Short Iron Condor Strategy: Key features and set-up

What is Short Iron Condor Strategy?

In the realm of options trading, the Short Iron Condor strategy stands out as a sophisticated way to profit from a stable market. The iron condor involves selling both a call and a put option while buying additional call and put options further out to guard against unexpected movements.

An iron condor is like betting your favorite lazy cat will continue lounging all day. You sell a call option above and a put option below the current stock price, and then you buy another call and put further out to protect yourself in case the stock suddenly jumps or dives. This strategy profits from minimal movement, time decay, and dropping volatility.

When to use a Iron Condor Strategy?

Iron condors is an option strategy which is perfect for traders who believe the market is about to be as thrilling as a Sunday afternoon nap—you don’t expect much movement. This strategy works best when you’re confident the stock price will stay within a certain range until expiration.

The idea is to collect a premium upfront by creating a spread and then sit back, hoping the stock doesn’t make any unexpected moves outside your chosen range. By combining a bull put spread and a bear call spread, you can set up an iron condor to profit from low volatility.

How to set up a Short Iron Condor?

Sell a Bear Call Spread:
- Sell a call option above the current stock price.
- Buy a higher call option to cap potential losses.
Sell a Bull Put Spread:
- Sell a put option below the current stock price.
- Buy a lower put option to cap potential losses.

Example:

Stock at ₹100.
Sell ₹105 call.
Buy ₹110 call.
Sell ₹95 put.
Buy ₹90 put.
If you receive ₹2 credit, max profit is ₹200, max loss is ₹300, break-even points are ₹92 and ₹108.

So basically an iron condor strategy involves selling a narrow range of options (short strangle) to profit from limited stock movement, while buying a wider range of options (long strangle) to limit potential losses if the stock moves too much. It’s essentially a way to cap both profit and risk.

Payoff Diagram of a Short Iron Condor

Imagine a bird with outstretched wings. The body represents the range where you profit, and the wings show where you start losing money. This is why the short iron condor strategy is sometimes referred to as a “bird” spread.

Iron Condor Example:

Let us look at an Iron Condor example:

Stock Price: Trading at ₹5,000.
Initial Setup:
- Sell a ₹4,800 Put Option for ₹100.
- Buy a ₹4,600 Put Option for ₹50.
- Sell a ₹5,200 Call Option for ₹100.
- Buy a ₹5,400 Call Option for ₹50.
- Total Credit Received: ₹100 (Put) + ₹100 (Call) – ₹50 (Put) – ₹50 (Call) = ₹100.

Calculations:

Maximum Profit: Total credit received = ₹100.
Maximum Loss: Difference between strike prices – Total credit received = (₹200 – ₹100) = ₹100.
Break-even Points:
- Lower Break-even = Lower short put strike price – Total credit = ₹4,800 – ₹100 = ₹4,700.
- Upper Break-even = Upper short call strike price + Total credit = ₹5,200 + ₹100 = ₹5,300.

Summary

Total Credit Received: ₹100.
Max Profit: ₹100.
Max Loss: ₹100.
Break-even Points: ₹4,700 and ₹5,300.

Impact of Time Decay on Short Iron Condor

Time decay is your friend here. Every day, the option values drop, helping you profit as long as the stock price doesn’t move too much.

Impact of Implied Volatility on Short Iron Condor

Iron condors benefit from decreasing volatility. Lower volatility means lower option prices, making it cheaper to buy back the options and close the trade.

Adjusting an Iron Condor

If the stock starts moving too much, you can adjust the spreads to reduce risk.

Here’s an example of an Iron condor Adjustment:

Stock drops: Roll the call spread closer to the stock price to collect more credit.
Stock rises: Roll the put spread closer to the stock price to collect more credit.

Hedging an Iron Condor

If the stock moves a lot, buy a long option to cap your risk.

Example:

Stock rising: Buy a ₹5400 call.
Stock falling: Buy an ₹4600 put.

This limits your max loss but reduces your maximum profit.

Summary

An iron condor is like betting your lazy cat will stay on the couch. You get paid if the cat doesn’t move much, but if it suddenly springs into action, you might need a backup plan. Use it when you think the market will be calm, but always have an exit strategy ready!