Today, traders can choose from many options and trading strategies. The risk associated with some strategies is more than the others. A few strategies restrict the risk involved in a trade. One such limited-risk options trading strategy is the iron condor. It helps you benefit from low-volatility market conditions.
Published on 04 July 2022
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Iron Condor Strategy: An Introduction
The iron condor is a four-legged option setup. It is an improvisation over the short strangle. In an iron condor trade, there are two Put Options and two Call Options. Their strike prices are different, but the expiration dates are the same. The objective of implementing the strategy is to minimise risk while making gains from low volatility. A trader can earn profits from the strategy regardless of a rise or fall in the index or underlying asset.
The strategy involves selling Put and Call slightly out-of-the-money (OTM) options, followed by the purchase of further out-of-the-money Call and Put options. By buying OTM Put and Call, you limit your downside risk despite a significant market movement in any direction. Conversely, the upside is restrained by selling slight OTM Put and Calls.
The right time to execute the strategy is when the trader believes there will be minimal stock movement within a specified time frame. Also Read: Best Time Frame For Intraday Trading
To sum it up, a trader performs the below-mentioned transactions to implement the iron condor options strategy:
Selling an OTM call option
Selling an OTM put option
Buying a further OTM call option
Buying a further OTM put option
Iron Condor Example
As mentioned earlier, there are four legs of trading in the iron condor strategy. It includes a bull call spread, and a bear put spread. Here, the strike price of the long call is higher than the strike price of the long put.
For a better understanding of the strategy, let us use an example.
Assume a company’s stock is trading at ₹80 in April. To execute the iron condor strategy, you will need to sell or buy options as follows. The lot size for all the options is 100 shares.
Buy a May put option with the strike price of ₹60 (at the spot price of ₹80)
Buy a May call option with the strike price of ₹100 (at the spot price of ₹80)
Sell a May put option with the strike price of ₹65 (for a price of ₹160)
Sell a May call option with the strike price of ₹95 (for a price of ₹160)
For these transactions, you have paid ₹160 for the options bought and received ₹320 for the options sold. Consequently, your overall gain is ₹160.
Now, if the price of the underlying stock is anywhere between ₹65 and ₹95 at expiry, the effect of the iron condor strategy is as follows. Let’s assume the stock price on expiry is ₹74.
Option 1 expires worthless since you can sell at ₹60 (rather than ₹74)
Option 2 expires worthless since you can buy it at ₹100 (rather than ₹74)
Option 3 expires worthless since you can sell at ₹65 (rather than ₹74)
Option 4 expires worthless since you can buy it at ₹95 (rather than ₹74)
With the help of this example, it is clear that by following the iron condor options trading strategy, you will be left with an initial profit of ₹160 since all options expire worthlessly. However, there will be a loss if the stock closes below ₹65 or above ₹95.
Benefits of the Iron Condor Options Trading Strategy
The benefits of the iron condor strategy are plenty over other options trading strategies. They include:
The investors are aware of the highest profit they can earn and the loss they can incur.
One can manage and adjust the strategy in between to restrict the losses if they can happen.
Options traders can manage a sideways market that is showing low volatility and earn gains from the market conditions. Also Read: How to Analyse Stock Market Trends?
Conclusion
The iron condor is a productive strategy for earning profits if the investor anticipates low volatility in the market. The technique focuses on seeing all four options expire worthlessly to earn a profit from the net premium received. As a result, it is best suited for experienced traders who have expertise in the game. The optimum point for this strategy is between the two inner strike prices. If beginners seek to execute the iron condor strategy, they must study the basics since there are four legs of trade to deal with. It is necessary to make informed trading decisions because the market conditions have to be just right for the execution of the strategy.
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All You Need to Know about Shorting in Futures & Options
Shorting is just a simple market view. Just like people purchase stock when they expect it to go up, they sell it when they expect it to go down. It's normally a directional outlook and nothing else.
Futures and Options are two important standardised derivative contracts. It is standardised based on the quantity, price, and expiration date. Therefore, quantity based on the lot size is a vital aspect that helps you engage and settle a futures or options contract.
A futures contract is nothing but an improvised forwards contract. It is designed to retain the fundamental transactional structure of a Forwards market. Futures Contracts also eliminate the risks that are generally associated with a Forwards Contract.
Generally, the iron condor strategy is successful in a low volatility market. But, a trader must possess a high level of expertise and analytical skills for its successful implementation. The strategy can increase your probability of success since it allows you to limit your risk, and there’s no need for the underlying to move anywhere.
Yes. You can earn profits using the iron condor strategy. However, the profit is capped at the premium received. To earn profits, there is a need for range-bound movement in the stock price. If the stock price rises more than the call option’s higher strike price or drops below the lower strike price of the put option, you can also incur losses.
The iron condor strategy is a component of options trading. Therefore, you need an options trading account to implement the strategy.
An iron condor options trading strategy involves lower risk since all strikes are far out-of-the-money with lower potential reward. On the other hand, the iron butterfly is a higher risk and higher reward strategy because of the at-the-money nature of the strikes.
Related Articles
All You Need to Know about Shorting in Futures & Options
Shorting is just a simple market view. Just like people purchase stock when they expect it to go up, they sell it when they expect it to go down. It's normally a directional outlook and nothing else.
Futures and Options are two important standardised derivative contracts. It is standardised based on the quantity, price, and expiration date. Therefore, quantity based on the lot size is a vital aspect that helps you engage and settle a futures or options contract.
A futures contract is nothing but an improvised forwards contract. It is designed to retain the fundamental transactional structure of a Forwards market. Futures Contracts also eliminate the risks that are generally associated with a Forwards Contract.
Generally, the iron condor strategy is successful in a low volatility market. But, a trader must possess a high level of expertise and analytical skills for its successful implementation. The strategy can increase your probability of success since it allows you to limit your risk, and there’s no need for the underlying to move anywhere.
Yes. You can earn profits using the iron condor strategy. However, the profit is capped at the premium received. To earn profits, there is a need for range-bound movement in the stock price. If the stock price rises more than the call option’s higher strike price or drops below the lower strike price of the put option, you can also incur losses.
The iron condor strategy is a component of options trading. Therefore, you need an options trading account to implement the strategy.
An iron condor options trading strategy involves lower risk since all strikes are far out-of-the-money with lower potential reward. On the other hand, the iron butterfly is a higher risk and higher reward strategy because of the at-the-money nature of the strikes.
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