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As the founder of BetterBeta Trading, I bring an independent option trader's perspective to successfully trading iron condor options strategies, focused primarily on the Russell 2000. Reducing volatility and hedging against outlier risks while generating steady profits are the building blocks of... More
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  • Theta Misconceptions When Trading Iron Condors 0 comments
    Nov 27, 2012 11:37 PM

    This chart has probably gotten more amateur premium/IC sellers into trouble than any other. A quick Google image search for "theta options decay" brought up a screen full of charts exactly like the one below. So what's wrong?

    (click to enlarge)Theta decay for ATM options

    At a quick glance, it tells us that option premium decay accelerates in the last 30 days. What this, and most theta decay charts on the web fail to mention, is that this chart is specific to at-the-money options. The decay model for OTM options, which typically make up the short legs of iron condors, have a very different curve:

    Theta decay for ITM, ATM and OTM options

    As you can see from the above graph (courtesy of trades4alpha.com), the OTM theta decay curve is decidedly different than that of ATM options. This significant difference drives all sorts of bad premium-selling habits, such as opening iron condors too late, holding short options longer than necessary and underestimating the gamma risks in the last 2 weeks of an option's life. Given the risk/reward ratio of iron condors, those ATM theta charts are likely the undoing of many rookie traders.

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