Why I Don't Like Iron Condors
Seeking Alpha Analyst Since 2020
Degree in Engineering and MBA
Options trading CBOE Advanced level certification
Book Author: "The Volatility Trading Plan" (Amazon)
Options trader instructor
Currently trading exclusively SPY, QQQ, and VXX proprietary strategies. Combining options flexibility of risk management and some creative ideas (outside-the-box thinking!) I developed tools to become a successful/profitable trader!
Summary
- The biggest issue of the Iron Condor is the continuous increase value of Gamma and the difficulty to repair it as long as Theta becomes more and more attractive.
- Adjustment possibilities of Iron Condors are less flexible than other options strategies, which from my perspective (Delta Neutral Trader) poses big concerns.
- Majority of traders select short strikes based on price variation and not on Deltas which turns this strategy even less attractive.
One of the most discussed options trading strategy is the Iron Condor. In short, it is composed of 2 sold Verticals Out-the-money: one Short Put Vertical and another Short Call Vertical. Usually, the sold strikes of each Vertical can be defined at 10 or 20 Delta. This will deliver probabilities of profit at the expiration of 80% to 90%. The total credit of the sold Verticals is the maximum profit for this trade. This sounds very attractive, but it is dangerous to understand this strategy in this simplistic way! In options trading, nothing is easy and straightforward. There are several dimensions to take into consideration – not only price movements...
Despite their attractive potential return, this strategy is not structurally built in the trader advantage. In fact, it presents lower attractive ways to adjust or repair when the price of the asset moves against. Although attractive when they are opened, easily can turn into losses fast with low alternatives to adjust.
Below, an example of an Iron Condor on QQQ with 40 DTE and sold strikes at 20 Delta.
You can easily understand the graph above the pros and cons of this trade.
If the stock remains within a certain trading range during the holding period, it can generate a nice profit, based on the invested capital. If we look into Greeks, my beloved Delta/Theta ratio is not the best when compared to the Ride or the SPY Speed trades (even Gamma is high enough at this point of the trade).
You can also see what happens if the QQQ price moves fast in one direction: the losses start to appear and, if that movement continues, they increase fast due to higher and higher Gamma as long as the price is moving towards one of the sold options. You can understand this effect by computing the slope of the t0 line (magenta line in the graph).
15 days after the same trade appears like this, where the t0 line is steeper near the short strikes than it was when the trade was entered.
Now, let’s focus on alternatives to adjust this trade in case things start to move against. In fact, this trade offers low alternatives for repairing. Unlike other strategies that I trade this one could simply go wrong and could be difficult to recover from a big loss.
There are 2 main repair trades for Iron Condors. The first and more obvious is when the price starts to approach one of the sold options the trade can simply buy back at a profit the opposite side and sell to open a new Vertical closer to the stock price (could be again at 20 Delta) for additional credit. This shrinks the price interval, and we lower the initial probability of profit and for sure this credit is not compensating the loss on the “touch” side Vertical. The second is to move the whole structure (with possible adjustments in sold strikes) further in time for additional credit. But this will reduce Theta of the whole trade and more time to get in profits and if the price continues to move against, the trade continues to lose…
So, there is not big flexibility to adjust/repair the Iron condor in an easy and straightforward way.
But there are better conditions when to enter Iron Condors to increase its success odds. Remember this is a Vega negative trade. Hence, when IV is high the trader gets a higher credit and the Risk /Reward of this strategy greatly improves. Most options traders base their decision to enter this trade because they think the stock price will remain in a range. This is not the right approach! What they will soon learn is that a stock can move fast in one direction and/or IV can increase and losses start to get bigger …
Traders should not base their decision to enter an Iron Condor on the stock’s price interval. Instead, they should consider primarily the implied volatility level of the stock options! If IV is relatively high and soon the trader expects it to decrease, this will increase greatly the odds of getting a profit. Again, as I am always saying when trading options IV is key by opposition to the stock trader where the price is key.
Probably during next year, I will focus on researching a new strategy based on this one and how to overcome its negatives. As you know, I like to manage risk using Greeks and I have some hypotheses to test. If the results are promising I will include a new strategy based on Iron Condors in my portfolio. But, until then, be cautious when trading Iron Condors!
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