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They're selling options to traders looking for big wins, and when those options expire worthless, the seller of the option gets to keep the premium he collected. Many traders use these spreads to trade range-bound markets, where there’s a sustained technical range with well-defined support and resistance levels. These are winning trades should the market remain within the defined range through the life of the trade. While Iron Condors and Iron Butterflies both take advantage of the same market dynamics, there are situations where it makes sense to use one over the other. Selling Options: Shorting Volatility Both Iron Condors and Iron Butterflies are non-directional, limited risk option spreads. Instead of trying to profit by being bullish or bearish, these option spreads are tools to make money from options you think will expire worthless. If you had the chance to look at the options market during the GameStop madness in 2021, you witnessed insane option prices. So many traders wanted to bet against the stock but didn't want to get destroyed in a short squeeze, so they preferred to buy puts. This made put options insanely expensive to the point where you could be right on the trade and still lose money. As a result, selling puts was a prevalent strategy to take advantage of overpriced options. These situations occur every day to varying degrees. When you short an option, you're selling it to another buyer. For example, let's say you sell a call with a strike price of $20 on a $15 stock for $1. The stock is still at $15 at expiration, and the option expires worthless. You get to keep the entire $1. It's well-known that most options expire worthless, so this is a compelling trade to many traders. However, the downside is your unlimited risk when shorting options. Suppose the stock in the example above was $30 at expiration. The option is now worth $15, and you're $14 in the hole. For this reason, many traders use spreads like Iron Condors and Iron Butterflies to cap their downside. These spreads involve shorting options but buying further OTM options to limit risk. What is an Iron Condor? If you're familiar with other options spreads, an iron condor combines a short vertical call spread and a short vertical put spread. Put another way, it's a short strangle where you buy "wings" (OTM options) to cap your downside. If you're unfamiliar with the dictionary full of the lingo we options traders use, an Iron Condor involves shorting an out-of-the-money (OTM) put and call and buying a further OTM put and call. These extra OTM options we buy are used to cap our downside. Because shorting options comes with an unlimited downside, the Iron Condor has the benefits of shorting options with the added benefit of limiting our downside. An iron condor is an option spread that involves using options to profit from a stock staying within a certain price range. Put simply, the iron condor enables traders to make profits even when a stock doesn’t move at all. The iron condor is composed of four options, a long put and call, and a short put and call. Here’s an example of an iron condor spread: BUY (1) 394 PUT SELL (1) 400 PUT SELL (1) 420 CALL BUY (1) 426 CALL As you can see, you’re selling an inner options spread, and protecting the unlimited loss by buying cheap out-of-the-money (OTM) “wings” that backstop the losses if your trade idea is wrong. Here’s what the payoff diagram for this trade looks like: The goal of this option spread is for the underlying stock price to remain within the range you define with your short strikes. Because we’re selling a $400 strike put and $420 strike call, we want the stock to trade within that price range. Should it remain inside this range, we make our maximum profit at expiration because the options expire worthless. However, as you can see, our long OTM options cap our downside, mitigating the biggest risk of selling options: the unlimited losses. Of course, because there’s no free lunch, this costs us money because we have to buy options that we hope ultimately expire worthless. Characteristics of the Iron Condor The Iron Condor is Market Neutral The iron condor is market neutral, meaning it doesn’t take a directional price view, and instead profits from the lack of directional price movement. Traders often refer to this characteristic as “short volatility” because you’re betting that the stock price will move less than the options market is pricing in. You would use an iron condor when you expect the underlying stock to stay within a tight trading range and not bounce around a lot. The Iron Condor is a Theta Decay Strategy Because iron condors collect a net credit and are hence net short options, it is a positive theta strategy, meaning it benefits from the passage of time. Iron Condor Payoff and P&L Characteristics Iron condors have limited maximum profit potential as well as a limited maximum loss. The maximum profit is equivalent to the net credit collected from initiating the trade. You can easily calculate this by subtracting the cost of your long OTM wings from your short options. Let’s use our previous example: BUY (1) 394 PUT @ 2.28 SELL (1) 400 PUT @ 3.20 SELL (1) 420 CALL @ 3.45 BUY (1) 426 CALL @ 1.47 First, let’s sum the prices of our short options. Our 400 put costs $3.20 and our $420 call costs $3.45, meaning we collect $6.65 for selling these two options. Then, we simply add together the price of our long options, giving us a debit outlay of $1.47 + $2.28 = $3.75. Now we just subtract the debit from our credit to find our net credit, $6.65 - $3.75 = $2.90. Our maximum profit is $2.90 The maximum loss of an iron condor is simply the “wing width” minus the net credit received. Wing width refers to the distance between the strike prices two calls or two puts. In this case, we’d just subtract the 426 call from the 420 call, giving us a wing width for $6. Now we just subtract our net credit of $2.90 giving us a max loss of $3.10. Iron Condor Pros and Cons Pro: Low Capital Requirements Because the iron condor is a limited risk strategy, you can execute it with significantly less margin than selling the equivalent short strangle (which is the same trade, except without the long OTM options capping your losses). This makes it a very popular way for undercapitalized traders to harvest premium. Pro: Structure Trades With High Probability of Profit and No Huge Downside Many option traders approach the market with a systematically short-volatility positioning. They’re constantly selling options and rolling them out further if the trade goes against them. This is a strategy that can print money for a long time until you’re on the wrong side of a volatility event. Many traders, like James Cordier of OptionSellers.com have blown up as a result. For this reason, some traders take a similar approach using iron condors, avoiding catastrophic losses. However, this strategy has significant drawbacks as you’re harvesting significantly less premium because you’re buying the OTM options and reducing your net credit. Con: High Commission Costs The iron condor requires four options per spread, making it twice as expensive to trade compared to most two-option spreads like straddles, strangles, and vertical spreads. Unlike the stock market, where commissions are zero across all retail brokers, option commissions still leave a dent in your P&L, with the standard introductory rate being $0.60/contract, which you have to pay to both open and close, bringing it to $1.20 per contract. So even for a one-lot, you’re paying $4.80 to open and close an iron condor, which is typically structured with a low maximum profit, meaning that your commissions can be a hefty percentage of your P&L when trading iron condors. Con: Less Liquidity The combination of requiring simultaneous execution of four different option contacts usually means it takes longer to get filled on these trades, making active trading more difficult. What is an Iron Butterfly? The Iron Butterfly is like an Iron Condo with a higher reward/risk ratio but a lower probability of profit. The primary difference is the short strikes. In choosing your strikes in an Iron Condor or Iron Butterfly trade, you’re defining the range you expect the underlying to remain within. Iron Condors are more forgiving, as that range is much wider. Iron Butterflies, on the other hand, short puts and calls at the same strike, making your defined range narrower and making it less likely that you'll profit on the trade. You will, however make more money if you're right on the trade. Iron butterflies and iron condors are sisters. They express very similar market views and are structured similarly. The primary difference in practice is that the iron butterfly is a far more precise strategy. It’s harder to be right, but if you are right, you make much more money. The iron butterfly is composed of four options: two long options and two short options at the same strike. Here’s an example: BUY (1) 404 Put SELL (1) 412 put SELL (1) 412 call BUY (1) 420 call And here’s what the payoff diagram for this trade looks like: As you can see, the character of the trade is quite similar to the iron condor except for the fact that it has a more narrow opportunity to make profit. However, when the trade is in-the-money, the profits are much higher. So while most iron condors have relatively low reward/risk ratios and high win rates, iron butterflies are the opposite. They have a lower chance of success with a much higher reward/risk ratio. In this way, you can have the same view (the market will stay within a relatively tight range) and structure dramatically different trades around it. The iron condor will probably work out and net you a small profit, while the iron butterfly is a more confident approach giving you the chance for fatter profits. Like everything in options trading, it’s all about tradeoffs. Characteristics of the Iron Butterfly The Iron Butterfly is Market Neutral Just like the iron condor, short strangle, and short straddle, the iron butterfly has no directional price bias. It doesn’t care which direction the underlying stock moves. Instead, the iron butterfly is concerned with the magnitude of the price move. It profits when the underlying stock stays within a narrow range and doesn’t make any significant price moves. Due to the iron butterfly using just one short strike, the underlying stock must stay in a much more narrow range than with the iron condor. Whereas the iron condor has the freedom to define a wide range using a short put and call, the iron butterfly is short only one strike, leading to the cone-shaped payoff diagram. For this reason, the maximum profit is much higher with the caveat that the probability of reaching the maximum profit is far lower than that of the iron condor. In this way, the iron butterfly enables you to express a market-neutral and short-volatility market outlook with a high reward/risk ratio that would usually be a trait of a net debit strategy. The Iron Butterfly is a Theta Decay Strategy The goal of the iron butterfly strategy is for the short option to expire worthless, or at least with less value than you initially sold it for. As with any short options strategy, much of the profit comes from the stock price not moving, resulting in the option rapidly losing time value due to theta decay. Iron condors capitalize on the same phenomenon but with a different trade structure. The Iron Butterfly Has Limited Profit and Risk Potential The max profit and loss math for the iron butterfly is quite similar to that of the iron butterfly. The max profit is the net credit received when opening the position The max loss math works similarly to simply shorting a call or put. The further away the stock is from the strike price, the more the losses build until your long option hedges kick in and cap the losses. Iron Butterfly Pros and Cons Pro: Short Volatility With High Reward/Risk Ratio In general, market-neutral strategies that capitalize on theta decay tend to have poor reward/risk ratios, only making up for this drawback with a high win rate. The iron butterfly turns this on its head and instead has a much lower win rate than traditional short-volatility strategies with a higher reward/risk ratio, giving you the potential for asymmetric profits. Pro: Selling Options With Limited Risk For many traders who lean towards selling premium, the potential for unlimited, catastrophic losses keeps them up at night. Despite the low probability of an extreme price move, black swans seem to creep up more than anyone expects. The iron butterfly allows traders to mimic the payoff structure of simply selling a put or call while capping losses with long options on either side of their short option strike. Con: Narrow Range of Profitability An iron butterfly has a narrow range of profitability compared to the iron condor because there is only one short strike. This means there’s a far greater margin of error for strike selection, whereas the iron condor allows you to choose two strikes and define as wide of a range as you’d like. Summary Iron Condors are made up of both a short vertical spread and a short vertical put spread. Iron Butterflies are made up of two short options at the same strike and two long "wings" that protect your downside. Remember that option spreads are trade constructions, not trade strategies. There's no inherent edge in trading Iron Condors or Iron Butterflies. They're just tools to apply to market dynamics where its more likely for markets to stay range-bound. Related articles Trading An Iron Condor: The Basics Butterfly Spread Strategy - The Basics 4 Low Risk Butterfly Trades For Any Market Environment Using Directional Butterfly Spread Options Trading Greeks: Gamma For Speed Options Trading Greeks: Vega For Volatility Why You Should Not Ignore Negative Gamma Iron Condor Vs. Iron Butterfly

