Manoj Kumar Jain

Short Iron Condor is an Options Strategy that can come to rescue of a lot of people. Many people want to apply the Strangle Options Strategy; but are held back by the fact that it leads to a lot of exposure in the market and in case of an unfavorable outcome, the downside is technically unlimited. For these people, there is another strategy which we are going to discuss today, the Iron Condor Strategy.

This strategy can also be considered as a modification or an extension of the regular Strangle Option Strategy. It is an option trading strategy; which utilizes one vertical spread with 2 put options and another parallel vertical spread with 2 call options. So basically, this strategy uses 4 options, all having different exercise price and expiring on the same date.

There are two ways to use this options strategy, one is Long Iron Condor; and the other is Short Iron Condor. We are going to talk about Short Iron Condor in this article.

Short Iron Condor

Short Iron Condor is for investors who believe that the market will remain within a specific range and there won’t be any extreme movement in the market.

To apply this strategy, following 4 steps are to be followed. We will also include an illustrative example to make it easier to understand.

1. Choose an upper limit and a lower limit between which you expect the market to move. This is your inner range.
   Example: We expect the NIFTY index to remain between 9500 and 10400 points. 10400 is our upper limit and 9500 is our lower limit.
2. Sell Call option for the upper limit and Put option for the lower limit.
   Example: Sell 1-month CE 10700 (INR 60 premium) and Sell 1-month PE 9500 (INR 80 premium). Total premium earned = INR 140.
3. Choose a new upper limit and a new lower limit beyond which you are not willing to take risk in the market. In other words, choose a range which will be your playing field i.e. if the market goes out of that range, then you don’t want to take any more risk in the market as it is too volatile for your risk appetite. This range would act as a kind of STOP-LOSS for your investment. This range is your outer range.
   Example: If the NIFTY index goes beyond 10700 points or below 9000 then it is too volatile for us and we would not like to invest anymore in the market. Our new lower range is 9000 points and our new upper range is 10700 points.
4. Buy Call option for the new upper range and buy Put option for the new lower range.
   Example: Buy 1-month CE 10700 (INR 20) and buy 1-month PE 9000 (INR 20). Total premium paid = INR 40.

Let’s continue with our example to understand the different scenarios that can occur at the time of expiry of the options.

Scenario 1: Our expectation was correct, and the market is somewhere between 9500 points and 10400 points.
In this scenario, we have earned a net premium of INR 100 (140-40). (Remember this is earnings per unit of the index, the more options you sell, the more you will earn; it is multiplicative).

Scenario 2: Our expectation was incorrect, and the market has breached our expected range i.e. the market has either gone below 9500 or gone above 10400.
In this scenario, we would begin to incur loss, but we have an additional cushion of INR 100 since it was the net premium that we had already received at the time of sale and purchase of the options. So, we will stay in profits if the market remains between 9400 (9500 – 100 cushion) and 10500 (10400 + 100 cushion). This is our breakeven range (9400-10500).

However, if the market goes beyond 10500 or goes below 9400, then we will begin to incur a net loss.

Keep in mind that we have applied the options strategy called Iron Condor Strategy; and hence we have covered ourselves for a situation where the market goes above 10700 or goes below 9000. Therefore, our maximum loss is limited to those two points. In other words; if the market goes above 10700, our loss would be capped at 200 (10700-10500) since our breakeven upper limit is 10500. Similarly, if the market goes below 9000, our loss would be capped at 400 (9400-9000) since our breakeven lower limit is 9400 points.

Conclusion

In Short Iron Condor Options Strategy, an investor can earn premium by a combination of sale and purchase of call and put options. If the market remains within the expected range, then the investor will get to keep his full premium. If the market goes out of the expected range, then the investor will start losing his premium; he may also start losing money but the maximum loss will be limited to his outer range.

Therefore, it is extremely important for an investor to choose both his inner and outer range carefully as this will determine whether he is earning the full premium, partial premium, or whether he is losing money in the market.

I hope this was a good and useful read for you! You can also watch MKJ sir’s video on the same. Link.

To read other articles, check out our full blog here.