Condor Options

It’s pretty common for people to approach us with questions about the right time to trade iron condors, and one of the most common assumptions they make is that it’s better to trade condors in low volatility, non-trending environments. This is an understandable assumption, but it’s totally false.

The best time to trade condors is in high volatility environments, regardless of the trend. So there are actually two points to be made here.

1. High volatility is your friend

Now we could talk about the nice, fat premiums you can get when fear is high and others are acting cowardly. But instead, let’s think about the worst case scenario for any given condor – namely, a huge market move that blows past both your short and long strikes on one side of the trade. That means you’ve hit your maximum loss, the trade is likely busted for good, etc. This is the danger to be avoided. Now, there are two given market environments in which you can trade. Environment A is characterized by a lot of lazy sentiment and low volatility readings. Environment B is characterized by rampant fear – bordering on panic – and high volatility readings. The question is: in which environment are you more likely to experience a trade-busting event?

The answer is Environment A: in the world of A, nobody is expecting a sizable move, and therefore no one is pricing such a move into the options. In the world of B, however, everyone is already on alert, some extra premium has already been added, and when that big move comes, we’ll likely be okay because that extra premium will have allowed us to construct our position with wider strikes than normal. To put it another way, condor traders trade volatility, and there are basically four ways things can shake out during the life of a trade:

So the best-case scenario from an implied volatility perspective is one in which IV is high when you open the trade, and then some volatility crushing event happens during the trade so that by exit/expiration, IV is low. The two next best cases are ones in which the IV environment is basically unchanged over the life of the trade. The worst case scenario is one in which you start in a low-IV environment, and then the IV of your options jumps on you. We marked this as dangerous because increased IV premium means your position could be underwater even if the price of your underlying doesn’t move much. It also means your current position may not be pricing risk appropriately.

One other thing to point out about that little chart: the only worst-case scenario occurs when you trade during a low-IV environment. So while it’s pretty counter-intuitive to be putting on iron condor trades when the rest of the trading world is freaking out, our analysis suggests that this isn’t just a great opportunity – when handled properly, it’s the safest place to be.

We tackle the second point – the irrelevance of the market trend – in Part 2.