What is an Iron Condor trade in options?

Short Answer

An Iron Condor is a 4 legged hedged option strategy that includes selling 1 slightly OTM (Out of The Money) Call as well as 1 Put option and, buying 1 Slightly Far OTM Put & 1 Call options in order to cover the risk of the Naked short positions. This strategy is implemented when the overall outlook of the underlying asset is neutral or rangebound and no major moves in any direction are anticipated. The maximum profit and loss are capped in this strategy, and by hedging, margin benefits can be enjoyed.

Detailed Answer

Iron Condor

An Iron Condor is a Multi-leg Option Strategy that consists of 4 legs used mainly to mitigate the risk of a Short Strangle strategy. It is also used to get the margin benefit by hedging a naked position from NSE. This strategy is implemented when the outlook of the price is to remain sideways or in a range and is not expected to make any major movements in either direction.

An Iron condor can also be termed as a modified “Short Strangle” which enables the trader to Cap the losses on both the ends of a Short Strangle that could lead to unlimited losses. It is a Net Credit Strategy in which the Credit from selling of The Call & Put option is used to buy an OTM (Out of The Money) Call & Put options as a hedge to the actual strategy which is a Short Strangle. The maximum profit in this strategy is the total Premium collected and the maximum loss is also capped at a certain extent.

To implement an Iron Condor, the following options have to be executed-

  • Sell a slightly OTM (Out of The Money) Put Option
  • Sell a slightly OTM (Out of The Money) Call Option.
  • Buy a farther OTM Put option.
  • Buy a farther OTM call option.

Some things to keep in mind while implementing this strategy-

  • The overall outlook of the underlying security has to be neutral to sideways.
  • The spread (Difference of the Strike Prices) between the PUT & CALL options bought should be similar to the Call & Put Options Sold.
  • All the options executed should be of the same expiry and all the legs should be of the same underlying asset.
  • The total number of Options Sold should be equal to the number of options bought.

The following Price payout graph will of the above implemented Iron Condor strategy on Nifty-

iron condor...png

In the graph above, it is clearly visible that the maximum loss is limited to a fixed extent and the profit range has narrowed but is far better than that of the unlimited loss in a Short Strangle.

The Profit & Loss Graph of a Short Strangle looks like this-

short strangle...png

Here the profit range is slightly broader than that of an Iron Condor but the maximum loss potential is unlimited if any Black Swan event occurs.

Hence by now, it can be clearly understood that the Iron Condor Strategy is a better option than that of a Short strangle as there are multiple benefits of the Iron Condor such as the Margin Benefit from NSE for hedged positions as well as limited losses.

Tagged With: iron condoroption trading
Categories: Option Trading
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