SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Iron Condors or Short Strangles?


In my early option trading days, I favored selling iron condors over selling strangles. I thought that selling a strangle was too risky because the potential loss was “undefined”. I thought this made sense because this is what I’d hear from other people that were more experienced than I was.

What I began to realize over the years was that the risk I was taking with iron condors was excessive, so the thought of selling a “naked” strangle was unimaginable. This risk was due to ridiculously large position size, or leverage, and over time I began to understand this reality better.

 

An iron condor is simply a short strangle with long options that are further out of the money than the short options. Some traders refer to the long options as “wings”.  Because an iron condor creates a maximum potential loss equivalent to the width of the spread, traders make the mistake of often trading their account up to or near the maximum number of contracts that would wipe out most of their account if that max loss occurred, which during periods of low market volatility may be as minor as a 10-15% drop in the market.The average intra-year drawdown for the S&P 500 has been about 14% since 1980, so this is something that occurs almost every year.

This is of course why you hear so many stories of retail traders and credit spread/iron condor newsletters blowing up. As is almost always the case, the risk isn’t really the strategy…but instead the position size of the strategy! There’s no strategy so good that enough leverage can’t make it a blow up waiting to happen. Due to the nature of out of the money option selling, the negatively skewed return stream can take a while to materialize when there are long periods of relatively calm market conditions.

 

Today, I think of a strangle as a cash secured put along with an out of the money short call. Thinking about the trade this way transforms a short strangle from seemingly risky into a rather conservative trade, due to the position sizing rule. For example, with SPX currently trading at about $3,000, a strangle would be sized at about 1 contract per $300,000. Compare this to selling 10-point wide put and call credit spreads to create an iron condor, and many newsletters might suggest that you sell something like 275 contracts per $300,000 of capital! Think about that for a moment…technically the iron condor has “defined risk” of $275,000 (ignoring the credit received), while the strangle has “undefined” risk because the short call is naked and prices can theoretically rise forever. 

Yet the risk is immensely different for the two trades due to the number of contracts involved. The strangle has a positive expected return and will very likely survive and succeed over the long-term due to the well documented Volatility Risk Premium (VRP), while the iron condor will cause an eventual blowup. When someone says they prefer iron condors over strangles because the risk is “defined” with an iron condor, they probably haven’t spent a lot of time thinking about position sizing. This should be the biggest lesson from this article…risk is defined by your position size to a much greater degree than it is by the strategy. Yet it’s a topic that is not well understood or appreciated by most traders.

 

I think about an iron condor similar to how I’d think about owning 100 shares of a stock and then buying a protective put. A strangle is like owning just those 100 shares, while an iron condor is like owning those 100 shares along with an out of the money protective put. That put will reduce your downside during extreme selloffs that are greater than the market already baked into prices, but at a substantial cost over the long run (again, due to the VRP). To illustrate this, I backtested SPY strangles and iron condors using the ORATS wheel. Selling 30 delta strangles on SPY since 2007 has produced an average annual return of 5.34% (volatility of 8.36%, Sharpe Ratio 0.64), while a 30 delta iron condor with wings set at 20 delta returned only 0.15% (volatility of 3.08%, Sharpe Ratio of 0.05). I ran the test a few times just to make sure I was getting consistent results.  The additional transaction costs and performance drag of the long options is so significant that almost the entire return generated from the short options disappears.

 

Conclusion

On your journey as an options trader you’ll hear a lot of conventional wisdom repeated over and over that simply isn’t true or provides incomplete information. One of those myths is how selling strangles is risky and instead a trader should sell an iron condor. This statement tells us nothing about position sizing. If you read this article and are still resisting the information I’m sharing, ask yourself this question: Is the reason you still want to use an iron condor over a strangle due to how you might look at the expected return of the strangle as I’ve laid it out and feel a little underwhelmed? Perhaps this article is also what you need to hear instead of what you want to hear, because I know I was in that camp at one time.

