When Not to Trade Iron Condors

Member K.S. poses some very good questions:

Having read both parts on your comments about the best time to trade iron condors [Ed: here and here], I wanted to ask if you ever decide to do fewer condors at a time when you expect a strong move in one direction?  I know you did last fall when worried about a decline but what about a rally?  this market’s momentum is quite strong — an interesting battle between that momentum and the resistance levels.

It’s worth getting clear about what constitutes a “strong move.”  A rally or selloff of x% is only noteworthy if the implied volatility in the options we’re trading expects a range of outcomes that is less than x.  In other words, every trade we put on will have breakeven points that are some distance from the current price of the underlying, but we would only take note of projections that were well beyond those points.  And even in that case, the more realistic approach is to enter additional spreads that offset some of the risk, since in real life, the majority of the time a strong move occurs in medias res – when we already have some trades on, and don’t necessarily want to shut everything down.  The exception – and last fall would be in this category – is when you anticipate a move that is well beyond current expectations.  But even then, the answer isn’t necessarily to be in cash only, but rather to be in positions that are long volatility.

Last month when I exited my first condor trade it felt somewhat like a game of chicken — or let’s make a deal.  Do I take the current deal or wait for something better as the market might sell off and more time value ticks away.  In the end, I did it on a pull back with about 9 or 10 days before expiration.  Would you argue that one benefit of several trades is that you can unwind one at a time over a few days to spread the risk of market movement either improving or worsening your trades? Or is it more based on risk — i.e. doesn’t matter how many trades you have if the underlying is near one of your sold strikes you should unwind them all when you get into the window?

Just as entering trades on a staggered basis helps spread out the range of price movement you can tolerate, I pretty regularly take positions off one by one in response to market movement – not as a matter of timing the market on a daily basis, but as a function of where profits can be protected most easily. Psychologically, it’s nice to be able to avoid expiration week drama whenever possible. And as a side note, it’s probably not a good idea to go back and look at where a trade would have closed had you held it for longer, unless you’re conducting a thorough backtest spanning numerous trades. Otherwise, the tendency we all have is to ignore easy wins and second-guess the difficult losses, and assuming you’re following a rule-based system with a positive edge, this may be counterproductive – i.e. it introduces more human risk.

Given a desire to do multiple trades over time with different underlyings, I was wondering if you had a list of choices beyond SPY, DIA, IWM, QQQQ that I have seen you use in the newsletter?

One issue is that the volatility risk premium of which we are perpetual sellers doesn’t exist when you start looking at individual equities.  That doesn’t mean one should never trade iron condors on individual stocks.  It just means that your reasons will be different: if you thought the volatility bid-up going into earnings was excessive, for example, or that after an extended move some stock or sector was likely to be range-bound.  Circumstances like those can be appropriate times to sell iron condors on some non-index product, but again, those are different theses than the one that drives the newsletter strategy.

One interesting avenue for academic research would be the extent to which the volatility risk premium exists in sector and index products other than the usual suspects (the Dow Jones Industrials, S&P 500, Nasdaq 100, and Russell 2000): do liquid options on sector-based, country-based, and other smaller indexes exhibit anything like that same premium?  I speculate that they would qua correlation hedges, but would not qua jump risk hedges.


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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More

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