Iron Condor Adjustment With Debit Spreads | Live Nifty Example | Bull Call Spread | Bear Put Spread

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Iron Condor Adjustment With Debit Spreads

In this video we would be looking at some possible adjustments that can be made to a troubled Iron Condor position.

So what is all the hype about adjustments?

When we make an adjustment to a trade it is supposed to reduce the risk. And on most occasions when we reduce the risk, we also reduce the return.

Also, most adjustment methods require us to deploy more capital. So this is something we have to keep in mind while working on the adjustment methods.

The best thing about options trading is that we have a wide variety of adjustment methods available. Each adjustment method has its pros and cons. But closing the trade should always be regarded as the best possible adjustment.

This is particularly true for direction-neutral strategies such as Iron Condor, Butterfly, etc. Rather than make any adjustments, one should consider exiting the trade when there is a sudden rise or fall in the price of the underlying security.

As learned in the previous videos, an iron condor is a combination of two credit spreads - a bull put spread and a bear call spread.

In the first adjustment, we will see how we can use a basic debit spread - either a bull call spread or a bear put spread - to make an adjustment.

A basic credit spread involves selling an OTM option while simultaneously purchasing a further OTM option. Conversely, a basic debit spread involves purchasing an option and selling a further OTM option.

Now let’s see how we can use a debit spread to adjust the tested side of an Iron Condor. But what is a tested side? The tested side is the side closest to being ITM. The untested side is the side furthest OTM.

For example, if the price of the underlying moves up, the Call side would become the tested side as it is the side closest to being ITM. Conversely, if the price moves down, the Put side would become the tested side.

Now let’s look at a sample Iron Condor trade:

Nifty is at 9100 on May 27, 2020. An Iron Condor position can then be entered as follows:

Buy three 25 June 8000 strike price Puts at 40.29
Sell three 25 June 8300 strike price Puts at 65.59
Sell three 25 June 9700 strike price Calls at 60.9
Buy three 25 June 10000 strike price Calls at 25.55

Say, two weeks into the trade, Nifty moved up to 9500, which is about 20% below the strike price of the sold Call of the IC. This should be our first trigger. An adjustment to the sample trade can then be made by adding a debit Call spread as follows:

Buy one 25 June 9500 strike price Call at the prevailing market price
Sell one 25 June 9600 strike price Call at the prevailing market price

One should note that the debit paid should be only about 40-50% of the difference between the two strike prices of the debit spread. That is, if the difference between the two strike prices of the debit spread is 100, the debit paid should be about ₹(40-50) x lot size.

A similar adjustment can be made to the Put side of the Iron Condor if Nifty moved to the downside.

The risk graph of the Iron Condor with the debit spread added would then look like this.

It is clear that this adjustment has removed some risk on the Call side but since this is an adjustment done for a debit there is some sacrifice on the reward side too.

Coming to the second adjustment, since the untested side of the Iron Condor, that is, the Put side would be in profit, you can close that side of the Iron Condor and move it closer to the Call side as follows:

Buy three 25 June 8200 strike price Puts at the prevailing market price
Sell three 25 June 8500 strike price Puts at the prevailing market price

The risk graph of the Iron Condor with the Put side rolled up would then look like this.

Note that the profit zone has become narrower but since you took more credit by moving the Put side closer to the Call side you have removed some risk out of the table.

There would be another part to this topic. As these are complex adjustments it would take some time to digest the information.Please look out for the second part of this topic later this week.