In another of my paperMoney trades, I experiment with iron condors. Today I opened a position on my next month's iron condor, expiring in December, on RUT. RUT is the Russell 2000 index, and options on it are European-style and cash-settled. This means they cannot be exercised early (very important for spreading), and in-the-money options at expiry won't cause securities to change hands - just money. Settlement at expiry is weird, though, so it's best not to take them to expiry in any case.
WTF is an Iron Condor?
An iron condor is a market-neutral option strategy that is short volatility but with limited profit/loss ranges. It consists of two vertical spreads: a put spread below the current index price, and a call spread above the current index price. The long options in the spreads are both farther OTM than the short options, so opening an iron condor position generates a credit. The farther apart the short option strikes are from each other, the lower the risk that the iron condor will lose money, but the less credit it generates on opening.
A picture is worth a thousand words. Luckily for you, I have both. Check out this page from Option Trading Tips: Iron Condor Description. I'm working on getting permission from ThinkOrSwim to include screen shots from their software. In the meantime, this is the best I can do, sorry.
Terminology does not agree on how to refer to iron condors that generate a credit when opened. They consist of two short vertical spreads, but many (including the website above) call that combination a Long Condor. To me, selling means that I get money; buying means that I give up money. So throughout this blog I will rightly or wrongly refer to iron condors like they're short: I sell them to open them and I buy them to get out. So today I sold an iron condor, opening a short position, and I generated cash. Questions? No? Excellent.
Where To Begin...
Here I have to give Mark Wolfinger props again, because about a year ago I looked at iron condors briefly when a co-worker (not a professional trader, in this case) told me about how he was making a guaranteed 10%/month on them. This seemed too good to be true, and after analyzing them a little I decided that it was: the probability-weighted return on his capital was far too low for the risk of ruin he was taking. I dismissed iron condors as hardly better than naked option selling, and was ready to leave it at that. In the process, however, I ran into Mark Wolfinger's blog Options for Rookies, and I started reading it regularly. Over the next few months I realized that there was more to iron condor trading than I first assumed. Guaranteeing 10%/month was indeed too good to be true, as I suspected. But there was nevertheless a viable trade there for someone willing to put in the time and effort to build experience. A firm believer that nothing worth doing is easy, I set out to learn. I'm just getting started on that journey, and though it will never end, I hope that soon I will have made enough progress to begin profiting from it. I don't know when that will be, but I know it isn't now yet.
I've followed MW's lead in a lot of respects, because I am more of a learn-by-doer than a learn-by-reader. As I try different approaches and find my own comfort zones and style, I start to diverge from him; this is natural. But some aspects of his trade are relatively arbitrary from my perspective: he trades RUT because he feels that its volatility is not-too-high but not-too-small; he trades options with 60+ days to expiry because he feels that is the right mix of risk (gamma) and reward (theta). Never having traded iron condors on any index, and never gotten burned in either direction in time-to-expiry, I figured 60+ days on RUT was as good a place to start as any.
My Own Trading Style
My current behavior pattern is to start looking for a new iron condor position around the first of the month two months before expiry. This gives me 60-80 days or so before expiry. Also like Mark, I look to get out of the condor early if the market is willing to let me buy back pieces of it at good prices. I don't try to choose a low-risk / low-reward condor that I never have to adjust, but I try to give it enough room to move that I can make adjustment decisions after work for trading on the open the next day. Taking some of his lessons to heart, I try not to increase my position in the course of adjustments; however, I will do so if I have previously reduced the position via cheap buy-backs. I try very hard to evaluate what the position is now, instead of whether I'm up or down from my entry point. This is a lot harder than it sounds, but Mark harps on it so much that it is starting to sink in.
In Theory, There Is No Difference Between Theory and Practice
A perfect situation in my trading style is to find a new iron condor on, say, October 1 for December expiry that I can put on generating 3.50 or so in premium while keeping the two short options a good 15-20 strikes apart. For this situation to remain perfect, the market needs to move up and down some so I can cheaply (like 20c or so) get out of the two spread legs, but not so much that I feel I need to adjust to protect my position. The perfect scenario ends about 30 days before expiry when I exit the last position without ever having to adjust. Net profit when perfect: nearly $3.00 per contract, or about 30% on margin risked.
But In Practice, There Is
In reality, that scenario never happens. I always have to adjust, I always agonize over how much insurance to buy and when, I seldom pay as little as 20c to buy back my spreads, I frequently enter the position for less than 3.50 credit, and I often find myself still trying to dump some position off with only 2 weeks to go.
I often have two condors on at any given time: one that I'm adjusting and working my way out of, and one that I'm watching eat up theta prior to its first adjustment. If I end up with over 1.00 per original contract profit, I'm thrilled. Note that because of adjustments, 1.00 per original contract is a lot less than 10% margin profit, because the margin gets bigger and the profits get smaller with insurance. If my net cash flows are positive at the end of a condor run, I'm satisfied. If I learn something along the way, it's all worth it.
I'm slowly starting to get a feel for what values of delta make me nervous, and I'm better at choosing adjustments that don't give me a negative theta, since that would negate the whole purpose. I'm always massively short vega, since that's the nature of an iron condor; and gamma doesn't really affect me too much 60 days out. It is nevertheless always the shadow in the corner, and I keep an eye on it more and more the closer to expiry I find myself. Experience has come very slowly, but it is starting to click. That's a cool feeling.
Right now I have a heavily-adjusted November position on. It's too complicated to explain without charts, so I won't try. But despite the drop in volatility the past couple of days as the market rallied, I was able to put on my December iron condor position for my target price of 3.50. It's a little tighter (short strikes are closer together) than some previous months, but I'm also getting a little more comfortable with adjustments; this lets me generate more premium credit at the start without so much fear. My new RUT December condor is a 610/620/770/780, meaning that I am long the 610 puts and the 780 calls, and short the 620 puts and 770 calls. Max profit: the 3.50 credit it generated. Max loss: 6.50.