Options trading is one of the many forms of trading in the stock markets. It is part of the secondary markets and requires an in-depth analysis and understanding of the markets to ensure an increase in the investor’s wealth. Investors and traders have to carry out fundamental and technical analysis of the stocks to determine quality stocks. There are many tools and techniques of technical analysis that can be adopted by traders to ensure a profitable position in the face of market fluctuations. An iron condor is one of the many strategies that can be used by traders.
Given below is the meaning of iron condor and the related details for adopting this strategy to make a profitable trade.
What is an iron condor?
The iron condor is an options strategy that requires a combination of bullish views and bearish views to make a strategic position. To understand this strategy, it is important the basics of options trading which include call and out options. A call option is an option to buy the shares whereas a put option is an option to sell. It is to be noted that these options can be exercised by the traders before the expiry of such options. However, there is no obligation for the same as in the case of future or forward contracts.
An iron condor is essentially a four-legged trading technique the uses four types of call put options strategies to take maximum advantage of the low volatility of the financial markets.
What are the benefits of the iron condor strategy?
Iron condor strategy is often used by traders as a low-risk strategy. Some of the key benefits of this strategy are mentioned below.
- Traders can make the best out of low volatility market conditions and extract a profitable position from the same.
- Traders can be well aware of the maximum profits that can be made by them and the amount that they can lose.
- Traders can manage this strategy to adjust as well as limit any chance of an excess loss-making position.
How does an iron condor work?
Iron condor options strategy allows the trader to open four positions. This includes the bull call spread and bear put spread. The strategies used by the trader in an iron condor are a four point plan where they will have to open the following positions.
- Sell an out-of-the-money put
- Sell an out-of-the-money call
- Buy a further out-of-the-money put
- Buy a further out-of-the-money call
The iron condor strategy can be explained with the following example in a better way.
Let us consider trading on the Nifty Index. Traders can buy or sell NIfty options that have a weekly expiry and take an iron condor options strategy on the same. Let us consider the current level of Nifty for this example and create an iron condor at this level 17000.
- Buy a Put Option at a Nifty level of 16600 (at the premium of Rs 20)
- Buy a Call Option at a Nifty level of 17400 (at the premium of Rs 20)
- Sell a Put Option at a Nifty level of 16800 (at the premium of Rs 40)
- Sell a Call Option at a Nifty level of 17200 (at the premium of Rs 40)
In the above case, the net premium received by the trader will be Rs. 40 (40+40-20-20). Let us assume the lot size of Nifty options is 50. So the net gains or the net credit for the trader will be Rs. 2000 (50* Rs. 40)
The ideal iron condor is when all the four options positions will expire worthless. For this, the trader needs Nifty to be between 16800 and 17200.
If Nifty at the time of expiry is at 17100, then the trader will take the following action.
- Buy Put Option will expire worthless as it gives the trader the right to sell at 17100 instead of 16600.
- Buy Call Option will expire worthless since it gives the trader the right to buy at 17400 instead of 17100.
- Sell Put Option will expire worthless as it gives the trader the right to sell at 16800 instead of 17100.
- Sell Call Option will expire worthless as it gives the trader the right to buy at 17200 instead of 17100.
The net gain in the above situation will be Rs. 2000 (net amount paid as premium)
If Nifty is 16600 at the time of expiry, then the trader will take the following action.
- Buy Put Option will expire worthless as it gives the trader the right to sell at 16600 which is equal to the current Nifty.
- Buy Call Option will expire worthless since it gives the trader the right to buy at 17400 instead of 16600.
- Sell Put Option will not expire worthless as it gives the trader the right to sell at 16800 instead of 16600.
- Sell Call Option will expire worthless as it gives the trader the right to buy at 17200 instead of 16600.
In the above case, the trader will incur a net loss of Rs. 160. If the lot size of Nifty is 50, then the net loss will be Rs. 8000 (Rs. 160*50).
An iron condor is an excellent options strategy that can help the traders in making the best out of a low volatile market condition. Traders can use this strategy to take suitable positions for any stock or on indices. The main target of the traders is to take four suitable open positions to ultimately profit from the premium paid.
The iron condor strategy is quite complex and hence requires a good understanding of the market to take profitable positions. Hence, it may not be suitable for beginners who may not yet have the best understanding of the markets.
Some other options strategies used by traders include long straddle, long strangle, covered call, married put, bull call spread, bear put spread, etc.
The ideal scenario in the iron condor strategy is when all the four options expire worthlessly.