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Backtesting Options Strategy: Iron Condor
Have you ever found yourself in a situation where you were expecting a market movement due to events such as earnings releases, fed meetings, etc., but you were unsure about the direction in which the market would move? Is there a way to trade on this view where you are uncertain about the direction of the movement?
Yes, there is a way. You can deploy a long strangle. But what if you want to reduce the upfront premium payment? (With less premium comes less risk)
No worries! Another options trading strategy, the long iron condor, can help you capture this move. Similar to the iron condor strategy, we have many other interesting trading strategies that you can use to trade, backtest and automate systematically in different market scenarios in our Systematic Options Trading course.
Let us learn more about the long iron condor strategy.
Note that backtesting results do not guarantee future performance. The presented strategy results are intended solely for educational purposes and should not be interpreted as investment advice.
In this post, we will cover all the essential questions related to the long iron condor strategy, such as:
- What is the long iron condor strategy?
- When can you trade a long iron condor?
- Why deploy a long iron condor and not directly buy a long strangle?
- What are the entry and exit rules?
- How to backtest this strategy?
If you are not familiar with or want to revisit the basic options terminologies like OTM, ATM, call, put, etc., going through the Options Trading Strategies In Python: Basic course would be helpful.
What is the long iron condor strategy?
The long iron condor strategy involves buying and selling four options with the same expiration date but different strike prices. Here's how it works:
1. Buy OTM Call Option: Buy an out-of-the-money (OTM) call option, which gives the right to buy the underlying asset at a specific price (strike price) on or before the expiration date.
2. Buy OTM Put Option: Simultaneously, buy an OTM put option, which gives the right to sell the underlying asset at a specific price (strike price) on or before the expiration date.
3. Sell Further OTM Call Option: In addition to buying the two options mentioned above, also sell a further OTM call option with a higher strike price than the one you bought. This helps reduce the strategy setup cost.
4. Sell Further OTM Put Option: Finally, sell a further OTM put option with a lower strike price than the one you bought. Again, this helps reduce setup cost.
All the concepts covered in this post are taken from the Quantra course Systematic Options Trading. You can preview the concepts taught in this classroom by clicking on the free preview button and going to Section 22 and Unit 1 of the course.
When can you trade a long iron condor?
Deploying a long iron condor makes sense in situations where you expect the underlying asset to experience a significant price movement but you are not sure about the direction of the movement. This strategy profits from an increase in volatility or when the price breaks a certain range.
Long Iron Condor Payoff
Why deploy a long iron condor and not directly buy a long strangle?
When buying a strangle to capture the move, you end up paying a higher premium for unlimited upside benefits. But generally, the underlying asset doesn’t move that much in a short period of time. So, you are better off letting go of some upside and reducing the premium upfront by buying the long iron condor. There are other pros and cons also involving greeks. You can learn more about option greeks like delta here.
What are the entry and exit rules?
Let’s create a long iron condor trading strategy which involves anticipating significant market movement. The strategy is based on contra signals. In this strategy, we will check for quieter markets and open a long iron condor position. The strategy can be as follows:
- Entry:
- Historical data indicating a weak or no trend. You can use technical indicators such as ADX to determine the trend.
- Market participants forecast significant volatility (market movement). This can be calculated with the help of the implied volatility metric such as the 'IV percentile'.
- Exit:
- We will exit the trade if the take-profit or stop-loss levels are hit.
- Otherwise, we will exit the strategy at expiry.
It is important to backtest this strategy so that we can know the effectiveness of this trading strategy.
How to backtest this strategy?
You can apply options backtesting to the above strategy in Python. You can calculate the indicator values and use them to generate entry and exit signals. Finally, you can backtest the strategy on historical data based on the generated signals and check its performance. We backtested a variation of the long iron condor strategy on NIFTY options over a period of 3 years, and these were the results:
Strategy Performance
Note that backtesting results do not guarantee future performance. The presented strategy results are intended solely for educational purposes and should not be interpreted as investment advice.
The strategy discussed above has been covered in detail along with the Python code in this unit of the Systematic Options Trading course. You need to take a Free Preview of the course by clicking on the green-coloured Free Preview button on the right corner of the screen next to the FAQs tab and go to Section 22 and Unit 6 of the course.
You can deploy a long iron condor strategy when you are expecting a significant market movement. But what if you are not expecting any movement in the market? In that case, you can deploy a short iron condor, which is the exact opposite of the long variation, i.e. you sell OTM call and put options and buy the further OTM calls and puts.
What to do next?
- Go to this course
- Click on
- Go through 10-15% of course content
- Drop us your comments and queries on the community
IMPORTANT DISCLAIMER: This post is for educational purposes only and is not a solicitation or recommendation to buy or sell any securities. Investing in financial markets involves risks and you should seek the advice of a licensed financial advisor before making any investment decisions. Your investment decisions are solely your responsibility. The information provided is based on publicly available data and our own analysis, and we do not guarantee its accuracy or completeness. By no means is this communication sent as the licensed equity analysts or financial advisors and it should not be construed as professional advice or a recommendation to buy or sell any securities or any other kind of asset.