It's a core tenant of how options are priced, and it's often the trader with the most accurate volatility forecast who wins in the long term. Whether you like it or not, you're taking an inherent view on volatility anytime you buy or sell an option. By purchasing an option, you're saying that volatility (or how much the options market thinks the underlying will move until expiration) is cheap, and vice versa. With volatility as a cornerstone, some traders prefer to do away with forecasting price directionality entirely and instead trade based on the ebbs and flows of volatility in a market-neutral fashion. Several option spreads enable such market-neutral trading, with strangles and straddles being the building blocks of volatility trading. But even though straddles and strangles are the standards, they sometimes leave something to be desired for traders who want to express a more nuanced market view or limit their exposure. For this reason, spreads like iron condors and butterflies exist, letting traders bet on changes in options market volatility with modified risk parameters. Today, we’ll be talking about the iron condor, one of the most misunderstood options spreads, and the situations where a trader may want to use an iron condor in favor of the short strangle. What is a Short Strangle? Before we expand on the iron condor and what makes it tick, let's start by going over the short strangle, a short-volatility strategy that many view as the building blocks for an iron condor. An iron condor is essentially just a hedged short strangle, so it's worth understanding them. A strangle comprises an out-of-the-money put and an OTM call, both in the same expiration. A long strangle involves buying these two options, while a short strangle involves selling them. The goal of the trade is to make a bet on changes in volatility without taking an outright view on price direction. As said, strangles and straddles are the building blocks for options volatility trading. More complex spreads are constructed using a combination of strangles, straddles, and "wings," which we'll explore later in the article. Here’s an example of a textbook short strangle: The goal for this trade is for the underlying to trade within the 395-405 range. Should this occur, both options expire worthless, and you pocket the entire credit you collected when you opened the trade. However, as you can see, you begin to rack up losses as the market strays outside of that shaded gray area. You can easily calculate your break-even level by adding the credit of the trade to each of your strikes. In this case, you collect $10.46 for opening this trade, so your break-even levels are 415.46 and 384.54. But here's where the potential issue arises. As you can see, the possible loss in this trade is undefined. Should the underlying go haywire, there's no telling where it could be by expiration. And you'd be on the hook for all of those losses. For this reason, some traders look to spreads like the iron condor, which lets you bet on volatility in a market-neutral fashion while defining your maximum risk on the trade. Iron Condors Are Strangles With “Wings” Iron condors are market-neutral options spreads used to bet on changes in volatility. A key advantage of iron condors is their defined-risk property compared with strangles or straddles. The unlimited risk of selling strangles or straddles is Iron condors are excellent alternatives for traders who don't have the temperament or margin to sell straddles or strangles. The spread is made up of four contracts; two calls and two puts. To simplify, let's create a hypothetical. Our underlying SPY is at 400. Perhaps we think implied volatility is too high and want to sell some options to take advantage of this. We can start by constructing a 0.30 delta straddle for this underlying. Let's use the same example: selling the 412 calls and the 388 puts. We're presented with the same payoff diagram as above. We like that we're collecting some hefty premiums, but we don't like that undefined risk. Without putting labels on anything, what would be the easiest way to cap the risk of this straddle? A put and a call that is both deeper out-of-the-money than our straddle. That's pretty easy. We can just buy further out-of-the-money options. This is all an iron condor is, a straddle with "wings." Another way of looking at iron condors is that you’re constructing two vertical credit spreads. After all, if we cut the payoff diagram of an iron condor in half, it’s identical to a vertical spread: Here’s what a standard iron condor might look like when the underlying price is at 400: ● BUY 375 put ● SELL 388 put ● SELL 412 call ● BUY 425 call The payoff diagram looks like this: The Decision To Use Iron Condors vs. Short Strangles Ever wonder why the majority of professional options traders tend to be net sellers of options, even when on the face of things, it looks like you can make huge home runs buying options? Many natural customers in the options market use them to hedge the downside in their portfolios, whether that involves buying puts or calls. They essentially use options as a form of insurance, just like a homeowner in Florida buys hurricane insurance not because it's a profitable bet but because they're willing to overpay a bit for the peace of mind that their life won't be turned upside down by a hurricane. Many option buyers (not all!) operate similarly. They buy puts on the S&P 500 to protect their equity portfolio, and they hope the puts expire worthless, just as the Florida homeowner prays they never have actually to use their hurricane insurance. This behavioral bias in the options market results from a market anomaly known as the volatility risk premium. All that means is implied volatility tends to be higher than realized volatility. And hence, net sellers of options can strategically make trades to exploit and profit from this anomaly. There's a caveat, however. Any source of returns that exists has some drawback, a return profile that perhaps isn't ideal in exchange for earning a return over your benchmark. With selling options, the risk profile scares people away from harvesting these returns. As you know, selling options has theoretically unlimited risk. It's critical to remember that when selling a call, you're selling someone else the right to buy the underlying stock at the strike price. A stock can go up to infinity, and you're on the hook to fulfill your side of the deal no matter how high it goes. So while there can be a positive expected value way to trade from the short side, many aren’t willing to take that massive, undefined risk. And that's where spreads like the Iron Condor come in. The additional out-of-the-money puts and calls, often referred to as 'wings,' cap your losses, allowing you to short volatility without the potential for catastrophe. But it's not a free lunch. You're sacrificing potential profits to assure safety from catastrophic loss by purchasing those two OTM options. And for many traders, this is too high a cost to harvest the VRP. In nearly any, backtest or simulation, short strangles come up as the clear winner because hedging is generally -EV. For instance, take this CBOE index that tracks the performance of a portfolio of one-month .15/.05 delta iron condors on SPX since 1986: Furthermore, there's the consideration of commissions. Iron condors are made up of four contracts, two puts, and two calls. This means that iron condor commissions are double that of short strangles under most options trading commission models. With the entry-rate retail options trading commission hovering around $0.60/per contract, that’s $4.80 to open and close an iron condor. This is quite an obstacle, as most iron condors have pretty low max profits, meaning that commissions can often exceed 5% of max profit, which has a big effect on your bottom line expected value. Ultimately, it costs you in terms of expected value and additional commissions to put on iron condors. So you should have a compelling reason to trade iron condors in favor of short strangles. Bottom Line Too many traders get stuck in the mindset of "I'm an iron condor income trader" when the market is far too chaotic and dynamic for such a static approach. The reality is that there's an ideal strategy for risk tolerance at a given time, in a given underlying. Sometimes the overall market regime calls for a short-volatility strategy, while others call for more nuanced approaches like a calendar spread. There are times when it makes sense to trade iron condors when implied volatility is extremely high, for instance. High enough that any short-vol strategy will print money, but too high to be naked short options. Likewise, there are times when iron condors are far from the ideal spread to trade. Another comparison is Iron Condor Vs. Iron Butterfly Like this article? Visit our Options Education Center and Options Trading Blog for more. Related articles Selling Naked Strangles: The Math Selling Short Strangles And Straddles - Does It Work? Trading An Iron Condor: The Basics Low Premium Iron Condors Why Iron Condors Are NOT An ATM Machine Can You Really Make 10% Per Month With Iron Condors? Comparing Iron Condor And Iron Butterfly Butterfly Spread Strategy - The Basics Iron Condor Vs. Iron Butterfly

