What is Iron Condor?

A common belief in the Indian financial market is: the more complex the strategy, the higher is the potential for profits. The same goes with Options trading and its numerous complex strategies. Options are contracts that grant the holder the right but do not bind them, to either buy or sell a sum of some underlying asset at or before the contract expires at a fixed price. Options can be acquired with brokers through online trading accounts as with any other asset group.

Although it's a little more complex than stock trading, Options yield comparatively better profits if the security price increases. This is because you do not have to pay the full premium for the issuance of an options contract. Similarly, selling Options will reduce your losses if the security price goes down, which is also known as hedging.

In Options Trading, the profit potential is high due to the effective trading strategies that are based on tried and true processes used by Options traders. One of the most widely used is the Iron Condor options strategy. However, to understand the iron condor's meaning, you need to know the types of options and terms related to the Iron Condor options strategy.

Types of Options Contract

Call Options

A Call Option is a contract wherein you win the right, but not the obligation, to buy a certain underlying asset at a decided-upon price and date between the contracting parties.

Put Options

A Put Option works exactly opposite to the call option. While the call option equips you with the right to buy, the put option empowers you with the right to sell the stock at the price on the date agreed upon by the contracting parties.

Some terms associated with Iron Condor Options Strategy

Owing to the broad concept of Options trading and the subsequent trading techniques, there is numerous jargon that you must understand before you jump to understand the Iron Condor options strategy. These terms are as follows:

• Strike Price: The price at which the options contract was initially bought or the pre-determined price.
• Spot Price: The current price of the underlying asset is attached to the options contract.
• Premium: It is the price you pay to the seller of the option for entering into the online trading options.
• In-The-Money (ITM) call option: When the underlying asset price is higher than the strike price.
• Out-of-the-money (OTM) call option: When the underlying asset price is lower than the strike price.

What is the Iron Condor Options Strategy?

Unlike a bull put spread or a bear call spread, an Iron Condor options strategy is a four-legged trading technique. The strategy has limited risk and allows investors to take advantage of the low volatility in the financial market.

The Iron Condor Options strategy involves buying and selling two Options simultaneously. All the options contracts are OTM (Out of the money). However, two of them are call options, and the rest are put options. The following transactions take place while implementing an Iron Condor options strategy:

• Sell an Out-of-the-money call option
• Sell an Out-of-the-money put option
• Buy a further Out-of-the-money call option
• Buy a further Out-of-the-money put option

How does an Iron Condor Options Strategy work?

Consider the following example:

Suppose the shares of a company are currently trading at Rs 30. A trader looking to execute an Iron Condor options strategy would have to do the following transactions:

• Buy a Put Option with a strike price of Rs 20 (at the cost of Rs 30)
• Buy a Call Option with a strike price of Rs 40 (at the cost of Rs 30)
• Sell a Put Option with a strike price of Rs 25 (at the cost of Rs 70)
• Sell a Call Option with a strike price of Rs 35 (at the cost of Rs 70)

All these options have the same underlying asset, a lot of Rs 100 shares, and the same expiration rate.

Now, at the end of these transactions, the overall profit is Rs 80 (70+70-30-30) as the premium received is Rs 140 and the premium paid is Rs 60.

Scenario 1: The stock price at the expiry of the contract is between Rs 35-25.

Let’s say at the end of the expiry, the price of the stock is Rs 32. Then,

• Buy Put Option will expire worthless as it gives you the right to sell at Rs 20 instead of Rs 32.
• Buy Call Option will expire worthless since it gives you the right to buy at Rs 40 instead of Rs 32.
• The Sell Put Option will expire worthless as it gives you the right to sell at Rs 25 instead of Rs 32.
• The Sell Call Option will expire worthless as it gives you the right to buy at Rs 35 instead of Rs 32.

Net Gain/Loss: Rs 80 (the initial difference of the premium)

Scenario 2: The stock price is below Rs 25 or higher than Rs 35.

Let’s say at the end of the expiry, the price of the stock is Rs 20 on expiry. Then,

• Buy Put Option will expire worthless as it gives you the right to sell at Rs 20 which is the same as the market price).
• Buy Call Option will expire worthless since it gives you the right to buy at Rs 40 instead of Rs 20.
• The Sell Put Option will not expire worthless as it gives you the right to sell at Rs 25 instead of Rs 20.
• The Sell Call Option will not expire worthless as it gives you the right to buy at Rs 35 instead of Rs 20.

Here, you will incur a loss of Rs 5 (Rs 20-25). Since the lot size is Rs 100, the total loss becomes Rs 500. However, as your initial gain was Rs 80, your total loss narrows to Rs 420.

Net Gain/Loss: Rs (420)

This is how the Iron Condor options strategy works for an options trader. If the stock price is within the specified limit, you realize profits based on the premium paid. If not, you incur a loss depending on the price difference between the stock and the contract.

Benefits of Iron Condor Strategy

The Iron Condor Options strategy includes numerous benefits when compared to other options strategies. They are:

• It allows options traders to manage a sideways market exhibiting low volatility and profit from market conditions.
• The investors know beforehand the maximum profit they can make and how much they stand to lose.
• The Iron Condor options strategy can be managed and adjusted in between to limit the loss if there is a possibility of it happening.

Iron Condor is an effective profit-making strategy if an investor believes that the market will enter a stage of low volatility. However, as the technique aims to see all four options expire worthlessly and profit from the net premium, the options strategy is one of the most complicated options strategies known to investors. It is always wise to consult your stock broker, such as IIFL, and discuss the strategy with experienced financial advisors. If you are a beginner and want to trade in Options, you can open a free trading account with IIFL and start trading in Derivatives such as Futures and Options.