out of the two strike prices where options are sold.

It will be profitable only if the market stays between the sold strike prices plus the credit received.

The strategy has defined risk and defined profitability.

Despite four legs and being a net credit strategy, the margin required is Rs 55,936. 

Calculations

The calculation of breakeven and maximum risk and maximum profit is a multi-step process. 

Calculating the net credit of the strategy:

In our case, it will be 76.15+108.1-30.8-25.95=127.5

(All debit legs are deducted from credit legs)

Net Credit in value = 127.5 X 50 (lot size) = Rs 6,375

This is the maximum profit in the strategy 

Maximum loss in points = 18,200-17,800-127.5=272.5=

Maximum loss in Rs = 272.5 X 50 = Rs13,625

Lower breakeven =17800+272.5 =18072.5

Upper breakeven =19000+127.5=19,127

Conclusion

One of the most commonly used intraday and positional strategies, a Short Iron Condor is a delta-neutral strategy.

It benefits from theta decay, which is the loss in time value.

The Short Iron Condor strategy is ideally created when volatility is high. However, traders create it all the time.

The strategy is also created when the trader expects the underlying asset to remain rangebound.

The Short Iron Condor is a net credit strategy. 

It is a risk and reward-defined strategy. 

The Short Iron Condor is created by combining a Call Credit Spread and a Put Credit Spread.