Timing Some investors believe they have a ‘feel’ for the market, or individual stocks and ‘know’ when that stock is going to make a large move. If you are one of them, then don’t open an iron condor position unless you believe the stock is NOT going to make such a move before the options expire. As an alternative you can have an iron condor position with a bullish or bearish bias. You do that by choosing appropriate strike prices for the options spreads you choose. Many investors (that includes me) cannot predict the future and are willing to own positions that profit when the market holds steady, trades within a range that’s not too wide, or if the market does move significantly in one direction, does so at a slow and steady pace. Underlying It’s generally safer to trade iron condors on indexes because you never have to be concerned with a single stock issuing unexpected news that results in a gap of 20% or more. True that can happen with an index if there is world-shattering news – but it’s a much less likely event. Most indexes in the U.S. are European style vs. American style. That means they cannot be exercised before expiration – and that’s to your advantage. We’ll discuss the differences between these option ‘styles’ another day. Expiration Month Most iron condor traders prefer to have positions that expire in the front month (options with the least time remaining before they expire). These options have the most rapid time decay, and when you are a seller of option premium (when you collect cash for your positions as opposed to paying cash), the passage of time is your ally and rapid time decay is a positive attribute for your position. However, there are negative factors associated with front-month options: With less time remaining, iron condor positions are worth less than if there were more time remaining. Thus, you collect less cash when you open the position. If the index undergoes a substantial price change, the rate at which money is lost is significantly greater when you have a front-month option position. It’s too early in your education to discuss why this is true in detail, but it’s because they gain or lose value more rapidly than options with longer lifetimes. This is effect of gamma, one of the ‘Greeks’ used to quantify risk when trading options. Because there are so many topics to discuss, I will not be getting to the Greeks for quite awhile. When you sell options that expire in the 2nd or 3rd month, you collect higher cash premiums (good), have positions that lose less when something bad happens (good), but there is more time for something bad to happen (bad). When you have iron condor positions, you don’t want to see something bad (and that’s a big market move). The more time remaining before the options expire, the greater the chance that something bad happens. That’s why traders who sell* iron condors are willing to pay you a higher price for them. Strike Prices and Premium Collected Choosing the strike prices for your iron condor position – and deciding how much cash credit you are willing to accept for taking on the risk involved – are irrevocably linked. Thus, I’ll discuss them together. Assume the call spread and put spread are each 10-points wide. For example: (RUT is the (Russell 2000 index) Sell 10 RUT Sep 620 put Buy 10 RUT Sep 610 put Sell 10 RUT Sep 760 call Buy 10 RUT Sep 770 call If you are not a member yet, you can join our forum discussions for answers to all your options questions. Market bias Most of the time that you open an iron condor, you have a neutral opinion, i.e., you have no expectation that the stock is going to move in one direction as opposed to the other. As a result, you tend to choose a call spread and a put spread that are equally out of the money. To put it simply – the call and put you sell will each be approximately the same number of points away from the price of the underlying security. In our example above, If RUT is trading near 690, the 620 put and the 760 call are each 70 points out of the money, and the position is ‘distance neutral.’ There are other methods you can use to have a position that is ‘neutral.’ Instead of equally far out of the money, you may choose to sell spreads that bring in the same amount of cash. This is ‘dollar neutral,’ a method seldom used. If you understand the term delta (we’ll get to it eventually) you may choose to sell spreads with equal delta. I don’t recommend this method for iron condors, although ‘delta neutral’ trading has a great deal to recommend it under different circumstances. If you are bullish, you can choose to sell put spreads that bring in more cash, attempting to profit if the stock or index does move higher, per your expectation. If you are bearish, you can choose to sell call spreads that bring in more cash, attempting to profit if the stock or index does move lower, per your expectation. How far out of the money Most investors believe that the further out of the money the options they sell, the ‘safer’ their position and the less risk they have. That's one way to look at ‘safety.’ Probability vs. Maximum loss. If you sell the RUT 580/590 put spread instead of the 610/620 put spread, there is a higher probability that the options you sell will expire worthless, allowing you to earn the maximum profit that trading this iron condor allows. I believe that is intuitively obvious, but for those who don’t see it, consider this (and for the purposes of this discussion, assume you hold this position until the options expire): Most of the time the options expire worthless, but part of the time, RUT moves far enough below 620, resulting in a loss. Part of the time that RUT is below 620 at expiration, it is also below 590. But, the probability that it’s below 590 must be less than the probability that it’s below 620 because part of the time RUT is going to be between 590 and 620. Thus, you lose money less often, when you sell options that are further out of the money. That fits the first definition of ‘safer’. But, you can also look at it this way. When you sell the 580/590 put spread, you collect less cash than when you sell the 610/620 put spread. This is always true: the more distant the options are from the market price of the underlying stock or index, the less premium you collect when selling single options or option spreads. This is why it’s so important to find your comfort zone when choosing the options that make up your iron condor. You can trade options that are very far out of the money. These positions have a very small chance of losing money. You can easily find iron condors with a 90% (or even higher) probability of being winners. However, the cash you collect may be too little to make the trade worthwhile. Some investors are willing to sell iron condors and collect between $0.25 and $0.50 for each spread, netting them $50 to $100 per iron condor. If that makes you comfortable, then it’s okay for you to trade this way. For my taste, the monetary reward is too small. NOTE: Selling a spread for $0.40 translates into $40 cash, and the possibility of losing $960. Remember that the maximum loss is very high, and one giant loss can wipe out years of gains. The maximum loss is $950 per iron condor, when you only collect $50 to initiate the trade. You can trade options that are far out of the money, but not so far that the premium you collect is too small. You still have a high probability of owning a winning position. You have the potential to earn more money because you collected more cash upfront. The maximum loss is reduced, and some consider this position ‘safer.’ That fits the second definition of safety. You can sell options that are closer to the money. This reduces your chances of having a comfortable ride through expiration, and increases the chances of losing money. In return for that reduced probability of success, potential profits are significantly higher. You may decide to collect $400 or $500 per iron condor. The maximum loss is much smaller, and again, that fits the second definition of owning a safer position. Your goal should be to find iron condors that places you well within your comfort zone. And if you are unsure of how your comfort zone is defined, use a paper trading account to practice trading iron condors (or any other strategy). I know that real money is not at risk, but if take the positions seriously, you can determine which iron condors leave you a bit uneasy and which ‘feel’ ok. Advice: Don’t make the decisions about comfort based on which trades are profitable. Base the decision on which iron condors make you nervous about potential losses both when you open the position and as the risk changes over time. It’s easy to randomly open positions and hope they work. But it’s better to open positions that fall within your comfort zone. Summary Here’s a statement I am going to make repeatedly when giving stock option advice: There is no ‘right’ choice. As an investor, you want to hold positions that are comfortable for you. The best way to discover your comfort zone is to trade. But, please use a practice account and do not use real money until you truly understand how iron condors (or any other strategy) work. Some traders always trade the near-term (front-month) options, while others (myself included) prefer options that expire in two, three, or even four months. Another comparison is Iron Condor Vs. Iron Butterfly Related Articles: Trade Iron Condors Like Never Before Why Iron Condors are NOT an ATM machine Why You Should Not Ignore Negative Gamma 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? Trade Size: Taming The 800-Pound Gorilla Want to join our winning team? Start Your Subscription

Iron Condor Description Iron Condor is a vega negative gamma negative trade. Choosing the strike prices for your iron condor position – and deciding how much cash credit you are willing to accept for taking on the risk involved – are irrevocably linked. If your strike has lower deltas, you will get less credit, but also higher probability. As we know, Risk/reward and Probability of Success have reverse relationship. Construction: Buy one out-of-the-money put with a strike price below the current price. Sell one out-of-the-money put with a strike price closer to the current price. Sell one out-of-the-money call having a strike price above the current price. Buy one out-of-the-money call with a strike price further above the current price. Lets take a look at typical Iron Condor trade using SPX and 15 deltas for the short options. As we can see, we are risking ~$750 to make ~$250 (around 33% gain), but we have a fairly high probability of success (~78%). We can select tighter strikes, for higher credit and better risk/reward, but we will be sacrificing the probability of success. Iron Butterfly Description Iron Butterfly spread is basically a subset of an Iron Condor strategy using the same strike for the short options. Construction: Buy one out-of-the-money put with a strike price below the current price. Sell one at-the-money put. Sell one at-the-money call. Buy one out-of-the-money call with a strike price above the current price. Lets take a look at Iron Butterfly trade using SPX: As we can see, we are risking ~$880 to make ~$4,120 (around 455% gain), but we have a fairly low probability of success (~30%). We can select further OTM long strikes, for lower credit and higher probability of success. But generally speaking, Iron Butterfly will usually have a better risk/reward but lower probability of success than Iron Butterfly. Which one is better? As you can see, there are tradeoffs to each strategy. Both strategies benefit from range bound markets and decrease in Implied Volatility. The Iron Butterfly has more narrow structure than the Iron Condor, and has a better risk-to-reward, but also lower probability of success. If the underlying stays close to the sold strike, the iron Butterfly trade will produce much higher returns. Both strategies require that the underlying price stay inside of a range for the trade to be profitable. The Iron Condor gives you more room, but the profit potential is usually much less. Generally speaking, Iron Condor is a High(er) Probability trade and Iron Butterfly is a Low(er) Probability trade. However, those probabilities refer to holding both trades till expiration. In reality, we rarely hold them till expiration. We usually set realistic profit targets and exit at least 2-3 weeks before expiration, to reduce the negative gamma risk. The bottom line is that the strategies are pretty similar because they profit from the same conditions. The major difference is the maximum profit zone, for a condor is much wider than that for a butterfly, although the tradeoff is a lower profit potential. Related articles Trading An Iron Condor: The Basics Butterfly Spread Strategy - The Basics 4 Low Risk Butterfly Trades For Any Market Environment Using Directional Butterfly Spread Options Trading Greeks: Gamma For Speed Options Trading Greeks: Vega For Volatility Why You Should Not Ignore Negative Gamma

