Iron Condor Options Strategy: A Comprehensive Guide
Cryptocurrency options trading is an effective way to hedge your portfolio against adverse market movements. Moreover, options provide a variety of earning opportunities, even in a sideways market.
One of the best option trading strategies on the sideways trend is a rather complex but effective strategy called “iron condor.” In this piece, we will present you with a comprehensive guide to the iron condor strategy and give examples of how to use it to your advantage.
Introduction
What Is an Iron Condor?
Iron Condor is a sophisticated, complex options trading strategy that allows you to earn income with limited risk. It is used when the trader expects the price of the underlying asset to remain in a certain range over a certain period of time.
There is no straightforward iron condor definition, but rather a description of the strategy. Basically, it is a combination of selling two vertical spreads, a put spread and a call spread, with the same expiration date and four different strikes. A short iron condor is more common than a long one, that is why we will mostly talk about the short strategy.
Let’s break down the strategy into details. The trader sells a put option and a call option on the asset with lower and higher strike prices, respectively. At the same time, they buy a put option and a call option on the same asset with even lower and higher strike prices, respectively. All options must be out of the money (OTM). As a result of starting the strategy, the trader’s premium for selling the options typically exceeds the cost of buying the options.
If correctly used, the strategy will be profitable as long as the price of the asset remains in a predetermined range between the strike prices of the sold options, with the consequence that all options remain not exercised. At the same time, thanks to the purchased options, the trader limits their losses in case the price goes beyond this range.
How to Build a Short Iron Condor
Like any other option strategy, short iron condor involves such basic steps as selecting an asset, determining strike prices, choosing the type of options (call/put), determining the expiration date of the options, and calculating the position size.
The specific strategy parameters will depend on the individual trader's goals and preferences, as well as market conditions and volatility levels.
The steps to build a short iron condor are described below.
Steps to Build an Iron Condor:
- Determine the underlying asset you want to trade;
- Determine the time horizon for your strategy and select an expiration date for your options;
- Determine the price range for the asset in which it is most likely to trade in the near future, which will allow you to choose the correct strike prices for your options;
- Make sure you have enough money in your account to execute the strategy and set appropriate buy and sell options orders;
- Sell the call spread by selling a call option with an exercise price above the current price and buying a call option with an even higher exercise price;
- Sell a put spread by selling a put option with an exercise price below the current price and buying a put option with an even lower exercise price;
- Keep an eye on asset prices and market volatility so that you can react quickly to changes and make adjustments to your strategy if necessary.
How to Set Up a Short Iron Condor
In general, traders can sell options at any distance from the current cryptocurrency price and with any size of spread between short and long options.
The closer the strike price is to the price of the underlying asset, the more credit will be received. On the other hand, the more likely the option is to be in the money.
At the same time, the wider the spread between short and long options, the greater the premium received, but also the higher the maximum risk will be.
Long Iron Condor vs. Short Iron Condor
A short iron condor and a long (reverse) iron condor differ from each other primarily by the order of options. In the reverse iron condor, the trader sells a call option and a put option with strike prices farther away from the current price of the asset and also than the call and put options strikes he/she is buying. In other words, the long iron condor is an inverted version of the short iron condor, where the buy and sell positions are reversed.
The long iron condor is suitable for traders who expect the cryptocurrency price to move significantly in either direction. In order for the strategy to realize the maximum profit potential, the underlying asset should move beyond the lowest or the highest strike price.
In this case, the maximum potential loss is equal to the net debit paid when the position is opened. The long iron condor is a net debit transaction since the premium paid for the purchased options exceeds the premium received for the sold options.
Short Iron Condor Spread
Goal and Explanation of Short iron condor Spread
In the short iron condor spread strategy, the trader sells options with an exercise price closer to the current price of the underlying asset. As a consequence, the received premium is higher than what he/she pays for buying options with farther-out strikes. In this case, by buying the latter, the trader limits the potential losses and reduces the cost of entering the position.
