John,
I'll try to hit these points quickly and then encourage you to spend some time thinking through things.
Iron condors are all about probabilities. The wider you make them the greater the probability your strikes will expire out-of-the-money, but in return you must accept a smaller credit. You can bring in a larger credit by selling the wings closer to the money, but in return your probability of seeing those short strikes expire out-of-the-money will be reduced. Which is better?
The answer to the question is, neither. They are equally good and equally flawed. The market tends to keep risk and reward in balance.
Most iron condor traders tend to trade spreads with rough probabilities ranging from around 60% to 80%. The metaphor of picking up nickles in front of a bulldozer addresses the fact that our reward is relatively small when compared to the maximum risk of the position. We may be fast enough to pick up those nickles and dimes, but if we experience misstep that oncoming bulldozer, i.e., the market, will level us. So, what do you do? You make sure you don't get leveled by the bulldozer.
Using deltas to select your short options is as good a technique as any. There is no magic, though. Sell a call with an 8 delta means that there is an approximate probability that 92% of the time it's going to expire out-of-the-money. The same is true on the put side. So if you sold calls with an 8 delta and puts with an 8 delta, that means that there is an 84% probability that both the call and the put will expire out-of-the-money. Pretty good odds. But, there is no free lunch. You will have to settle for a pretty small credit to get those odds.
Personally, I like selling a bit closer to the money and getting a slightly larger credit. The reason is that the larger credit afford more cash with which to finance adjustments to the position. The corollary to having an 84% probability of success on your trade is that there is a 6% probability that the trade will produce a loss. With that anemic credit the maximum loss on the position can be devastating, if it is allowed to occur. I want to have enough of a credit to pay for one, perhaps two, adjustments to my position to protect against that potentially devastating loss.
As far as implied volatility goes, the structure of the position itself insulates you to a good extent from changes in implied volatility. The reason is because the options you are selling have a negative vega while the options you buy have a positive vega. The short options tend to have a bit more vega than the long contracts, so the overall position will have a modest negative vega to it. What does this mean? It means that if IV rises the position will tend to lose money and if IV falls it will tend to make money. The trump card for the iron condor is theta, though. Eventually all of those options will lose all of their time value. Implied volatility only effects time value, so when its gone so are the effects of implied volatility.
You do need to pay attention, however. If IV levels are falling in the market you may want to focus on trading negative vega positions like iron condors, but when IV levels hit relative lows it may be time to balance out that negative vega or perhaps even develop a positive vega bias to the portfolio in anticipation of higher IV levels. Now, there are guys out there that just trade iron condors and don't spend their time trying to hedge against changes in IV. So, take from that what you will.
Christopher Smith
TheOptionClub.
--- In OptionClub@yahoogro
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> Forgive the elementary nature of this question (actually a few questions), as you will see it is probably a good thing I am looking at this as only a paper trade. Looking at a February RUT condor consisting of 520/510 puts with 700/710 calls. My reasoning for choosing the 520 put and the 700 call as my short positions is they each have a delta of 8 in keeping with a suggestion from a course I took. The 520 put is out more than two standard deviations and the 700 call is between one and two standard deviations. So, as far as I can tell this is a high probability venture, but of course the reward is limited. (at about .80) Is this considered to be too low of a risk reward? It seems to me having to put up $920 to get $80 is not a great ratio. I have heard the term "picking up nickles in front of a steamroller" and it may apply here. Am I putting too much emphasis on the deltas? Finally what consideration should I be giving to the volatility on these options? The 520 put is at 38.09 while the 700 call is at 21.48. How does an experienced trader view this aspect of a potential trade? As always, thanks to each and everyone of you who offer your insight to those of us still finding our way. John
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