Why Steady Condors is different? Can you make 10% per month with Iron Condors? Yes, you can - but this is a wrong question to ask. The right question is how much you lose when the market goes against you? Steady Condors at its core is managed by the Greeks but mostly resembles a variation of iron condors. Anyone who has traded more than a handful of non-directional iron condors knows they can be extremely challenging in a trending market potentially causing a lot of stress, large drawdowns, and significant losses. Our manage by the Greeks philosophy is designed to take advantage of the volatility skew that naturally exists in index options like RUT and SPX and to deal with the inherent flaws this creates for traditional condors. We all know that the market “takes the stairs up and the elevator down” and this is built into index options pricing. For condors this means that you will be able to sell much farther OTM puts than calls for the equivalent premium. This causes a traditional iron condor to naturally set up short Delta (bearish). If the market makes a move up after trade launch you will start to lose money immediately even with declining implied volatility typically helping your short Vega position. August 2011 Case Study We certainly saw plenty of upside in the recent years. But as we all know, the market tends to take the stairs up and the elevator down. Steady Condors is short Vega, and I thought it would be a good example to show the backtested example of the Steady Condors trade during the August 2011 correction/crash. The trade began like normal on July 6, 2011. 44 DTE. Note that RUT was at 844. No adjustments were necessary until 8 days into the trade when RUT was at 832. Interesting though was RUT had first moved up to nearly 860 before starting its descent. The short leg of the put debit spread was rolled down 20 points. Business as usual. On July 18, 32 DTE and 12 DIT, another debit spread was added (one other had also been added a few days prior) and the call credit spreads were taken off for 20 cents. RUT at 816, down about 1 standard deviation since entering the trade. Being down 1 standard deviation in 12 days isn't necessarily concerning, but RUT has declined over 40 points from its high. PnL is in good shape, up about 1%. On July 27, 21 DIT, RUT is at 806 and another debit spread is added (rolling down the 800 short to 780). At this point the move down is still reasonable (around 1 standard deviation after 21 days). PnL is in good shape up about 2% at this point. The debit spread adjustments are causing the trade to look more like a bearish butterfly than a condor. No additional long puts have been necessary yet at this point. Skipping ahead to Aug 2, 27 DIT and 17 DTE, RUT is now at 783. A few more debit spreads have been added at this point. The idea is to simply keep managing position delta as RUT moves further down. PnL is in great shape, closing in on target profit, up close to 4%. In situations like this I will consider going for more profit because it's possible to make significantly higher returns when the trade finishes under the "wing". One or two months per year we can usually get 5%+ out of the MIC. Later in the day on Aug 2 position delta reached the adjustment target again so at this point a long put was added. Rational for the long put (compared to yet another debit spread) was as follows...1. There is more than enough potential profit and theta in the trade 2. This was the second adjustment in the same day with the daily move over 1.5 SD 3. RUT has moved down 66 points since trade launch and 82 points since the high. 4. The short leg of the put credit spreads are now carrying a delta of 30 increasing the short gamma of the position. One day later on Aug 3 another long put was needed. It would certainly be reasonable to take profits at this point, the key is to keep the t+0 line as flat as possible while maintaining as much theta as possible. Note how flat the t+0 line is, and also how it curves up if a serious crash would occur. Translation: minimal fear of additional downside. One day later on Aug 4 with RUT at 752 the trade was taken off for target profit of 5% and because RUT touched the short put strike, and theta was now negative. IV had increased 56% in the 29 DIT and the total move represented over 2 standard deviations. Max margin at the beginning of the trade was just over $26,000, and by the end of the trade margin was down to less than $17,000. Just to show the power of risk management, the next picture is the original trade with no adjustments. Although the setup is important, it's the adjustments that make the difference. Without them, the trade would have been down 22% at the point it was taken off for target profit. One last interesting point...On Monday Aug 8 RUT closed down 64 points at 650. If you wouldn't have taken the trade off on the 4th the trade would actually have been up 67% at the end of the day on the 8th. Frankly I'm not familiar with another variation of Iron Condor that can actually make a gain after the index declines by 11%+. Note: our current setup is slightly different, but the general principle is very similar. Related articles: Steady Condors 2015 Report: 46.7% Return 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? Why Iron Condors Are NOT An ATM Machine Can You Really Make 10% Per Month With Iron Condors? Is Your Iron Condor Really Protected? Want to learn more? Start Your Free Trial

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. Another comparison is Iron Condor Vs. Iron Butterfly 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 Selling Naked Strangles: The Math Selling Short Strangles And Straddles - Does It Work? Selling Options Premium: Myths Vs. Reality Karen The Supertrader: Myth Or Reality? Karen Supertrader: Too Good To Be True? How Victor Niederhoffer Blew Up - Twice The Spectacular Fall Of LJM Preservation And Growth James Cordier: Another Options Selling Firm Goes Bust Trading An Iron Condor: The Basics The Hidden Dangers Of Iron Condors

Trade Explanation: For the Volatility Advisory in NFLX, we are selling the Apr 427.5 puts and 520 calls and buy the Apr 425 puts and 522.5 calls for a net credit of $0.91 to open. Underlying Price: $474.22 Price Action: We are selling this $2.5-wide Iron Condor in the online streaming company for a credit of $0.91. For an Iron Condor trade, we sell an out-of-the-money Call Vertical (520/522.5) and Put Vertical (427.5/425) simultaneously. The company has earnings after the close and the option markets are pricing in a move of 8-9%. We expect the shares to move after the report but are giving ourselves a nice range of $92.5 between the short strikes. We need the shares to continue to trade between our break-even levels of $426.59 on the downside and $520.91 on the upside. The following was described as a rationale for the trade: Volatility: Volatility is elevated in the Apr options which makes this trade attractive. The IV percentile rank is elevated at 73% also which also gives us a good opportunity to sell this Iron Condor. We expect volatility to fall sharply after earnings which will contract the value of this short-term neutral position. Probability: There is an 80% probability that NFLX shares will be below the $520 level and a 80% probability that it will be above the $427.5 level at Apr expiration. This trade offers a good Risk/Reward scenario with the amount of credit collected vs. the probability numbers for this position. Trade Duration: We have 2 days to Apr expiration in this position. This is a short-term position and time decay will increase quickly due to the time frame and the earnings report. Logic: We want to take advantage of the increased volatility in our option by initiating this earnings play. Our short verticals are outside of the anticipated one standard deviation move that the options are pricing in so our probabilities are positive. The shares will hopefully remain between our short verticals and we will be aggressive in closing the trade. My comments: It is true that Volatility is elevated in the Apr options, but this is completely normal, considering the upcoming earnings and does NOT make the trade attractive. It is also true that volatility will fall sharply after earnings, but it is not relevant if the stock will be trading above the long strikes. In this case, the trade will still lose 100%. 2 days to Apr expiration makes the trade much more risky because there will be no time to adjust or take any corrective action. "80% probability that NFLX shares will be below the $520 level" means nothing when earnings are involved. The price action will be determined by earnings only, not by options probabilities. "The shares will hopefully remain between our short verticals" - hope is not a strategy. The short strikes are less than 10% from the stock price, which is not far enough, considering NFLX earnings history. Now, I want you to take a look at the last 10 cycles of NFLX post-earnings moves: (This screenshot is taken from OptionSlam.com). Now, I'm asking you this: WHO IN HIS RIGHT MIND WOULD TRADE AN IRON CONDOR WITH SHORT STRIKES LESS THAN 10% FROM THE STOCK, ON A STOCK THAT HAS TENDENCY TO MOVE 15-25% AFTER EARNINGS ON A REGULAR BASIS??? The stock is trading above $530 after hours. If it stays this way tomorrow, this trade will be a 100% loser, and there is NOTHING you can do about it. But frankly, the final result doesn't really matter. To me, this trade is simply insane and shows complete lack of basic options understanding. That said, I'm not completely dismissing trading Iron Condors through earnings. For many stocks, options consistently overestimate the expected move, and for those stocks, this strategy might have an edge (assuming proper position sizing). But NFLX is one of the worst stocks to use for this strategy, considering its earnings history. Watch the video: If you want to learn how to trade earnings the right way (we just booked 30% gain in NFLX pre-earnings trade): Start Your Free Trial

Such lawsuits are common and typically lack merit because offering documents are properly drafted to protect the companies involved and disclose the risk. I find it unlikely that the documents were not properly drafted. For instance, in one of the few actual UBS documents I could find on UBS’s yield enhancement strategies provided “yield enhancement strategy products are designed for investors with moderate risk tolerance who want to enhance the low to moderate return typically generated in a ‘flat’ or ‘sideways’ market.” That’s a great description for trading iron condors. So, if the documents were fine (most likely, but you never know), what was the issue?Most likely overzealous brokers pushed the strategy without really understanding the risk profile. My takeaway from reading about this is two part. First, investors typically don’t understand options, and the media certainly does not. Most advisors do not either. For instance, the media has called the strategy used by UBS a “leveraged, esoteric options strategy.” Iron condors are neither esotericor typically leveraged. They are the definition of a defined risk option strategy. A profit/loss graph of an iron condor looks like: There is a maximum loss on any single trade that can be controlled based on the strikes and premiums received. UBS’s strategy purportedly used iron condors on the S&P 500 index, the NASDAQ, and other “primary” market indexes – so volume should not have been an issue. Other writers have demonstrated their ignorance of the strategy. One popular critique of the UBS strategy reads: “The problems with YES began in 2018 with violent fluctuations in the S&P 500…The most volatile period was between October and December 2018, during which time the market declined 20%--then followed by a rebound of 12% through January 2019. The violent swings caused the premiums of both the put and call side of the iron condor strategy to spike, leading to losses on both sides of the trade.” But this is practically impossible. An investor can’t experience losses on BOTH sides of the graph (in effect doubling the losses), unless the traders are idiots. The only way to have that happen is to close out one half of the trade for a loss, in the hopes that the profits on the other side will increase, but then the market whipsaws back, thus causing losses on both sides. Of course, at this point, the strategy is no longer an iron condor. It’s a simple vertical spread: The odd thing about this critique is that even vertical spreads have loss limits. Let’s say the UBS traders had a maximum loss rate of ten percent. A structured iron condor can have a max loss of ten percent the same as a vertical spread. If the traders are trading to profit from time decay across multiple indexes, risk could be further controlled through the use of reverse iron condors that have a profit and loss graph of: In the event of a large move, such a position could help offset losses. (There are other ways to protect against such a move as well – anything from simply buying long dated out of the money puts and calls to trading volatility instruments). The problem with a normal iron condor in a low volatility market is that traders do not receive a very high premium for the risk they take. In order to get a 1% or 2% return per month, UBS traders would have to be taking risks that were outside of the “moderate” or “low” range. Traders probably started taking chances they shouldn’t have. Much of the media has commented that the UBS traders “compounded” their results by trying to “make up” for losses after blowing up trades. (Who of us hasn’t done that?) Traders make trade adjustments or open new trades on the prediction that either (a) the price will return to the mean or (b) the price will continue moving. It appears the UBS traders made the bet that the price would continue moving, and instead it reverted to the mean. Of course,when traders do that, they are no longer trading risk defined iron condors. They are making directional market bets – bets that if wrong, make the situation worse. What can we, as option traders, learn from this? Trading is as much psychological, as it is methodical, even for supposed professionals. Losses will occur and decisions will be made trying to “make up” for losses rather than staying within stated trading guidelines. This is a mistake. Plan trades, plan for what happens when the trades go wrong, and when they do go wrong, stick to the plan. Sure you might occasionally “fix” what went wrong, but more often than not, you’ll likely make the situation worse; The general public views option as “high risk” investments. They are not, when handled properly. In fact, as option traders know, options can be used to mitigate risk. Try to combat the disinformation when you can; Don’t trust plaintiff class action lawyers. I personally do not understand all of the class type legal advertising that exists because of the strategy. By all accounts, all UBS agreements require FINRA arbitration of individual claims. This greatly decreases the profit potential for attorneys, unless the client lost hundreds of thousands of dollars (in which case the client is probably not calling Saul from the internet for the case). Strangely, that is what can currently be seen. Christopher Welsh is a licensed investment advisor and president of LorintineCapital, LP. He provides investment advice to clients all over the United States and around the world. Christopher has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Christopher has a J.D. from the SMU Dedman School of Law, a Bachelor of Science in Computer Science, and a Bachelor of Science in Economics. Christopher is a regular contributor to the Steady Options Anchor Trades and Lorintine CapitalBlog.