In case the price of the asset remains within a certain range, the options of both spreads will not be exercised. Thus, the trader can earn on the difference between the premiums paid and received if the price of the asset remains within the specified range that was selected when setting up the strategy.
Maximum Profit and Risks
The short iron condor strategy has limited maximum losses and potential profits.
The maximum profit is limited to the net credit received in advance. Net credit = (sold put options - bought put options) + (sold call options – bought call options) – exchange commissions.
Maximum potential loss = widest spread – net credit received + exchange commissions.
Profit/Loss Diagram and Table for Short Iron Condor Spread
The iron condor got its name because of the payout chart, which resembles the body and wings of a large bird.
On the chart, the profit and loss zones are clearly defined by the iron condor. If the price closes between two short strings at expiration, the entire credit is realized as a profit. And if the underlying price is above or below one of the long strike prices at expiration, the maximum loss will be realized.
At any time before expiration, the trader can choose to close the position for profit by closing the entire position, closing a single spread or buying out only short options. If options are bought for less money than they were sold, the strategy is considered profitable.
Another graphical representation of the potential profit or losses has a form of a table.
A profit/loss shows the expiry prices, the corresponding payoff for each option, and the overall profit/loss in the last column.
Appropriate Market Forecast
The short iron condor spread is appropriate in a market that is expected to be range-bound with low volatility. The strategy is designed to profit from a stock or index price that stays within a certain range.
Iron Condor Payoffs and Examples
The iron condor strategy has specific payoffs and examples that traders can use to understand how the strategy works.
Iron Condor Example on Cryptocurrency Trading
Let's look at an example of the iron condor strategy on cryptocurrency. For example, the current Bitcoin price is $20,000. The trader assumes that over the next month it will fluctuate between $19,000 and $21,000.
To implement the strategy, the trader will use short call and put options, each of which with a strike price at a distance from the current price equal to the width of the spread. At the same time, the width of the spread was set at 1 thousand dollars.
Therefore, trader:
- Sells 100 call options with an exercise price of $21,000 at a total premium of $30,000 ($300 per option);
- Sells 100 put options with an exercise price of $19,000 for a premium of $15,000 ($150 per option);
- Buys 100 call options with an exercise price of $22,000 for a premium of $20,000 ($200 per option);
- Buys 100 put options with an exercise price of $18,000 for a premium of $10,000 ($100 per option).
The amount of premiums received for the sold options equals $45,000 ($30,000 for selling call options + $15,000 for selling put options).
The sum of costs for buying options equals $30,000 ($20,000 for buying a BTC call option and $10,000 for buying a put option).
Thus, the net credit we received is $15,000 ($45,000 – $30,000).
Iron Condor Payoff Diagram
With the example described above, the graph of gains/losses of the iron condor will look as follows:
Iron Condor Max Profit and Loss
The table of maximal loss and profit will look as follows:
According to the table, the maximum profit is $15,000 (equal to the net credit). Therefore, if the price of BTC stays between the strike prices of our put options, we will get the maximum profit of the net credit of $15,000.
The maximum potential loss in this case will be $85,000 = $1000 (spread width) x 100 (number of options) – $15,000 (net credit).
How to Calculate Breakeven Points
The iron condor strategy has two breakeven points, which are calculated by the formulas:
Upper break-even point: short call strike + net premium received.
Lower break-even point: short put strike – net premium received;
In our example, the net premium received per option would be ($45,000 – $30,000) / 100 options = $150/option.
Therefore, the upper breakeven point is: $21,000 + $150 = $21,150;
And the lower break-even point equals: $19,000 – $150 = $18,850.
If the BTC price stays in this price range when the options date expires, then the entire iron condor strategy will be in the profit zone. If the price of BTC goes beyond these points, the strategy will incur losses.
