Markets often spend more time in ranges than trending, leaving traders frustrated with inconsistent directional movement. However, there's a way to profit from these range bound markets using a simple yet powerful trading strategy.
Understanding Range Bound Markets
When markets remain range bound for several days, they become even more erratic on smaller timeframes. One day it goes up showing all positive signals and data, and the next day it completely reverses direction and gives a deep down move. In such scenarios, directional trading becomes inconsistent.
The Iron Butterfly Strategy
The Iron Butterfly strategy is a simple yet effective way to profit from range bound markets. It involves selling both Call and Put at strikes closest to the market price with the nearest expiry, and then buying a higher strike Call and lower strike Put with the same expiry. This buying protects us from unlimited loss.
The strikes we choose for buying depend on various factors, but the easiest choice is to pick the highest Open Interest Call strike and highest Open Interest Put strike. Try to keep the distance between Sell and Buy strikes the same on both sides.
Example of Iron Butterfly Strategy
Let's take an example where Nifty is trading near 25000 on Friday afternoon, with weekly expiry on Tuesday. We sell 25000 Call at 128 and 25000 Put at 138, and buy 25250 Call at 35 and 24750 Put at 38.
Our maximum profit equals the net premium we receive, which is 128 + 138 - 35 - 38 = 193 points. Our maximum loss equals the difference between buy and sell strikes minus the net premium, which is 250 - 193 = 57 points.
Key Takeaways
- The profit zone is the range where the strategy makes money at expiry.
- Using weekly expiry and entering in the second half of the week allows us to capture the range bound behavior in a shorter timeframe.
- Always check if you are comfortable with the payoff before entering the trade, and adjust the strikes accordingly to balance your risk and profit.
Remember, this is perspective, not prediction. Do your own research and consider your own risk appetite before using this strategy.