Unfortunately, most people are being misled when it comes to Iron Condors. The potential gains are certainly amazing, but the risks are high as well. Anyone trying to achieve a 5% per month return is likely taking on a lot more risk than they realize. I’ve heard this story from beginner traders too many times to remember – “everything was going great, I was making loads of money with my weekly condors, and then WHAM, I lost 6 months’ worth of gains in 1 week”. Those are the risks when it comes to Iron Condors, and the shorter the timeframe you are trading, the more likely you are to suffer a catastrophic loss at some point. Early February was a prime example. Anyone trading weekly Iron Condor would have been killed. GAMMA RISK Short-term Iron Condors have a huge amount of Gamma risk. Gamma risk is effectively price risk. Trades with negative gamma will suffer from a big move in the underlying stock. Iron Condors as you might have guessed, are short gamma. Short-term Iron Condors have a lot more negative gamma (or price risk) than longer term Iron Condors. Let’s evaluate two theoretical examples set up just before the recent selloff. SHORT-TERM IRON CONDOR This short term Condor could have been set up towards the close on Thursday February 1st when RUT was trading at 1575. LONG-TERM IRON CONDOR This longer-term Condor could have also been set up late on Thursday the 1st of February. Notice that between the two examples, Delta and Vega and almost the same, but the longer-term trade has almost no Gamma. The trade off is lower Theta as Gamma and Theta go hand in hand. ONE WEEK LATER Let’s fast forward to the close of trading on Monday February 12th and RUT has dropped nearly 100 points to 1496. The short-term Condor has been well and truly crushed and is down over $10,0000. In comparison, the long-term Iron Condor is actually in profit to the tune of $100! SHORT-TERM CONDOR LONG-TERM CONDOR I hope you enjoyed this case study, if you want to learn more about how to manage Iron Condors, join me for a live training session coming up soon. Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. He likes to focus on short volatility strategies. Gavin has written 5 books on options trading, 3 of which were bestsellers. He launched Options Trading IQ in 2010 to teach people how to trade options and eliminate all the Bullsh*t that’s out there. You can follow Gavin on Twitter.

A lot of option trading websites promise you to make 10% per month with Iron Condors. Is this true? Well, it is actually not that hard to make 10% per month with iron condors. The problem is, in order to make 10% on your entire account, you would need to place ALL capital into Iron Condors. If you do that, it's only matter of time till your account is toast. So yes, if it's too good to be true, it usually is. Many of them actually recommend placing 70-80% of your account into those trades (and keep the rest in cash). They claim that since they have 3-4 trades (usually on the broad market indexes like RUT, SPX or NDX), it provides them the necessary diversification. What they fail to mention is the fact that those indexes are 90% correlated and tend to move in tandem. To me, this is not diversification. To add insult on injury, many of them recommend placing 80% of your account into weekly trades. To me, this is a financial suicide. I love Iron Condors! I love Iron Condors and I trade them regularly when the conditions are right. In the long run, those trades can produce a steady 8-10% gain per month. Depending on the deltas of the sold options, they usually have pretty high winning ratio. You can expect to win in 8-9 months per year. The trick is not to lose much in the losing months. Of course this is easier said than done. With proper risk management, most of the time this goal is achievable. However, once in a while, despite all the good efforts, the Iron Condor trade can lose 40-50% and there is nothing you can do about it. To reduce the possibility of a big loss, I have few strict rules for Iron Condors: Open the trade 6-8 weeks before expiration. To reduce the gamma risk, never hold till expiration week. Close about 2-3 weeks before expiration or when sufficient profit has been achieved. Never let the average loss to be much higher than the average gain. For example, if your average winner is around 15%, don't allow the average loser to be more than 25-30%. Iron condors are a short Vega trade. So it makes sense to trade them when volatility is high and expected to go down. I would not trade them (or at least significantly reduce the allocation) when VIX is around 12-15. So what is the problem? As long as you follow those rules and don't allocate big portions of your account to those trades, you should be able to survive few occasional losses. Here are some mistakes that people do when trading Iron Condors and/or credit spreads: Opening the trade too close to expiration. There is nothing wrong with trading weekly Iron Condors - as long as you understand the risks and handle those trades as semi-speculative trades with very small allocation. Holding the trade till expiration. The gamma risk is just too high. Allocating too much capital to Iron Condors. Trying to leg in to the trade by timing the market. It might work for some time, but if the market goes against you, the loss can be brutal and there is no another side of the condor to offset the loss. Trading every single month, regardless of the market conditions. To me, it doesn't make sense to place an Iron Condor trade when VIX is at 12. You are not getting enough credit for the risk and you have to choose the strikes too close to the underlying. Unfortunately, some options "gurus" make those mistakes on a consistent basis. What can go wrong - a case study To demonstrate what could go wrong with this approach, let's go back few weeks, to Friday April 12. RUT has been on a steady climb, and you decide to place a bull credit spread using weekly options expiring the next Friday. With RUT at $943, you decide to sell the 920/910 put spread for $0.67. If RUT stays above 920 by next Friday, that's a potential 7.1% gain in one week. Not bad. If you can do it week after week, you are going to be very rich. Fast forward to Monday April 15. RUT is down to $906 and your spread is worth $7.00. That's 68% loss. Ouch. But wait - maybe we can give it few days to recover? Fast forward to Thursday April 18. RUT is at $901 and the spread is worth $9.40, a 93% loss. The big loss was caused by 2 factors. The first one of course is a sharp and quick move. The second one is a sharp increase in the IV (Implied Volatility) of the options due to the sharp move. Iron Condor is a vega negative trade, and any spike in IV has a negative impact on the trade, multiplying the loss. The easy excuse - blame the market Market conditions play a big role in the success of this strategy. The recent market strength has been tough for credit spread traders. Implied Volatility has been on a steady decline, and options premiums simply do not justify the risk. In order to get a decent credit, you had to go closer and closer to the current price every cycle. And when IV spikes, the trade can be a big loser. Many options newsletters that trade exclusively credit spreads have experienced heavy losses. Some of the subscribers have reported losing as much as 80% of their accounts. By the way, if you are not a subscriber, you probably not going to see those losses in the track records. Many newsletters use a trick called "rolling" that allows them to hide the loss almost as long as they wish. In some cases, after heavy losses they simply "reset" the old portfolio and start a new one from scratch. It is very easy to blame the market, Mr. Bernanke, the irrationality of other investors etc. The simple truth is that allocating 80% of the account to credit spreads and presenting it as "safe and conservative strategy" is very misleading. Credit spreads can be very brutal and should be treated with respect. Conclusion At SteadyOptions, we trade credit spreads too. But they are always part of a well diversified options portfolio and never exceed 20% of the account. We also hedge them with gamma and vega positive trades to reduce the risk. This is why we are doing so well and have never experienced a major drawdown. If you are still not a member, we invite you to take the SteadyOptions free trial and see by yourself. Please refer to Frequently Asked Questions for more details. Related articles: Why You Should Not Ignore Negative Gamma Options Trading Greeks: Gamma For Speed Why Iron Condors Are NOT An ATM Machine

