Options Trading: How traders with limited capital can use the Iron Condor strategy

Similarly, when a company’s quarterly performance is below the Street’s expectations, its share price falls. These are very logical, sound, and practical situations. The catch is: what happens when the markets pre-empt the quarterly financial performance of a company and as a result, its share price is range bound? This may seem like a difficult situation for novice traders, but not for savvy traders. Savvy traders follow an interesting strategy that works when the share price moves in a narrow range after its results. It is called Iron Condor.

Here, one sells a near-money call option and buys an out-of-the-money call option of the same expiry. At the same time, one sells a near-money put option and buys an out-of-the-money put option of the same expiry. All four transactions need to be done simultaneously.

Let us understand this with an example:

STOCK CMP = Rs 980
Sell put with an exercise price of Rs 940 at a premium of Rs 1.35
Buy put with an exercise price of Rs 920 at a premium of Rs 0.50
Sell call with an exercise price of Rs 1020 at a premium of Rs 1.80
Buy call with an exercise price of Rs 1040 at a premium of Rs 0.95

Here if the price of a stock remains unchanged or remains in a narrow range (between Rs 940 and Rs 1020) at the time of expiry, then a trader makes a maximum profit of Rs 1,062. But if the stock goes below Rs 920 or above Rs 1,040, then the trader sees a maximum loss of Rs 11,438.

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This strategy should ideally be initiated on stocks where implied volatility is on the higher side — typically above 90. For trading large quantities, one should also check if stock options are relatively liquid and be careful while executing the trade.Iron Condor helps in benefitting from such heightened volatility and subsequent cool-off. In such a situation, the premium payable on an options contract goes down after an event (quarterly result in this case). Since this is a net credit strategy, a fall in premium is beneficial for a trader.

Traders should not wait till expiry. Post the results (or an event under consideration) it makes sense to exit a trade, as price adjustments can be fast.

Now, let us understand the advantages of this strategy. The biggest advantage of this strategy is well-defined profit and loss situations. A trader takes cover on both sides by buying out-of-the-money options. This ensures that in case his view goes wrong, then the potential loss is contained.

Given the limit on the maximum loss on both sides, the margin requirement is relatively less compared to strategies wherein a trader is long or short net credit strategies. This strategy involves selling options, and it is a net credit strategy. However, since this strategy requires relatively less margin, even traders with limited capital can consider this.

(The author is the founder & CEO of SAS Online – a deep discount broker)

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