Many option traders, including hedge funds, money managers, and individual investors, favor the iron condor option strategy. By simultaneously selling a bear call spread and a bull put spread, the options strategy is carried out. Its name comes from the way the graph resembles a bird spreading its wings. With this strategy, four different strike prices are used, all of which have the same expiration month.
The inner strike prices, points B and C, are typically where this strategy is applied, with the distance between the puts and calls being roughly equal.
The appeal of this strategy is the larger net credit received for simultaneously selling an out-of-the-money call spread and an out-of-the-money put spread; however, because the maximum losses are capped, it is more conservative than a straddle or strangle.
Strategy
Investors who believe there won’t be much movement in the stock price before expiration would execute an iron condor, allowing them to earn a higher premium. Furthermore, even though two vertical spreads are being executed in this case, the margin needed to execute an iron condor is the same as that needed to execute a single vertical spread. The trader is assured of winning at least one side of the trade for this reason.
Due to its potential for balancing risk and reward, the iron condor is a preferred options trading strategy among many options traders. An iron condor trader anticipates that the underlying stock will trade within a constrained range, causing the option to expire between the two short strikes. Depending on the iron condor’s range and how it relates to the stock price, it can also be executed with a slight tendency either to the bullish or bearish.
To avoid any unexpected movement in the stock, which could turn a winning trade into a losing trade, it is almost always a good idea to close out the position a few days before expiration. Markets can change quickly and without warning, so keep in mind that even though higher implied volatility increases the net credit a trader can receive, it also makes a trade more risky and volatile. Because of this, it’s wise to always be aware of your risk exposure and how to adjust your trade should the market move against you.
Profit/Loss
Once the stock leaves the inner short strike prices and pierces either the upper call spread or lower put spread, the trader begins to lose money on this position. The difference between the call or put side, minus the premium paid, is used to determine the maximum loss. similar to a bull put or bear call spread.
If the stock expires between the two short strikes, denoted by points B and C on the graph above, the maximum win is determined.
Breakeven
There are two breakeven points on an iron condor.
Upper Breakeven = short call strike + credit received
Lower breakeven – short put strike – credit received
Example
A trader could sell a 105-110 call spread for Rs1.50 net credit and a 90-95 put spread for Rs1.50 if the stock XYZ is trading at Rs100. There, the trader would get a Rs3 premium all in all.
The trader would keep the entire Rs3 premium and all of the options would expire worthless if the stock fell to Rs96.
If the stock rose to Rs112, the trader would incur a net loss of Rs5 after incurring losses of Rs7 on the 105-strike price call and Rs2 on the 110-strike price call. However, since they only lost a maximum of Rs2 (Rs5-Rs3) when they sold this position for Rs3.
Conclusion
Investors who anticipate a neutral market favor the iron condor as an options strategy. A trader’s chances of success increase as they move further away from the money, but the premium they will receive decreases. When time decay picks up and there are 30 to 60 days left before the strategy expires, it is best to start using it. It enables investors to take on positions with low risk, high capital returns, and a high likelihood of success.
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