(Note: These are technical terms. You need to know concepts like call, put, expiration date, and all of that in order to understand these strategies, because of its technical characteristics. Kindly follow our other articles as well to learn about the same in a simple language.)
Simple Definition “An iron condor consists of two long puts, two long calls, four strike prices, and the same expiry date. Iron condors are best used when an asset closes above or below one of its two middle strike prices on expiration day”.
A low level of market volatility will be exploited in order to make money.
If a stock stays in the middle of a range throughout the expiration of the options, an iron condor is a winning strategy.
There is a positive correlation between the price of the security and the implied volatility.
How does it work?
Iron condors have a reputation for being “difficult to understand”, and it is true that mastering this strategy does take some time, but once mastered, it is an excellent method for generating stable returns. Iron condors are used almost exclusively by certain really successful traders. Now, let’s talk about something called an iron condor. Consider it from two perspectives.
- Strangles of various lengths is used in the initial set of strikes, with one short and one long.
- One further way to think about it is as two different credit spreads, namely a call credit spread that is higher than the market and a put credit spread that is lower than the market.
- The moniker “iron condor” comes from these two wing-like projections on the back of the bird. These can be set up at points that are relatively removed from where the market is at the moment, but according to the formal definition, they must involve strike prices that are successive for the same expiration period.
- A credit spread is, in essence, a technique that involves selling options. Selling options enables investors to profit from the time premium as well as the high volatility that are built into options contracts.
- You can establish a credit spread by buying an OTM (Out Of the Money) option and selling an OTM option that is closer to the money.
- This results in the credit being created, and the hope is that both of the options will become useless before they expire, allowing you to maintain the credit.
- You get to keep the whole credit as long as the stock does not go above the specified price of the nearer option. This condition must be met for the option to be considered profitable.
- Example
(Important: The Example is merely intended to serve as a graphical representation. you can see how the strategy graph looks like if you look at it Otherwise, it is extremely difficult to understand this method through theory and description in the real life situations. We ask that you study the terminology and practice it on paper in order to better understand what we’re saying.) (All Table Sources: Open source/Internet)
Difference between the Long Iron Condor and the Short Iron Condor
- These both are two polar opposites in the practice. To execute a long iron condor strategy, one must first buy the two options with an inner strike and then sell the two options with an outer strike.
- The short iron condor, on the other hand, is the complete opposite of this practice. This technique intends to profit from either an increase in the implied volatility of the underlying stock or a significant price fluctuation in the stock itself. Short iron condors are built similarly to long iron condors, with the main variation being the length of the inner strikes against the length of the outer strikes.
- By paying a debit, you open this trade with a fixed risk. Due to the long iron condor’s use of two debit spreads rather than two credit gaps, the strategy is only profitable if the price and/or implied volatility significantly rise before expiration.
- Time expiry affects both long option holdings in this method, working against the investor. Thus, long iron condors aren’t as commonly utilized.
Conclusion
A small change in the price of the underlying asset can be used to benefit tremendously by an option trader using the iron condor technique. Many market participants feel that in order to turn a profit, there must first be a big shift in either direction before the market can be considered profitable. Non-directional asset prices can be a great source of profits for investors as you’ve learnt through this method. Do not let the difficult structure of this strategy dissuade you from learning more about this strong trading method. Although the structure of this strategy may appear to be complex at first, and that is the reason it is employed by experienced traders, you should not let the structure prevent you from learning more about this strategy.
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