Credit spreads are an efficient way of trading Options with less capital and the potential for earning high returns.

Iron Condor (IC) is one of the strategies I have been experimenting with recently. To understand an IC, it is essential to understand Bear Call (BC) and Bull Put (BP) spreads.

Bear Call

If you believe the value of an underlying asset is expected to go down, you can deploy a BC spread and profit from this strategy.

In this strategy,

Sell and Buy a Call on the same expiration date on the same stock
Sell and Buy Calls both should be OTM
Buy Call is placed at a higher strike price than the Sell Call

This is a shorting technique where you are willing to sell a call at a lower price than you are willing to buy a call. So, you profit out of the premium you receive in this transaction. If the stock price stays the same or drops, both the OTM call options expire worthless, and you get to keep the premium.

Let us assume the last closing price of NVDA is $129 and you believe the stock value will go down before August 02, 2024 (I am writing this on July 13, 2024).

Buy a Call at 135$ with a premium of 3.95
Sell a Call at 131$ with a premium of 5.35

The net premium received of 5.35-3.95 = 1.40. The total premium collected for 1 contract(100 stocks) will be $ 140$.

If the stock stays at the last traded price of $129 or goes below, you get to keep the premium.

However, if the stock starts moving upward, then the following scenarios could happen,

Expiration Scenarios:

Stock Price at $129 (Below Both Strikes):

$135 Call: Out of the money (OTM), expires worthless.
$131 Call: Out of the money (OTM), expires worthless.
Profit: Net Credit = $1.40

Stock Price at $132 (Between Strikes):

$135 Call: Out of the money (OTM), expires worthless.
$131 Call: In the money (ITM), expires at $1.00 (since 132 - 131 = 1).
Loss on the $131 Call: $1.00
Total Profit: Net Credit - Loss on $131 Call = $1.40 - $1.00 = $0.40

Your loss will be limited if you place the spread not too far.

Stock Price at $136 (Both Strikes ITM ):

$135 Call: In the money (ITM), expires at $1.00 (since 136 - 135 = 1).
$131 Call: In the money (ITM), expires at $5.00 (since 136 - 131 = 5).
Loss on the $131 Call: $5.00
Gain on the $135 Call: $1.00
Net Loss: Loss on $131 Call - Gain on $135 Call = $5.00 - $1.00 = $4.00
Total Loss: Net Credit - Net Loss = $1.40 - $4.00 = -$2.60 (Max Loss)

Between Strikes is a trailing value from anywhere 40$ to 260$ as both strikes are in the ITM.

Fun Fact: As of my writing on Jul-13 2024, it is not wise to short NVDA 😂

Bull Put

If you believe an underlying asset is expected to go up, you can place a BP spread, a long strategy.

In this strategy,

- Sell and Buy a Put on the same stock at the same expiration date

- Both the Put options are placed in OTM

- Sell Put strike price should be higher than the Buy Put

Let us assume you expect NVDA to go up before Aug 02 in value from the last price of 129$

Sell a Put at 128$ with a premium 5.15$
Buy a Put at 125$ with a premium 4.00$
Net Premium = 5.15-4.00 = 1.15$

If the stock prices expire OTM on the expiration date, then both the Put and the Call expire worthless, and you get to keep the premium collected.

You may incur a loss if the trade starts playing against you by the stock price descending from the current price. The loss would be bounded as you would buy the stock at 128$, and the worst case that could happen is both strikes going ITM, and you would sell the stock at 125$, resulting in a max potential net loss of -1.85.

Expiration Scenarios

Stock Price at Expiration: Above 128$

The 128$ put option expires worthless.
The 125$ put option also expires worthless.
Net Premium Received: 5.15$ - 4.00$ = 1.15$
Profit: 1.15$ (the maximum profit, as both options expire worthless)

Stock Price at Expiration: Between 125$ and 128$ (e.g., 127$)

The 128$ put option is in the money and will be exercised. You have to buy the stock at 128$.
The 125$ put option expires worthless.
Loss on the 128$ put: 128$ - 127$ = 1$
Net Premium Received: 1.15$
Net Loss: 1$ - 1.15$ = -0.15$
Profit/Loss: -0.15$ (depends on the exact stock price between the strikes)

Stock Price at Expiration: Below 125$

The 128$ put option is in the money and will be exercised. You must buy the stock at 128$.
The 125$ put option is also in the money. You will sell the stock at 125$.
Loss: 128$ - 125$ = 3$
Net Premium Received: 1.15$
Net Loss: 3$ - 1.15$ = 1.85$
Profit/Loss: -1.85$ (the maximum loss, as both options are exercised)

Iron Condor = Bear Call + Bull Put

This is one of my favorite strategies. If you are not sure which side the stock price will move on, then no worries; you can take both sides of the stock movement and benefit from it.

Applying the IC strategy means choosing a range for the stock's upper bound and lower bound on the day of expiration by setting a BC expecting a descent and BP aiming for an ascent on the same expiration date.

From the above example, if you think the stock price of NVDA would be between $125 and $133$, you can combine BC and BP and place a trade as below.

If the stocks are between the range you spread the Put and Call, you can collect a premium upfront for $255. In the worst case, you would lose $144. Overall, trading an IC seems fairly safe with a decent risk/reward trade-off.

Disclaimer: The information provided in this blog is for educational purposes only and should not be construed as investment advice. The strategies discussed are not suitable for all investors, particularly those unfamiliar with exchange-traded options. Readers should conduct their own research and consult a licensed financial advisor before making investment decisions. Trading options involves significant risk and is not appropriate for every investor.

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