Range bound markets are hard to trade mostly because of lack of movement. For option sellers however, it is not a bad market to trade. No movements can create opportunity for option sellers to make a money via selling options. It is when the market becomes choppy in a very large range then we have problems. Something quite evident in recent weeks.
Conditions that make the winning trade lose in the sudden swings. This puts a pressure on the trader as the current loss in the position makes them exit. However, the range being active, it would come back to the centre, frustrating the trader.
The immediate remedy is to create a trade that is protected. This helps in keeping up with the trade without losing patience. The logic is that an option seller is always concerned with unknown and potentially large loss if the trade were to go wrong.
However, the protected option seller will always sell an option and simultaneously buy a cheaper option of the same option type (call/put) and same expiry. Now, we know the maximum money that we can lose.
The loss is contained to the difference between the strikes minus the premium credit received. Now one may even wait till the day both options expire and still not lose more than the maximum loss defined by the trade.
This same characteristics of protected option selling is monetized by the Iron Condor Strategy. Let us define the trade first then see with an example what it looks like.
Iron Condor or Short Iron Condor (since we will be receiving the premium) is a strategy where we sell a higher strike Call and Lower strike Put option compared to the current market price. Along with this for protection further higher strike Call and further lower strike Put options are bought.
Let us understand this with an example.
Just for the example:
We have sold: Higher Call: 24500 & Lower Put: 25000
And bought: Even Higher Call: 25200 & Even Lower Put:24300
As we can see the Maximum Profit is 9150 for the strategy with 1 lot of each option. This is basically the Net Premium inflow after all Buy and Sell (122). Maximum Loss is 200 points difference minus the inflow of 122 which is 78 or for 1 lot, 5850.
Not the best reward to risk ratio but not bad for an Option Seller. Also, remember that if the buy strike levels that is 24300 or 25200 were to be broken and if Nifty is sensed to be out of the range before the expiry date, then we can always exit then. The best part is that the loss in that case before expiry would be much less than 5850.
Lastly the strike selection could be a problem of plenty. In this case, we can choose both Call and Put strikes to sell that corresponds to higher Open Interest (OI). In our example, we have green bars indicating Call OI, red bars indicating Put OI. Those are the ones I have chosen.
Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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