You might consider that the 5% return of the SPY strangle since 2007 is similar to the long-term global equity risk premium, which serves as the benchmark for virtually everything since so few investments have been proven to be able to reliably exceed it over the long term.Until someone shows you an independently audited decade plus long track record of a fund or newsletter selling iron condors with the “X% per month” average returns that are often fantasized about and marketed to new traders, use the position sizing algorithm presented in this article instead as your baseline. Think in terms of notional risk instead of margin requirements, and you’ll substantially reduce the risk of an unrecoverable negative surprise on your trading journey.

 

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse manages the Steady Momentum service, and regularly incorporates options into client portfolios.


Related articles

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Traditional or Roth Retirement Account?

    When US investors save for retirement, there are many important decisions that have to be made including which investments to use as well as which type of accounts to fund. Tax favored retirement accounts such as 401(k)’s and IRA’s should be utilized to the maximum extent possible because of the opportunity for tax advantaged growth.

    By Jesse,

    • 0 comments
    • 160 views
  • My Favorite Investing Books, Blogs, Papers, and Podcasts

    There are so many excellent sources of investment education available today that I thought a short post about some of my personal favorites could be beneficial. Below are different forms of content that have been particularly impactful to my investment philosophy, and they are not in any specific order.

    By Jesse,

    • 0 comments
    • 359 views
  • Go For Gold! The Business Behind The Dazzle

    The price of gold is often in the news—sometimes it's rising, and other times it's dropping but for the most part, it has been on a steady increase for many years. It is certainly worth more now than it did twenty years ago. When its price is on the rise, we may have thought about the benefits of selling our gold for profit and making some passive income from it.

    By Kim,

    • 0 comments
    • 230 views
  • Using Bullish Calendar Spreads to Profit on MSFT Stock

    A calendar spread is an income trade where the trader sells a near term option and buys a longer-dated option with the same strike price. Usually this is done with monthly options, but it can also be done with weeklies. They are long volatility trades so can be a nice addition to a portfolio as a way to offset some short vega.

    By GavinMcMaster,

    • 0 comments
    • 440 views
  • 3 Principles to a Successful Investment Experience

    Although not an exhaustive list, what I’ll present in this article are three core principles that overwhelmingly stack the odds of a successful long-term investment experience in your favor. These three principles are asset allocation, diversification, and rebalancing.

    By Jesse,

    • 0 comments
    • 333 views
  • Important Tips For First Time Currency Traders

    Diversifying your portfolio is important for all investors, and currency investments are a great way to do that. However, there are a lot of misconceptions and common mistakes that first time currency investors make, and this leads to big losses.

    By Kim,

    • 0 comments
    • 356 views
  • Iron Condors or Short Strangles?

    In my early option trading days, I favored selling iron condors over selling strangles. I thought that selling a strangle was too risky because the potential loss was “undefined”. I thought this made sense because this is what I’d hear from other people that were more experienced than I was.

    By Jesse,

    • 0 comments
    • 1,787 views
  • How To Be A Successful Day Trader From Home

    The good news is that if trading is your passion, then it’s possible to become a successful day trader and work from home. However, it’s not as easy as setting up shop and jumping online. There are specific steps and processes you need to have in place if you’re going to be able to make a living for yourself and have a bright career and future.

    By Kim,

    • 0 comments
    • 469 views
  • 3 Key Pieces Of Advice For New Traders

    These days, everyone claims to be an ‘expert’ on absolutely everything. Apparently, it only takes having a Twitter account to be a seasoned expert on any given subject; all in all, the Internet is full of nonsense. It’s becoming harder and harder to find legitimate answers amongst the quagmire of false information online.

    By Kim,

    • 0 comments
    • 496 views
  • Why New Traders Fail

    Our first advice to new traders is: "Learn First, Trade Later". The markets will always be there, but if you start trading without proper fundamentals, your capital will be gone very fast. The barrier to enter trading is so low today, commissions are near zero, and the whole trading game looks very promising.

    By Kim,

    • 0 comments
    • 684 views

  Report Article

We want to hear from you!


There are no comments to display.



Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs Expertido