Why Iron Condors are NOT an ATM machine

Steady Condors first goal is to manage risk and to prevent big losses.

Nice recovery!

"Another nice month for those who have hung in there with Steady Condors. Good job, Kim, and to those of you who are sticking with it. And a good opportunity to share some things about the limitations of a relatively small sample size of live trading and backtesting...

A lot of people bailed on Steady Condors last year because of a drawdown and losing year. Think about it this way:

What if the only data you had access to on the S&P was since 2009? You'd have returns of 26%, 15%, 2%, 16%, 32%, and 14% (rounded). That would obviously be a very misleading sample to draw conclusions from. The disclaimer of "past performance does not guarantee future results" is not just a legal requirement, but a true statement. Past performance does matter, but it's NOT the limitations of what is possible.

I posted this on the LCD forum last week from Ben Graham: "The essence of investment management is the management of risk, not the management of returns."

You can't control returns, only manage risk 

I really dislike when people make trading sound like if you are really good at it you somehow have control over your returns. The only thing you can do is build a winning strategy (better yet, multiple winning strategies with low correlation) and then manage your risk and position size so that you stay in the game long enough to let your edge work out over the long term. But a lot of people will make ridiculous claims in order to sell a product with no accountability to a regulatory body like I have to deal with as an investment advisor.

And you must have realistic expectations and a proper mindset which I believe is:

1. Selling options and iron condors can be a very good strategy when the risk management is robust. With most of the services out there it's not, and if their track record doesn't have a big loss in it, it probably just hasn't happened yet. Selling OTM options and then rolling losses forward is incredibly misleading to the uninformed. No different than the S&P example above to where if we extended the sample size by one year to 2008 you add in the second worst year in history where many people locked in devastating losses to their portfolio because they never considered it possible for markets to go down that far and fear took over. Those unaware of history are doomed to repeat it. It will happen again, we just don't know when. The S&P has experienced two 50%+ drawdowns since 2000 and a max drawdown of over 80%.
2. Selling options and iron condors can add value and diversification to your portfolio. They aren't the holy grail. Just like everything else.
3. Your maximum drawdown is ahead of you, not behind you. We do have a limited sample size with Steady Condors, that's obviously why I brought up the S&P example. The reality is that backtesting complex options strategies is a LOT of work and sufficient option data just really doesn't exist for us to go back much farther than what we have displayed. Many drew too many conclusions about the future of steady condors based on limited past data. Again, have realistic expectations."

There is a lot of wisdom in Jesse's post.

And now I would like to explain how Steady Condors performance reporting is different from most other services.

We report returns on the whole portfolio including commissions

What does it mean?

When you trade Iron Condor (or any other options strategy), you NEVER can allocate 100% of the account to the trades. You always need to leave some cash reserve in case you need to adjust. This cash reserve usually varies from 15% to 30%.

Lets assume cash reserve of 20% and see how we would report the performance.

Our 20k unit has two trades each month (RUT and SPX). With 20% cash, we allocate ~$8,000 per trade. If both trade made 5%, that means $400 per trade or $800 total for the two trades. In our track record, you will see 800/20,000=4%. Other services will report it as 5% (average of the two trades). In addition, our returns will always include commissions. If you see 5% return in the track record, that means that $100,000 account grew to $105,000. Plain and simple.

To see how this method can have dramatic impact on the performance, let's examine a hypothetical service that claims to make 10%/month and have up to 3 trades.

With 3 trades, it is reasonable to allocate 25% per trade and leave 25% in cash. If all 3 trades made 10%, they would report 10% return (average of all trades). However, the return on the whole portfolio is 7.5%, not 10%. That's before commissions, which might take another 1-1.5% from the total return. If they have only 2 trades, and both made 10%, they would still report 10%, while a real return is 5% (half), and even less after commissions. There are months where they might have only 1 trade, but if that trade made 10%, they would still report 10%, although the real return was 2.5%.

Another point worth mentioning is rolling. If you look at some services, you might see few last months of data missing. That would usually mean that the trades were losing money and have been rolled for few months, to hide losses. In some cases, the unrealized losses can reach 25-50%. You will never see those losses in their track record.

It is very important to know how returns are reported, in order to make a real comparison. Always make sure to compare apples to apples.

Related Articles:
Can you double your account every six months?
Can you really make 10% per month with Iron Condors?

Should You Leg Into Iron Condor?
Exiting An Iron Condor Trade
Iron Condor Adjustments: How And When
Iron Condor Adjustment: Can I "Roll" It Forever?
Is Your Iron Condor Really Protected?

Click here to read how Steady Condors is different from "traditional" Iron Condors.