Iron Condor: How This Options Strategy Works (With Examples)

Options trading strategies are crucial for any order placed in the options market. Trading without any specific strategy in place can expose you to the high risks associated with naked options trading. Fortunately, you can set up and implement different trading strategies based on your market sentiment and outlook. There are strategies for bullish, bearish, and even neutral market views. 

If you expect the price of an underlying asset to remain neutral, it means that you are not sure of the direction of potential price movements. You may expect the price to move significantly or minimally in either direction. In case you believe that the price of an asset may not move substantially in the coming weeks, it means you have a neutral non-volatile outlook. 

The iron condor options strategy is a suitable options trading technique for this kind of market outlook. Let us decode what the iron condor strategy is all about and how you can set it up for your next trade in a neutral non-volatile market. 

The Iron Condor: An Overview

The iron condor options strategy is a four-legged trading setup that involves a long and a short position in call options and puts options each. This essentially means that you buy two call options and sell two call options — leading to a setup with four different options contracts, each with a different strike price but the same expiration date. 

In an iron condor strategy, you have four different strike prices. You should use this strategy when you expect the price of the underlying asset to remain between the two middle strike prices. To better understand how this works, let us look at the four different positions that make up the iron condor options trading strategy in more detail. 

Setting up an Iron Condor

To construct the iron condor strategy, you must simultaneously initiative the following four trades in the market: 

• Trade 1: Purchase an OTM put option whose strike price is way below the underlying asset’s current market price. 
• Trade 2: Sell an OTM (or ATM) put option whose strike price is above the strike price of the other put option — and closer to (but still less than) the current market price of the underlying asset. 
• Trade 3: Sell an OTM (or ATM) call option whose strike price is slightly above the current market price of the underlying asset. 
• Trade 4: Purchase an OTM call option whose strike price is way above the underlying asset’s current market price. 

This essentially gives you four different strike prices for trades 1 to 4 in increasing order — where trades 1 and 2 have strike prices below and trades 3 and 4 have strike prices above the underlying asset’s current market price. 

Understanding the Trades in an Iron Condor Strategy

The two middle trades (i.e. trades 2 and 3) essentially make up a short strangle — where you short a put at a strike price below the asset’s current price and short a call at a strike price above the asset’s current price. The main drawback of a short strangle of this kind is that the maximum potential loss from the setup is unlimited. If the asset’s price rises, the loss continues to build up. Since the price of any asset can theoretically increase without any limit, so can the loss in this trade. 

The iron condor strategy introduces two new trades (i.e. trades 1 and 4) to protect you against this unlimited downside risk. Known as the wings of the iron condor options trading strategy, these two trades act as a long strangle — where you purchase a put option with a lower strike price and a call option with a higher strike price when compared with the underlying asset’s current price. This essentially makes the iron condor strategy a short strangle contained within a long strangle. 

Example of the Iron Condor Setup

Let us discuss a hypothetical example of an iron condor options trading strategy to give you more clarity on how to set up these trades and profit from limited price changes in the underlying asset. 

Say the stock of a particular company is currently trading at Rs. 1,000. You expect that this stock’s price will remain within the specific range of Rs. 900 to Rs. 1,100 over the next month. So, you decide to set up an iron condor strategy with the following four legs:

• Trade 1: Purchase a put option on the stock at a premium of Rs. 5 per share, with a strike price of Rs. 850 — which is well below the stock’s current market price. 
• Trade 2: Sell another put option on the stock at a premium of Rs. 15 per share, with a strike price of Rs. 900 — which is above the strike price of the other put option and closer to (but still less than) the stock’s current market price. 
• Trade 3: Sell a call option on the stock at a premium of Rs. 20 per share, with a strike price of Rs. 1,100 — which is slightly above the stock’s current market price. 
• Trade 4: Purchase another call option on the stock at a premium of Rs. 10 per share, with a strike price of Rs. 1,150 — which is well above the stock’s current market price. 

This means the four strike prices are: Rs. 850, Rs. 900, Rs. 1,100 and Rs. 1,150. You expect the stock’s price at expiry to remain within the two middle strike prices, i.e. between Rs. 900 and Rs. 1,100. 

Now, let us see what happens if the stock’s price at expiry remains within this range, falls below the lowest strike price or rises above the highest strike price. 

• Scenario 1: Stock Price is Between Rs. 900 and Rs. 1,100

If the price of the stock at expiry is within this range, all four options expire worthless. Your profits in this case will be the net premiums collected, which is Rs. 20 per share (i.e. Rs. 15 + Rs. 20 — Rs. 10 — Rs. 5) 

• Scenario 2: Stock Price Falls Below Rs. 850

Let’s say the stock price falls below Rs. 850, say to Rs. 800. In this case, here’s what happens to each trade in the iron condor options strategy: 

• Trade 1: The bought put option with a strike price of Rs. 850 begins to gain value and is in the money. So, your profit from this trade would be Rs. 850 - (Rs. 800 + Rs. 5) = Rs. 45. 
• Trade 2: The sold put option with a strike price of Rs. 900 is also in the money. The loss in this case will be Rs. 900 - (Rs. 800 + Rs. 15) = Rs. 85.
• Trade 3: The sold call option expires worthless and your profit from this trade would be the premium received, which is Rs. 20. 
• Trade 4: The bought call option also expires worthless and your loss from this trade will be the premium paid, which is Rs. 10. 

So, the net outcome from the iron condor strategy in this scenario will be a loss of Rs. 30 [Rs. (45 + 20) - (85 + 10)].

• Scenario 3: Stock Price Falls Above Rs. 1,150

Now, let’s say the stock price rises above Rs. 1,150, say to Rs. 1,250. In this case, here’s what happens to each trade in the iron condor options strategy: 

• Trade 1: The bought put option expires worthless. So, your loss from this trade would be the premium of Rs. 5 that you paid. 
• Trade 2: The sold put option with a strike price of Rs. 900 will also expire worthless. The profit in this case will be the premium received, which is Rs. 15.
• Trade 3: The sold call option with a strike price of Rs. 1,100 is in the money, so your loss in this case will be Rs. 1,250 - (Rs. 1,100 + Rs. 20) = Rs. 130. 
• Trade 4: The bought call option will also be in the money. Your profit in this case will be Rs. 1,250 - (Rs. 1,150 + Rs. 10) = Rs. 90.

So, the net outcome from the iron condor strategy in this scenario will be a loss of Rs. 30 [Rs. (15 + 90) - (5 + 130)].

Conclusion

This sums up our extensive guide on the iron condor strategy and how it works. Now that you know its advantages and limitations as well as the market scenarios in which it works best, you can easily decide to set up this four-legged strategy if you expect a low-volatile condition for the underlying asset you are trading in. 

To set up any options trading strategy and save them for appropriate market conditions in the future, all you need to do is check out the options strategy building feature on the Motilal Oswal Research 360 platform. Here, you can easily choose the underlying asset and the market outlook and select relevant strategies for your trades. The market sentiment options include bullish, bearish, neutral non-volatile and neutral volatile. For each outlook, the MO Research 360 platform gives you suitable strategies to capitalise on the movement (or lack thereof) that you expect. Sign up on this platform today to leverage these advanced features free of cost.