Table of contents
A non-trending pattern is where the market is moving sideways, suggesting low volatility in prices. Since the price of securities is one of the prime determinants of trading strategies, the sideways market can be a confusing pattern for traders.
What is an iron condor?
The iron condor is a strategy to trade four different options at different strike prices but having the same date of expiry. The strategy aims to minimise risks and losses. The iron condor is an option trading strategy suitable for a market with low volatility.
Components of the iron condor
- Call option – The option holder has the authority to purchase the stock.
- Put option – The holder has the option to sell the stock and the other party is obligated to buy the stock.
- Strike price – The original price of the options contract i.e., the pre-determined price agreed by both parties while entering into the contract.
- Spot price – Options are derivatives whose prices fluctuate based on the underlying asset. Spot price represents the current market price of the underlier.
- In the money – Price of underlier > Strike price
- Out the money – Price of underlier < Strike price
Understanding the iron condor strategy
A non-volatile market makes speculations difficult. Hence, traders enter into different contracts to hedge themselves from risks.
The four option contracts are:
- Sell a put option @ out-of-the-money
- Buy a put option @ out-of-the-money (Strike price lower than the sell option)
- Sell a call option @ out-of-the-money
- Buy a call option @ out-of-the-money (Strike price higher than the sell option)
Take the example of the below stock option chain of Punjab National Bank listed on BSE as of 21 Oct 2023 with option contracts expiring on 26 Oct 2023.
So, a trader interested in iron condor may enter the below contracts:
- Sells a put option @ ₹71
- Buys a put option @ ₹70
- Sells a call option @ ₹74
- Buys a call option @ ₹76
The first two contracts are bullish: the trader buys a put option and sells another at a higher price, earning the premium difference. The next two contracts are bearish: the trader buys a call option and sells a put option, exercising them if the price moves as expected. If the price decreases as speculated, the bear exercises the put option to make additional profits apart from the premium.
Short iron condor and long iron condor
Long condors are option strategies to handle a market of non-volatility by entering into four contracts with different strike prices, where the highest and the lowest strike prices are assigned to buy options.
Short condors are options strategies when the market is volatile but the direction is uncertain. Here too, there are four options with different strike prices where the lowest and the highest prices are associated with sell contracts.
Example of the iron condor strategy
Consider the price of stock ABC trading at ₹ 100 in the market.
You enter into an options contract using the iron condor option strategy.
- You buy a put option for ₹ 100 at a strike price of ₹ 80.
- You sell a put option for ₹ 150 at a strike price of ₹ 90.
- You sell a call option for ₹ 150 at a strike price of ₹ 110.
- You buy a call option for ₹ 100 at a strike price of ₹ 120.
Your initial profit is ₹ 100 (150+150-100-100).
Case 1:
Assume that the market price of the stock during the expiration of the contract is at ₹ 105.
- The first option is invalid as you will incur a loss, since the market price to sell is ₹105, while the strike price is ₹ 80.
- The second option is invalid as your counterpart wouldn’t sell the stock at ₹90 when the market price is 105.
- The third and fourth options are invalid, too, as neither of you would buy the stock at ₹ 110 or ₹ 120 when the market price is ₹ 105.
So, your final profit stands at ₹ 100.
Summing up
The iron condor is one of the most popular techniques among option traders. In a market with low volatility, determining the correct strike prices for the iron condor strategy is the trick to earn profits.
FAQs
Condor means a vulture with huge wings. An iron condor is named after the shape of its profit and loss graph, resembling a large bird with wings. The iron condor uses both calls and puts, unlike a plain condor that uses only one type.
An iron condor is a neutral options strategy that profits from low volatility and little or no movement in the underlying asset. However, it can be modified with a bullish or bearish bias by adjusting the strike prices or the spread widths.
The success rate of iron condor is the probability of making a profit from this option strategy. It depends on the strike price, underlying price, time to expiration, and volatility of the underlying security. However, past performance does not guarantee future success.
Yes, you can close an iron condor early by buying back the four contracts that make up the strategy. This may help you lock in gains or minimise losses, depending on the market conditions and the price you pay to close the iron condor.
The best strategy depends on your goals and your risk tolerance. Short strangles offer more profit and lower transaction costs, but also more risk and capital. Iron condors offer less risk and lower capital requirements, but also less profit and higher transaction costs.