Introduction to Iron Condors The Iron Condor is a combination of a bull put spread and a bear call spread. The basic construction is: Sell 1 OTM Put Buy 1 OTM Put (Lower Strike) Sell 1 OTM Call Buy 1 OTM Call (Higher Strike) All options expire at the same month. The distance is usually the same between the short and the long legs of the calls and the puts. A typical P/L chart looks like this: The Iron Condor option strategy is a theta positive gamma negative and vega negative strategy. That means that it benefit from time decay, but suffers if the underlying moves too much and/or Implied Volatility increases. One approach that can maximize credit received and the profit range of the iron condor, is to leg into the position. "Legging in" refers to creating the put spread and the call spread at times that when market makers are inflating the prices of either the sold call or put. However, most experts agree that this approach hardly justifies the risk. Iron Condor Trading Parameters So before you start trading with the Iron Condor option strategy, there are two most important things you need to decide about: How far in time to go (expiration). How far OTM to go (strikes). The time can vary between one week and three months. Those are the extremes, most people go for 3-10 weeks. Going with close expiration will give you larger theta per day. So you might earn 5% in one week or 10% in month or 15% in two months. Obviously 5% every week is better than 10% every month. But there is a catch. Less time to expiration equals larger negative gamma. That means that a sharp move of the underlying will cause much larger loss. If the underlying doesn't move, then theta will kick off and you will just earn make money with every passing day. But if it does move, the loss will become very large very quickly. Another disadvantage of close expiration is that in order to get decent credit, you will have to choose strikes much closer to the underlying. Based on my experience and personal preference, I like to open the IC trade 6-8 weeks before expiration. It works for me, it doesn't necessarily mean it will work the best for you. In any case, the absolute minimum time that I would recommend is 3-4 weeks. Another advantage of going further out in time and getting decent credit is the fact that you can close the trade early and remove the risk. I never hold till expiration, trying to close around 10-14 days before expiration. When only 20-25 cents is left, it's not worth the risk to continue holding. You kept most of the credit, leave the last few cents to someone else. This brings us to the choice of strikes. The delta of the options gives you an approximate estimate of the probability to expire ITM. If you open IC with short calls and puts having delta of 15, that means that the trade has probability of ~70% to end between the strikes. There is always a trade-off between risk/reward and probability of success. The better the risk/reward, the lower probability of success. Iron Condor Profit/Loss and Exit strategies One of the more difficult aspects of options trading is knowing when to take a profit. The profit on the Iron Condor option strategy is calculated as return on margin. Margin on iron condors is the difference between the strikes. For example, if you trade 2100/2110 call spread, the margin will be $1,000. The capital requirement is the margin less the credit. In case you got $200 credit, the capital requirement is $800. So if you sell the IC for 2.00 credit and closed it for 1.00 debit, the gain is 100/800=12.5% I usually manage the put and the call credit spreads separably. I will place a GTC order to close the spreads at 0.25 debit each, which is around 20-25% of the credit received. The last 25 cents are not worth the risk. As a rule of thumb, you should aim to limit the losses to 1.5 times the average monthly earnings. For example, if your average monthly return is 10%, you should aim to lose no more than 15% in losing months. There is no point to make 8-10% for few months and lose 50% in one month. Typical issues with Iron Condors “I would have had a great year if it wasn’t for one or two months”. If you trade condors without a detailed risk management plan you will eventually experience large losses. There are few serious issues with "traditional" iron condors: If the market makes a move up after trade launch you will start to lose money immediately even with declining implied volatility typically helping your short Vega position. Markets tend to rise over time, so most of the cycles you are fighting the Iron Condor on up moves. “Rolling” adjustments isn't really an immediate risk reducing technique if the market continues to fall and implied volatility continues to rise. As you move from the center of an Iron Condor, gamma kicks in and makes the T+0 curve “bend” and change relatively quickly so you tend to adjust fairly soon. How to address those issues? To address the issues with "traditional" iron condors, we developed a very unique version of the iron condor strategy. We call it Steady Condors. Steady Condors is a market neutral, income generating, manage by the Greeks strategy. Here are the highlights: For downside protection, we use long puts and debit spreads at trade setup and as adjustments instead of rolling our threatened options. This helps reduce the Vega and Gamma so as price moves down and volatility moves up. To flatten the T+0 curve on the up side, we sell fewer call credit spreads. We normally only use enough call credit spreads to balance our setup. This limits upside risk from the beginning of the trade and it’s easy to manage. If the market is moving up, we take the calls off at predefined adjustment points.It doesn’t hurt the profit potential too much and also eliminates the upside risk. We would typically open the trades 6-8 weeks before expiration and close them 2-3 weeks before expiration, in order to reduce the negative gamma risk. Those steps help to keep the drawdowns reasonable relative to realized and expected returns. This is a typical P/L chart of our Steady Condors setup: You can see the relatively flat T+0 line and limited upside risk. To get an idea how this Iron Condor option strategy would perform in a down market, we presented a case study from August 2011 cycle. The trade began on July 6, 2011 with RUT at 844. On Aug 4 with RUT at 752 the trade was taken off for target profit of 5%. Frankly I'm not familiar with another variation of Iron Condor that can actually make a gain after the index declines by 11%+. Conclusion Steady Condors is a strategy that maximizes returns in a sideways market and can therefore add diversification to more traditional portfolios. Selling options and iron condors can add value to your portfolio. The strategy produced 46.7% non compounded return in 2015 (56.5% compounded return) and 17.8% CAGR (Compounded Annual Growth Rate) since inception, with 14.6% annual volatility, resulting 1.27 Sharpe Ratio. Our reported results are net of commissions and are on the entire account. Does it mean you should stop trading "traditional" iron condors? Not at all. They should still work well - as long as you implement prudent risk management. Steady Condors just provides you a viable alternative and addresses some of the issues traders face when trading this strategy. Related Articles: Trading An Iron Condor: The Basics Why Iron Condors are NOT an ATM machine Why You Should Not Ignore Negative Gamma Trade Size: Taming The 800-Pound Gorilla 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? Want to join our winning team? Start Your Free Trial

I could have done nothing for now, and if on October 18 (when my spread expires) RUT is still above $865, I could just roll to the SAME strike prices for the NEXT MONTH, for even more credit. And keep doing it forever, until RUT is below my short leg and it can be closed for profit or expires worthless. This seems too good to be true, but here's my logic: Is it too good to be true? It is expected for the price to come down eventually. So I could roll the same strike price (855/865) forever, to a point (worse case scenario) that I would get $1,000+ credit (some more for time value) and pay $1,000 to cover it again (if it becomes well ITM). This RUT spread would eventually come down to less than $855 in this case, and in long term, since we're approaching new highs, eventually expire worthless for full profit. I mean, as long as EMA(50) and EMA(200) are below my short leg, there are good chances that the RUT price will come back to it (to close for profit), or simply expire worthless, to digest the recent climbing. So in theory, there would be no loss adjusting the legs (use same strike price for following month), and eventually they could always be closed for less than the original credit received. This would apply specifically to indexes like RUT, which is low volatile and can never be assigned before expiration." Thoughts on what I'm missing here? Seems to be almost no risk of loss provided we keep rolling it this way? Before I even had a chance to reply, another member posted the following reply: "rod, that would be great if we could simply keep rolling a spread that went against us. But I think when you roll a spread that is in the money and has gone against you, it will be a debit, not a credit. For example, the RUT September 850/855 bear call spread is going for a mid price of 3.15 credit. Since RUT closed at 856, the spread is in the money. The same spread for October is going for 2.95, which means that if you rolled it from September to October, you will incur a cost of at least 0.2, probably closer to 0.3. So there will be cost to roll it over to the next month. Now say you roll it, and the RUT comes back down and closes at 848 at October expiration, you should be able to keep that credit. Now if you get into an OTM call credit spread, say September 860/865, the credit is $2.10. The same spread for October is going for $2.50. So it seems that if a spread is OTM, you get bigger credits the farther in time you go out. The reverse is true with spreads that are ITM; the credits are smaller. Someone like Kim could probably explain why this is so. But I don't think you can simply roll an ITM spread that has gone against you and still get a credit. Someone please correct me if I am wrong." Unfortunately, it is (too good to be true) My response: First of all, I don't accept the concept of "rolling". What you do is closing one position (for a loss) and opening a new one. A loss is a loss, no matter how you call it. The question is: do you want to own the new position or you roll just to salvage the losing trade? Now for your question. As tradervic mentioned, the ITM spread cannot be rolled for a credit. The reason is simple. If RUT is at 855, the 850/855 spread will be worth a full $5 at expiration. As you go further from expiration, if will be worth less and less. If you think about it, it makes sense: further you go out in time, more time value those spreads have. So October spread will be always worth less than September. So you roll for a debit, and what if the index continues higher? You will have to roll again for a debit, this time probably larger debit since you are deep ITM. Sure at some point it will reverse, but meanwhile you might already have a very significant loss. And here is a response from Chris: "And I want to emphasize what Kim has said -- the concept of "rolling" is idiotic. You simply CANNOT think in those terms. You have closed a losing trade and opened a second trade -- likely one you never would have opened on its own. You are almost always better off putting your capital to use on another trade. Simply put, DON'T EVER ROLL UNLESS IT IS A TRADE YOU WOULD DO IF NOT ROLLING. Now this does happen sometimes, I have rolled calendars and spreads before because I liked the trade I was rolling into. But I independently evaluated it." Rolling is just a way to hide losses Rolling from month to month is something many condor services do on a regular basis. Option selling strategies, especially those that roll from month to month to hide losses in their track record, often have hidden risk. This risk became obvious last year when some of them have experienced catastrophic losses of 50-90%. The simple truth is that in most cases, rolling will increase your risk, not reduce it. Is it what you want? If the underlying continues in the same direction, after few rolls the trade will be a complete toast. This is not something we do at Steady Condors. We use different adjustment strategies, which reduce risk instead of increasing it. We just closed another winning month, booking 6.7% return on the whole portfolio (including commissions). Our return in 2015 so far is 23.7%. As a reminder, Steady Condors reports returns on the whole portfolio including commissions, non-compounded. If we reported returns like other services do (ROI/average of all trades, before commissions and compounded), we would be reporting 35.2%. Click here to read how Steady Condors is different from "traditional" Iron Condors. Related Articles: Why Iron Condors are NOT an ATM machine How to Calculate ROI in Options Trading Why You Should Not Ignore Negative Gamma Can you double your account every six months? Can you really make 10% per month with Iron Condors? Want to join our winning team? Start Your Free Trial

Question from a reader: Mark's response: Thanks for the question Tom, It's far more than the risk/reward ratio. But first let me explain that when I offer a strong opinion, it is just that. An opinion and not a fact. I believe that those who sell low-premium spreads eventually blow up their trading accounts. I agree that there are ways to manage risk, but there is often a psychological barrier. Too many traders think in terms of the cash collected when opening the trade and cannot allow themselves to pay $1 or $2 to exit a position when the original premium collected was a mere twenty-five cents. These are the traders who will hold to the bitter end. And that means the occasional $975 (+ commissions) loss. That would not be an insurmountable problem if traders held positions of appropriate size. But Tom, as I'm sure you know, success brings confidence, over-confidence, and cockiness. Eventually position size is too large and that inevitable loss is often enough to destroy the trader. Very sad. Thus, the primary reason I dislike these trades is that the wrong traders use this method. In my opinion, this is not a great trade for anyone, but I'm sure there are experienced people who make decent money doing this. But I feel a responsibility to do whatever I can to discourage this very risky strategy. I would never consider it myself, and am comfortable recommending that everyone stay away form these low reward plays. Plan ahead I agree that having a plan in place is important for the trader who adopts low-premium, high probability trades. I just feel that the inexperienced trader will find any number of reasons for not following the plan. And that's even more true when the first time an adjustment is made – it turns out that the adjustment was unnecessary. Although I'm a big fan of exiting such trades early, there is not much incentive to do so when the original credit is so small. Holding to the end is probably part of the trade plan. I don't think you are missing anything. This strategy, as any other, is appropriate for the right trader. But it requires enormous discipline – just to keep size at an appropriate level – and then more discipline to lock in a loss to exit – even when the probability of success is still on your side (the short options are not yet ATM). I believe that someone who has the experience to be certain he/she has that much discipline would choose a different strategy.

