We pursue a market-neutral strategy that collects the volatility risk premium. The volatility risk premium is defined as the difference between present implied and future realized volatility, or colloquially as the premium option buyers pay over and above the typical level of realized volatility in order to protect against price fluctuations in an underlying asset; this premium is a persistent feature of exchange-traded options on world equity indexes and other assets, and has been observed by both practitioners and academics alike. Our belief is that a strategy that collects this premium can be profitable while remaining largely uncorrelated with market returns. For more information, see The Volatility Risk Premium in Index Options.
We collect this premium by trading iron condor option spreads on equity indexes. We trade multiple spreads in each expiration cycle in order to dynamically hedge against directional price movement.
We emphasize risk management and position sizing, and we can’t say it enough: never take on more risk than you can handle, and never initiate a trade if you don’t know how much risk you’re taking on. This doesn’t mean we’re risk averse – not at all! – but it does mean we’re risk aware. We know that risk management and position sizing aren’t sexy or fun, but those techniques keep traders alive and in the game. Subscribers to our site are advised to define, in advance, what approach they will take to each trade. Additionally, we teach subscribers how to size iron condor trades on a risk-adjusted basis.
We take the following steps in order to reduce certain kinds of risk:
- Restricting application to widely traded indexes and sectors reduces exposure to individual commodity-, equity- or industry-specific events.
- The use of risk-defined, market-neutral option spreads helps reduce the frequency and costs of dynamic hedging.
- Analysis of changes in implied and realized volatility allows us to identify environments in which the volatility risk premium should be bought or ignored, rather than sold.
The Iron Condor
We’ve written a series of posts describing our strategy in greater detail, and new members in particular should read them through in order to understand the meaning and thinking behind our trade alerts:
- What is an Iron Condor?
- Iron Condor Trading Rules
- Why Delta Matters
- Asset Allocation is Extremely Important
- Why Adjusting Iron Condors Can Be Dangerous
- Trading, Overtrading, and Waiting
- The Best Time to Trade Iron Condors, Part 1: Volatility is Your Friend
- The Best Time to Trade Iron Condors, Part 2: Ignore the Trend
- A Rough Formula for Calculating the Success Odds of Your Iron Condor
- Relax, Don’t Do It (Trading Options Near Expiration)
- Hard Stops?
- 8 Hedging Ideas for Iron Condors, Part 1
- 8 Hedging Ideas for Iron Condors, Part 2 (members only)