Exiting an Iron Condor
At any time before the expiration date of the options, the trader may close the position. Reasons for exiting a position can vary, depending on the trader's goals and market conditions. For example, the trader may decide to exit the position before the expiry date of the options, as the price of the underlying asset is approaching one of the break-even points. In this way, the trader will avoid potential losses.
Exiting a Short Iron Condor
To exit a short iron condor position, the trader must purchase call and put options with the same strike prices and expiration dates they were sold with earlier. In this case, the premium paid may be higher or lower than the premium he/she received when selling options. After closing the sold options, the trader needs to sell the bought put and call options in order to fully exit the position.
It is important to take commissions and tax costs into account when calculating the profitability of the strategy.
Exiting a Long Iron Condor
In the case of exiting a position using the long iron condor strategy, the same procedure is used as with exiting the short iron condor.
When to Exit an Iron Condor
The decision to exit an iron condor position should be based on your trading strategy, the current price of the underlying asset, the time until expiration of options, changes in market volatility and other factors. In general, exiting a position before options expire should be considered when approaching one of the break-even points, when market volatility changes, or when the desired profit is achieved.
Adjusting and Rolling an Iron Condor
Adjusting an iron condor involves making changes to the strike prices of the call and put spreads to better align with the market forecast. Rolling an iron condor involves closing out the existing position and opening a new position with different expiration dates and strike prices.
How to Adjust an Iron Condor
To adjust an iron condor, traders can increase or decrease the strike prices of the call and put spreads to better align with the market forecast.
Rolling an Iron Condor
To roll an iron condor, traders can close out the existing position and open a new position with different expiration dates and strike prices.
Impact of Time Decay and Implied Volatility on an Iron Condor
Time decay and implied volatility can seriously affect the iron condor strategy. When calculating an iron condor strategy, you must consider both of these factors and their impact on potential iron condor risk and return.
Time decay means that the value of options falls over time. Thus, if the price of the underlying asset does not change, the iron condor strategy may become more profitable over time. The decline in value may allow the investor to repurchase option contracts for less than they originally sold them for.
Implied volatility is an indicator that reflects the expected volatility of the underlying asset in the future. Therefore, high volatility can increase the risk of loss if it causes the price of the underlying asset to move outside the given price range.
Conclusion
As we have explained the iron condor options strategy, now you should have a basic understanding of how to trade options using the iron condor.
The iron condor options trading strategy can be used to generate income with limited risk. However, it is quite complex and requires traders to have experience and understanding of current market conditions, as well as a willingness to adjust or roll back the strategy as needed.
As we have covered iron condor quite extensively, we hope the given information will help you to successfully implement this strategy. If implemented correctly, the iron condor can be a highly effective way to profit from the sideways movement of the cryptocurrency market.
FAQs
What Is Iron Condor in Options Trading?
The iron condor is an advanced options trading technique that involves simultaneously entering four different option positions. These positions include two short options (one put and one call) and two long options (also one put and one call). The goal of this strategy is to profit from the underlying asset's price movement within a specific range over a certain period. The iron condor is best suited for neutral markets, where the trader expects minimal price fluctuations.
Iron Condor vs. Iron Butterfly: What Are the Differences?
Iron condors and iron butterflies are both neutral options trading strategies, but there are some differences between them. With iron butterflies, traders sell a call spread and a put spread at the same strike price. By contrast, iron condors involve selling a call spread and a put spread at different strike prices.
How Successful Is an Iron Condor?
The success of an iron condor depends on the market conditions and the trader's ability to adjust the strategy as needed. Traders should have a solid understanding of the strategy and the appropriate market forecast before implementing the iron condor.
When Would You Use an Iron Condor?
The iron condor is appropriate in a market that is expected to be range-bound with low volatility. The strategy is designed to profit from a stock or index price that stays within a certain range.
Are Iron Condors Profitable?
Iron condors can be profitable if the underlying asset price stays within the range of the strike prices of the call and put spreads. Traders should be aware of the risks involved and adjust or roll the strategy as needed to maximize profitability.
*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.