An example of legging into an iron condor is selling an OTM put spread and then selling an OTM call spread after the underlying has increased in price. When the underlying increases in price, the short put spread moves further OTM increasing the trade’s probability of profit (POP). Unless there is a large expansion in volatility accompanying the underlying’s move higher, the short put spread also loses value and becomes profitable. Is it worth the risk? There are different opinions about the issue. This is what Mark Wolfinger thinks: I do not like the idea of legging into iron condor trades by selling puts first. It simply doesn't work as well as it should – when considering the risk involved. I know that's not good news for the trader who usually has a bullish bias, but there are good reasons. When the market rallies, IV tends to shrink. When IV shrinks, the value of the call spread that you are planning to sell also shrinks. By that I mean it increases in value by less than you anticipate. Often much less because it is an OTM spread. I'm assuming that the iron condor trader is not looking to sell options that are CTM (close to the money). It takes a significant upward move for that OTM call spread to increase in value by enough to compensate the trader for taking the leg. If you do sell the put spread first, and the market cooperates, it's often better to buy back that put spread, take the profit, and forget about getting a little better price on the call spread. It's different with calls. If you correctly (i.e., you are correctly short-term bearish) sell the call spread first, then you have the opposite effect. If the market declines, the put spread widens faster than expected and you have an iron condor trade at a good price. Thus, unless bearish, I suggest not legging into iron condor trades. Christopher Smith agrees: Traders who recognize this theorize that they can achieve higher yields and better probabilities of success if they could sell one side of the iron condor and then sell the other side after the market has moved away from that initial spread. An example would be to sell the bull put spread when the market has pulled back and appears poised to rally higher. Once the bull put spread is sold the trader would then wait for the rally to carry the market higher, at which time the bear call spread would be sold to complete the iron condor. The net result is that the trader probably has a wider, higher yielding spread than they would have had if they simply sold both sides at one time. Easier Said Than Done While this seems simple enough, in practice consistent legging into an iron condor is a difficult task to accomplish with an consistency. In fact, I typically recommend against the practice unless you happen to be an experienced directional trader. The problem with legging into an iron condor is that most people begin the process with the mindset and desire of eventually opening an iron condor. What often happens is that they open one side of the iron condor and then look for the market to make a move the opposite direction so that they might open the other side of the trade - but they either miss the opportunity or the market simply does not give them the chance. Now they have a dilemma, because they wanted to be in an iron condor, but they're not. Now they may be losing money on the initial vertical spread and struggle to decide whether they should sell the other side at a reduced credit, stay in the original position and "hope" for the market to reverse and save them, take a loss on the original trade, etc. In short, they have made a mess of the legging in process. Are You a Directional Trader? Selling bull put spreads or bear call spreads are directional plays. This is true even if you intend to eventually roll into a non-directional spread like an iron condor. Until you complete the condor by selling the opposite wing, you are a directional trader. Most iron condor traders attempting to leg-in do not recognize this and that is where their trading plan begins to unravel. My recommendation is that if you want to trade iron condors, then trade iron condors and focus upon your risk management and trade management skills. That is where the money is won and loss. If you legging into the trade still appeals to you then it is probably better to re-tool your trading approach to that of a directional trader. A directional trader will play the swings in the market. As the market pulls back and then begins its next swing up a bullish position may be taken. As a bullish peak is made and the market begins to oscillate lower a bearish trade may be opened. If these trades happen to be credit spreads in the same month and on the same security you just might find yourself in an iron condor. The difference is that a directional trader does not start with the notion of trading an iron condor. They begin with the idea that they will get long or short the market. If, and that is a big "IF," the market completes its cycle and the opportunity presents then they may find themselves in a non-directional spread. The question now is whether the manage the combined position as a single non-directional trade or whether they continue to manage the individual vertical credit spreads independently. This is a decision the trader must make well before entering the market as it presents another opportunity to create a mess. If you happen to be a skilled directional trader, then it might make sense to trade vertical credit spreads and leg into an iron condor if and when the opportunity presents. For those who want to trade non-directionally, the better practice is to open the iron condor as a single trade from the start. What do you think? Share your feedback. Visit our Options Trading Education Center for more educational articles about options trading. Related Articles: Trading An Iron Condor: The Basics Trade Size: Taming The 800-Pound Gorilla Trade Iron Condors Like Never Before Why Iron Condors are NOT an ATM machineWhy You Should Not Ignore Negative GammaCan you double your account every six months?Can you really make 10% per month with Iron Condors?Exiting An Iron Condor TradeIron Condor Adjustments: How And WhenIron Condor Adjustment: Can I "Roll" It Forever?Is Your Iron Condor Really Protected? Start Your Free Trial

Question: "I currently have a RUT Sept IC [iron condor] paper trade that I opened on Aug 27 for a credit of $1.90. This morning the position had a profit of $1.20 and would cost $0.70 to close." If you can watch a position during the day would you advise locking in a profit at a certain point in a situation like this? I cover early. That’s my comfort zone, and you must find your own. However, even that is insufficient. How early to cover and how much to pay remain the unanswered questions. The best place to discover the answers is in the original trade plan. When you have such a plan, it is easy to follow. Sure you can modify it as needed, but the plan gives you a general guideline for making decisions. For example, if your plan was to earn $1.50, then I would say that earning $1.20 is acceptable ONLY when the current position makes you uncomfortable. If you have doubts, then quitting earlier than anticipated makes sense. Lacking a trade plan, I believe: How much you collected originally is immaterial. How much profit you have is immaterial All that matters is this: You can cover this position by paying $0.70. Do you want to take the risk of holding this position when your potential is all, or part, of $0.70? Are the options far enough OTM that you are comfortable when holding? Or would you be holding just because you cannot bear the thought of paying ‘so much’ to close? Would open this iron condor as a new position for $0.70. If ‘yes’ then do not close. If ‘no’ then you have a decision to make. Is it too risky to hold? I cannot possibly know the answer. It’s a personal decision. If you do hold, what is the target? If it is another 5 cents, get than $0.65 cent bid in now. There is no reason to risk losing the whole profit to earn another $0.05. I offer this advice: Don’t allow the actual result to sway you. If you decide to hold, and this time that turns out to be a losing decision, don’t conclude that you should close early next time. If you close early and the position goes out worthless, that does not mean you should hold next time. Trading is about RISK and REWARD. Not how much you coulda, woulda, shoulda earned. Also, your decision on holding/closing should influence your decision. But that becomes part of the trade plan. You are in the learning phase of your options trading career. You are gaining experience. Education is an ongoing process, and requires time. Before you risk real money, you must (IMHO) understand the strategy you are using and have some basis for believing you are capable of managing the risk of your investment, should the market move against you. You are still paper trading. So trade. Manage risk. Keep a daily diary of how you ‘feel’ about your positions: Are you comfortable? Are you concerned about volatile markets or pending losses? Are you confident (overconfidence is a killer)? Are you anxious to lock in profits or do you prefer to try to collect the last penny from a trade? Put your thoughts into writing. Keep a trade plan for every trade. Be conscious of position size and have a good reason for increasing or decreasing size. As time passes, keep a record of how well you like the plan or whether you feel the plan did not serve its intended purpose. Answering these questions – in your diary – is important. Your own commentary will lead you down a path that is good for you. And you can modify your comfort zone as the years go by. It takes time to find a strategy that you can handle effectively. But, no strategy is always ‘right.’ Times change and markets change. Be prepared to change your trading habits. Take your time. If you develop good habits now, those habits will last a lifetime. If you go broke now, you may give up trading options. I cannot tell you what will work for you – but you will figure it out as you go along. The primary goal is to survive. That means protecting your assets. The secondary goal is to make money. The tertiary goal is to build wealth. The fourth rule is to never forget your primary goal. Concentrate on getting experience with iron condors, finding your comfort zone, and protecting your assets. That is what is important. Mark Wolfinger has been in the options business since 1977, when he began his career as a floor trader at the Chicago Board Options Exchange (CBOE). Since leaving the Exchange, Mark has been giving trading seminars as well as providing individual mentoring via telephone, email and his premium Options For Rookies blog. Mark has published four books about options. His Options For Rookies book is a classic primer and a must read for every options trader. Mark holds a BS from Brooklyn College and a PhD in chemistry from Northwestern University. Related articles: Should You Leg Into Iron Condor? Iron Condor Adjustments: How And When Iron Condor Adjustment: Can I "Roll" It Forever? Why Iron Condors Are NOT An ATM Machine Can You Really Make 10% Per Month With Iron Condors? Is Your Iron Condor Really Protected? Want to learn more? Start Your Free Trial

