Monthly Income Strategy with Options

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In this post, we present one of the most popular options trading strategies for consistent monthly income that “lazy” traders deploy to earn between 20%-30% per annum with a reasonably good accuracy.  Anecdotal experience suggests that such trades yield about 2%-3% 70% of the expires and lose 1%-1.5%- 3 times out of 10 expires for simple trades. Still a good bet!

Presenting the Iron Condor

An iron condor is a trade of two “credit spreads”, meaning you earn upfront – There is a spread on a call option and one on the put option – sold on any underlying for the same month. Since it’s a spread, It is a non directional strategy. Due to this reason, the margin required for this strategy is a little higher but then so are the returns compared to a simple fixed income instrument.

Here is how Iron Condor is constructed:

Sell 1 OTM (Out of Money) Put and Buy 1 OTM Put (Lower Strike)

Sell 1 OTM Call and Buy 1 OTM Call (Higher Strike)

The strategy locks in its Profit Potential which is nothing but the net credit received. The Max Profit is achieved when the price of the underlying is in between strike prices of the Short Put and the Short Call, that is the strikes you wrote.

The Maximum Loss is capped between the  long strikes hence mathematically, at expiry, it will be equal to: Strike Price of Long Call – Strike Price of Short Call – Net credit received

You can see in the graph that profit and loss is limited in Iron Condor. But the risk in the Iron condor is more than the reward you get. However Iron Condors are profitable most of the times. The rest of the times the risk needs to be managed aggressively when the market moves against the extremes.

Illustration

Now what if you think in this month nifty will not close beyond 11000 and not fall below 10500, you can sell an iron condor for that month. You can sell a credit spread on 11000 call by selling 11000 call and buying either 11100 call or 11200 call according to your risk capacity. Similarly you can sell a 10500 put and buy 10400 or 10300 put as per your risk. Remember the more gap you give between the sold and the bought options – the more money you make but more risky your iron condor becomes. If you are willing to take less profits you can also trade iron condors with 90% winning probability – and that’s the best strategy for beginners.

Since the Condor has a limited loss potential, one tends to enter these 30-40 days in advance of an expiry and one may choose to leave the trades to expire. To limit losses, when adverse moves happen, one may want to also be actively adjusting the condor as else earnings potential may come down otherwise.

Adjusting an iron condor

The Iron Condor is ideally suited to a situation where directional breakouts are not likely or volatility is expected to decline sharply. However, at times, situations do arise which need active money management and can be assisted by either pure instinct or technicals or if you have experience, options Greeks.

  1. Rollover the condor one or two steps in the direction of the loss: Thus lets say the market hits the upper barrier of 11000, you should rapidly wind up the earlier trade and create another one, example at 11500 with both sides of the puts and calls being squared up and another one entered. The more you delay the more expensive it will become to square up the previous leg
  2. Close the losing leg in small lossand let the other leg expire worthless. Since the loss is limited, one may want to do this but the issue is what if nifty dives back in the opposite direction after you close the losing leg
  3. Take a small loss before it escalates and wait for the next month.

Ideally, and when you are not stopped out one  may choose to be out of the trade if the expiry is seven days away or the profit target of 3 percent is achieved. Even though you know your maximum risk but why wait for the full loss if you can stop it out earlier.

Things to Note

Remember that you should go as far deep OTM as possible if that makes sense to you. The further you go, the probability of wining be more though of course yields will be lower. It depends on how experienced you are.

Sometime volatility will drop after you have traded an iron condor – and you will be in good profit in few days. In that case don’t wait till expiry – just book your profits!

 

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