Nifty Long Condor Spread With Calls

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Before looking at the Nifty trade I took recently let's have a quick recap of what we learned regarding the time value of an Option so far.

Time Value or Extrinsic Value:

The rate of decay of an Option is proportional to the square root of the time remaining until expiration.

For example, if a monthly (30-day) option premium of Nifty is valued at 375, then the 60-day option premium would be calculated as 1.414 (square root of 2) times the monthly option value, that is, 1.414 x 375 = 530.25. Similarly, a 90-day option premium would be calculated as 1.732 (square root of 3) times the monthly option value, that is, 1.732 x 375 = 649.5.

A close look at the premiums would reveal that the difference between the premium of the 90-day and the 60-day options (119.25) is less than the difference between the premium of the 60-day and the 30-day options (155.25). This just goes to prove that the closer an option gets to expiration, the rate at which time value decays gets faster.

We can also conclude that a 3-month option loses its value 42.3 percent faster than that of a 9-month option. The calculation is obtained as follows:

100 x (1 - sqrt (3)/sqrt (9)) = 100 x (1 - 1.732/3) = 100 x (1 - 0.577) = 100 x (0.4226) = 42.3.

Similarly, a 2-month option loses its value 29.3 percent faster than that of a 4-month option. The calculation is obtained as follows:

100 x (1 - sqrt (2)/sqrt (4)) = 100 x (1 - 1.414/2) = 100 x (1 - 0.707) = 100 x (0.293) = 29.3.

Now if we compare a 1-month option to a 9-month option, the former would lose its value 66 percent faster than the latter. The calculation is obtained as follows:

100 x (1 - sqrt (1)/sqrt(9)) = 100 x (1-1/3) = 100 x (1-0.33) = 100 x 0.66 = 66.

In a previous video, the link to which would appear above, we learned two ways to reduce the cost of the long put - one is to sell an OTM call right at or above the strike price of the long put and the second is to implement a 2:1 call ratio spread, that is, buy a call right at or above the strike price of the long put and sell twice the number of calls at a higher strike.

Now we would be showing you another way to reduce the cost of the long Put. It is to enter a long condor spread with Calls right at the strike price of the long put.

Long Condor Spread With Calls:

A long condor spread with Call options is a combination of two vertical spreads - a long call spread and a short call spread. A long call spread is formed by buying calls and at the same time selling the same number of calls at a higher strike price. Conversely, a short call spread is formed by selling calls and at the same time buying the same number of calls at a higher strike price.

But in our case we entered a skip strike long condor spread, that is, we skipped a strike price (10800). Also as one Sold Call option is already covered by the Nifty Future, we would need to buy only two Call options of the 10900 strike price to form a perfect hedge.

Let’s look at the exact trade now:

There are two legs in the trade:
Buy Nifty July Future and Nifty December 10500 Put
Long Condor Spread with Calls - Buy 3 x 10500 Calls; Sell 3 x 10600 Calls; Sell 3 x 10700 Calls; Buy 2 x 10900 Calls

The two legs can be entered simultaneously or one leg at a time. Though the Iron Condor leg would enhance the profit we can make from the trade it does not add any additional risk.

Calculations:

Premium received from the Long Condor Spread = 3 x (23.5 + 17) - 3 x 29.7 - 2 x 11.8 = 8.8 x 75 = ₹660

Maximum loss at expiry = [(Futures’ Purchase Price + Premium Paid for the Long Put) - Long Put Option’s Strike Price] x Lot Size =[(9387 + 1325) - 10500] x 75 = ₹15900.

The maximum loss would be experienced only if we carry the long put until expiry. Although we would have received a better premium had we just sold a Call at the 10500 strike (29.7 x 75 = 2227.5) we enhanced the amount of reward we would receive by implementing the Iron Condor.

There would be three scenarios for the above trade at expiry:

If Nifty is between the purchase price of the Future and the long Put, you would be in profit as all the options would expire and you would keep the premium received and also you would be in profit in the Future and the long Put leg. In this scenario you would earn anywhere between ₹1000 and ₹50000.
If Nifty is below the purchase price of the Future, you would keep the premium received but would be in loss in the Future and the long Put leg, about ₹4000.
You would make the maximum profit of about ₹50000 when Nifty is in between the short strikes of the Iron Condor, this is the best scenario.
If Nifty closes above all the strikes of the Iron Condor you would make any where between ₹10000 and ₹25000.