Some adjustments are made because we anticipate a specific event in the market (buy vega in anticipation of a increase in implied volatility). Others are made because we fear a big rally or decline. However, most of the time adjusters seek to find a trade that reduces risk for as many different market conditions as possible. Traders tend to find that one specific adjustment type is their favorite because it has brought satisfactory result sin the past. Some adjustment techniques are well-suited to a specific strategy and the pair go well together. [Rolling down when trading CTM iron condors] The trap Some adjustment methods are so attractive because they offer a very reassuring risk graph. The problem with that adjustment type is that the graph may be deceiving. This is the topic of today’s post. Readers who are familiar with my philosophy concerning the purchase of individual calls or puts as insurance for an iron condor trade know this: I recommend NEVER buying any option for protection when that option is farther OTM than the option (or spread) being protected. There are situations when ignoring that advice brings excellent results. However, much of the time the trader can get trapped and loses even more money than would have been lost without the adjustment. That is a situation that has to be avoided. So let’s make this one basic premise for all iron condor adjustments: No iron condor adjustment is acceptable when losses may become higher than that of the original trade with no adjustment Translation: An adjustment must never add to losses. An adjustment must earn a profit (if it were a standalone trade) at any time that the position being protected loses more money that it is losing when the adjustment is made. In my opinion, there are no exceptions unless you are sophisticated enough to recognize the extreme danger and will get out of the trade early enough to prevent a disaster. Here is an example: Example: Let’s say you are short the 750/760 call spread for some unspecified index. Wanting protection against a big rally, you buy one or more extra 760 calls. When looking at the risk graph, all we tend to notice is the large potential profit when the index rises to 800, 850, 900 etc. However, the crucial part of the trade gets ignored (by those who have not thought this through well enough). As time passes, those extra calls lose much of their power. Sure, the graph still looks good and the position performs well when the market moves a lot higher. But that is not the scenario for which we bought protection. The adjustment trade must reduce losses when the index creeps higher and approaches the short strike. We should not be concerned with risk when the index rallies to 850. That is an unlikely scenario. The trader has to worry about the market moving to 740, 745, 750 – especially as expiration nears. [One of my tenets is that we should not be holding positions in this very risky situation, but some traders hold anyway]. When your ‘protection’ is owning extra 760 calls, and time is getting short, those calls do not help when the rally continues slowly as the days pass. In fact, they could easily expire worthless while your short spread finishes in the money by as many as ten points. That would be a double disaster: losing a lot of money on the original position and seeing the adjustment trade expire worthless. The problem occurs because the trader bought calls with a higher strike than her short calls. The situation is identical when you buy puts that are farther OTM than the short puts being protected. Unless you know the adjustment is to be held for a VERY short time and will be replaced, do not buy protection that is farther OTM than the position being protected. Two of the most difficult aspects of managing risk for negative gamma positions is deciding when to make the adjustment and which specific trade to make as the adjustment. Today, let’s talk about timing. If we adjust frequently, we run the risk of buying every rally and selling every dip – exactly what we don’t want to do. If we had done nothing, we’d be holding a winning trade. On the other hand, if the market edges higher (or lower, take your pick) day after day, then these frequent adjustments could save us a pile of money because we would never be too far from delta neutral. If we adjust in stages or at predetermined levels (price of underlying, delta of short, money lost etc.) we have exactly the same situation as above – but the numbers are all larger. If we adjust and the market reverses direction, we will have spent a decent sum adding protection when it turns out that we would have been better off not to have adjusted. And to make matters worse, we would have locked in a reasonable loss for at least a portion of the position by making that adjustment. On the other hand, if we do not make the adjustment, we own a position that is out of balance, is currently underwater, and has reached a point where we are threatened with ever-increasing additional losses. That is no time for the prudent trader to become stubborn. It is time to do something to reduce risk. When? There are two basic approaches: 1) Time adjustments for all trades as consistently as possible. The specific method used is less important than being consistent. 2) Use your best judgment to determine the type of market conditions under which you are trading. Use technical indicators, follow the trend, follow your gut, keep careful records of how much the index is up or down every day, etc. If it seems as if we are in a trending bull or bear market, then adjust much more often as a safer way of managing risk. You could even initiate the trade with one adjustment built-in. [begin with an unequal iron condor, perhaps 8 calls and 10 puts; or begin with calls (or puts) with a smaller delta than the other side.] Don’t sit and wait for a reversal that may never arrive. Trade scared and trade with safety in mind. Or don’t trade and wait for better conditions. If it seems that the market is not trending or that you cannot draw useful conclusions about what you see, then return to your standard risk management technique. Be ready to change course for extra safety. Bottom line: Whatever it is that you see in the market, the objective is to play it safe. Play it small. Or don’t play at all. There is a ton of money to be made by trading iron condors or selling credit spreads. But that is only true part of the time. When the markets are unfavorable for those methods, we must minimize losses so that we are in good shape to collect when it becomes our turn. And we do not know when our turn will begin or end. Related articles: Should You Leg Into Iron Condor? Exiting An Iron Condor Trade Iron Condor Adjustment: Can I "Roll" It Forever? Why Iron Condors Are NOT An ATM Machine Can You Really Make 10% Per Month With Iron Condors? Is Your Iron Condor Really Protected? Want to learn more? Start Your Free Trial Mark Wolfinger has been in the options business since 1977, when he began his career as a floor trader at the Chicago Board Options Exchange (CBOE). Since leaving the Exchange, Mark has been giving trading seminars as well as providing individual mentoring via telephone, email and his premium Options For Rookies blog. Mark has published four books about options. His Options For Rookies book is a classic primer and a must read for every options trader. Mark holds a BS from Brooklyn College and a PhD in chemistry from Northwestern University.

Another choice is to roll the position to one that satisfies all the conditions required for a brand new trade. If rolling is not appropriate, there are other acceptable risk-reducing adjustment choices. The worst choice is to do nothing (after the position reached the point where your trade plan calls for action), and hope that good things will happen. Example Let’s assume that you made a trade in which there is a short call spread and the market is rising. Let’s further assume that this position is essentially unhedged (i.e., if it is part of an iron condor, the put spread is not worth enough to provide any reasonable hedge when the market rallies further). You are short a 10-lot GOOG (price $740) call spread, the Feb 760/770 (or substitute strike prices that place you at the very edge of your comfort zone and where you believe the best move is to cover all or part of that risk). However, you decide to hold for the moment. The option gods are on your side. A few days pass and GOOG retreats to 730. This feels good and you feel justified in not having acted aggressively. However, expiration is still 32 days away, and this stock can easily run through the 760 strike. One intelligent plan is to exit now and take advantage of the fact that you did not lose additional money by acting when the stock was moving higher. When I find myself in this situation, I seldom exit. I feel vindicated that the market moved lower, and all exit plans are put on hold. I believe that postponing the exit is the most common choice for traders in this situation. I am now convinced that this is a poor decision. Another plan is to accept reality: The stock is still near an uncomfortable price level, and the small decline is not necessarily a promise of more decline to come. The conservative trader can covers a portion of the short spread as a compromise between greed and fear. I don’t believe traders make this move either. The common mindset is to heave a sigh of relief as fear fades away. The mindset is that “the stock is finally slowing down and I no longer feel threatened.” The Fallacy This is fallacious reasoning. We feel good. We believe, or at least hope, that the position is once again suitable to hold. However: It only takes one day’s rally to once again put the position in jeopardy. In only takes a relatively small move for the stock to pass its recent high and threaten to surge higher. It only takes that to force you to exit with a larger loss than you had earlier. Unfortunately, this is not a rare occurrence. It is very likely that the stock is not 100% exhausted and will challenge the recent highs. The problem is that we cannot tolerate holding when that happens. We are already at the edge and cannot take more (rally). When we fail to exit when we get that small reprieve, we need MUCH MORE decline to become comfortable. We need VERY LITTLE upside to force an exit. Isn’t the small rally far more likely than the larger decline? If the market behaves; if another week passes and GOOG declines by 1 or 2%, we are not yet out of trouble. For many traders, the spread will remain too expensive to cove,especially when recent market action has been favorable. The problem is that it still takes only a small rally to threaten the large loss. The fallacy is believing that a short-lived sell-off or calm market means that all is well. All is not well because it takes a significant passage of time or a decent-sized decline to bring this spread down to where many traders would finally cover. Being able to get out of the position at a price that is far below the current spread value is far less likely than being forced to exit on the next rally. It is not because the market is bullish. It is because so much more is needed for the trader to earn some money from the position, whereas, it does not take much for the trader to be forced to exit at a price even worse than today. The fallacy comes in believing that the stock has at least as good a change to move higher (enough to force an exit) or lower (enough to make a voluntary exit). It can move in either direction. However, the chances of coming out ahead are small. The penalty for being wrong grows quickly while the reward for being correct accumulates slowly. Thus, the probability of recovering losses is too small to take this risk. The reason for managing risk in the first place is to prevent sitting on bad positions such as this one, and this is not the time to abandon our plans and allow hope to take over as risk manager. Mark Wolfinger has been in the options business since 1977, when he began his career as a floor trader at the Chicago Board Options Exchange (CBOE). Since leaving the Exchange, Mark has been giving trading seminars as well as providing individual mentoring via telephone, email and his premium Options For Rookies blog. Mark has published four books about options. His Options For Rookies book is a classic primer and a must read for every options trader. Mark holds a BS from Brooklyn College and a PhD in chemistry from Northwestern University. Related articles: 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? Why Iron Condors Are NOT An ATM Machine Can You Really Make 10% Per Month With Iron Condors? Is Your Iron Condor Really Protected? Want to learn more? Start Your Free Trial

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: 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%. Selling options and iron condors can add value and diversification to your portfolio. They aren't the holy grail. Just like everything else. 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.

NFLX announced earnings today after the close. Couple hours before the market close, I got a following trade alert from one of options sites I follow: Trade: SELL -1 IRON CONDOR NFLX 100 APR 15 520/522.5/427.5/425 CALL/PUT @.91 LMT [TO OPEN/TO OPEN/TO OPEN/TO OPEN] Trade Explanation: For the Volatility Advisory in NFLX, we are selling the Apr 427.5 puts and 520 calls and buy the Apr 425 puts and 522.5 calls for a net credit of $0.91 to open. Underlying Price: $474.22 Click here to view the article

Digging through some old forum posts, I came across the following question from one of our members: "My bear call spread is ITM now (RUT 855/865). I adjusted it by rolling it to the next strike (closed 855/865, opened 875/890). But I was wondering if this could be approached differently. This seems too good to be true, so I'm wondering if I'm missing something. I could have done nothing for now, and if on October 18 (when my spread expires) RUT is still above $865, I could just roll to the SAME strike prices for the NEXT MONTH, for even more credit. And keep doing it forever, until RUT is below my short leg and it can be closed for profit or expires worthless. This seems too good to be true, but here's my logic: Click here to view the article

By Mark D Wolfinger Let’s begin with a basic fact: There are many methods for adjusting a position so that risk is reduced. Some are inexpensive, others cost more than most traders are willing to spend. Some are effective most of the time, but the protection offered is minimal. Others are so effective (alas, that happens rarely) that the gains an be spectacular. [Think of owning an extra put or two before the market opens down 20% one fine day] Click here to view the article

Kim, With RVX now at around 22 what do you think of opening the Feb Iron condor? Maybe with the "fiscal cliff" discussion out there its better to wait. However personally I think these analysts who are blaming the current market on the fiscal cliff do not know what they are talking about. Thanks! Richard