Iron Condor concept explained – Easy Read

Iron Condor

Iron Condor concept explained using house prices

Your opinion on the house prices in an area is that it will remain stable for the next 30 days.

You want to make money on this opinion while keeping your risk low.

We can use an iron condor to take advantage of the expected stability in the property prices.

Technical explanation, we will simplify it right after this:

An iron condor is an options strategy created with four options consisting of two puts (one long and one short) andtwo calls (one long and one short), and four strike prices, all with the same expiration date. The goal is to profitfrom low volatility in the underlying asset. In other words, the iron condor earns the maximum profit when the underlying asset closes between the middle strike prices at expiration.

Source: Investopedia

Simplified explanation of Iron Condor

Your opinion is house prices will remain stable for the next 30 days.

We want to make money on this stablility of house prices, while not taking too much risk.

Let us make some assumptions here:

  • Current price of the house: 1,000
  • For a period of 30 days, we sell insurance to a house owner. Insured amount: 800 Insurance premium we get: 10
  • For a period of 30 days, we buy insurance from another person on the house. Insured amount: 700 Insurance premium we pay: 5
  • We can pay rent to the house owner with a condition he sell us the house if price(printed in newspaper) crosses a particular price in 30 days. Rent amount paid to owner: 10, agreed that if house price crosses 1400 the owner sells you the house at 1400.
  • We can ask for sub-rent the house with an agreement to sell the house to the renter if prices crosses: 1300 in the next 30 days.
  • Rent amount paid to us: 15

We have now set up a Iron Condor.

Let us see the total amount we have paid or recieved:

Insurance premium paid: -5

Insurance premium received: +10

Rent we paid: -10

Rent we receive: +15

If we total the above we have a received a total of: -5 +10 -10 +15 = +10

Iron Condor is a credit spread.

Let us see what happens at the end of 30 days:

Case 1:

House(share) price remains at 1000

We keep the insurance premium from house owner: +10

The person who sold us insurance keeps the premium: -5

House owner keeps the rent: -10

We keep the rent from sub-let: +15

Profit/Loss = -5 +10 -10 +15 = +10

This will remain true for all cases where the price is between 800 and 1100.

Case 2: Price goes below 800, let us assume 700.

Price is below 800, we have to pay the house owner for the Insured amount: 700 – 800 = -100

We keep the insurance premium: +10

Price is at 700, the person who sold us keeps the insurance premium: -5

House owner keeps the rent: -10

We keep the rent from sub-let: +15

Profit/Loss = -100 + 10 – 5 – 10 + 15 = -90

Even if the prices goes to 0, our maximum loss is -90.

Case 3: Price is 1500

We keep the insurance premium from house owner: +10

The person who sold us insurance keeps the premium: -5

House owner sells you the house for 1400, and you sell it to someone sub-let person for 1300 = 1300-1400 = -100

House owner keeps the rent = -10

You keep the rent from sub-let = +15

Profit/Loss = 10 – 5 – 100 – 10 + 15 = -90

As you can see our maximum loss is -90

Our maximum profit is +10 if price stays between 800 and 1300.

The above scenario is only for demonstration.

If you think that the price of a share(house in the example) will stay stable over the course of a month iron condor can help you make some money.

We trade at Zerodha. India’s No.1 broker. Open Account, click here.

All information here is for educational/research purposes only, we do not recommend trading.

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