Condors vs. Iron Variety

Mark: If you will, address an options trading question (maybe a rookie question) to which I’ve never found an answer.

What is the benefit of selling iron condors (bull put spread/bear call spread) over buying condors (bear spread/bull spread – puts or calls, but not both)? The profit/loss graphs of the IC and the condor are identical. Clearly, with the IC the cash remains in your account and is increased by the premium collected rather than paying for the condor and collecting a profit (hopefully) later on, but the interest earned on the funds is, at least presently, negligible. Also, it appears that there might be a slightly greater premium for an IC over a condor, but I don’t have enough of a statistical sample to draw that conclusion.

So, why are iron condors so popular while non-iron condors are rarely mentioned? Thanks, as always, for your wisdom.

Cliff

That’s a very interesting question and the truth is I don’t know.

I believe it’s a trader mindset. I believe that most traders prefer to have the cash in their account (iron condor), rather than pay cash for a position (condor). In this situation, the positions are equivalent and there is no theoretical advantage to trade one over the other.

However, there is a practical consideration. Because the trader anticipates that all options will expire worthless (obviously only when the trade is held though expiration), there is an extra reward for winning: There are no exercise/assignment fees to pay.

When the condor buyer wins, one of the spreads is completely ITM while the other is worthless. That requires payment of one exercise fee and one assignment fee. We know that some brokers do the right thing and provide exercise and assignment at no cost to the customer. However, that is not a common situation. Thus, all things being equal, the iron condor is better by the amount of fees saved.

More on mindset

Covered call writing is very popular among rookie traders. It’s easy to learn and nearly all brokers allow their novice traders to adopt that strategy. Selling cash-secured puts is the equivalent strategy, and adds cash in the trader’s account, but most brokers don’t allow their beginners to make that play. That’s true despite the fact that the trades are 100% equivalent.

Where does trader mindset come into the picture? I can’t be certain, but I feel that most traders who get used to writing covered calls never make the effort to switch to selling puts – even when their broker would give them permission. There is a certain comfort in trading a familiar strategy.

I believe it’s the same with condors. More books are written on iron condors, more bloggers use iron condors as topics, and thus, people who adopt this strategy begin with the iron condor and never make the change.

In the condor case, it’s correct not to make the change, but writing covered calls is not a good idea when the trader understands the equivalence of selling cash-secured puts. What’s the edge? Fewer commission dollars per trade. To me, the other, and more important point is that it’s far easier to exit prior to expiration. when the stock rises above the strike, OTM puts become cheap (eventually) whereas it’s not easy to trade ITM, higher priced call options as a combination with stock.

Exiting not only locks in the profit, but it frees cash for another trade.

931

, , ,

16 Responses to Condors vs. Iron Variety

  1. Robert 03/22/2011 at 9:56 AM #

    Mark,
    I was about to ask the same question Condors vs Iron Condors. In my case it is the broker’s rule that does not allow selling call spreads in retirement accounts. Could you please suggest a good alternative to selling IC in retirement accounts.

    Thanks,
    Robert

    • Mark D Wolfinger 03/22/2011 at 10:02 AM #

      Robert,
      Your broker has idiotic rules. Moronic.
      However, just buy the condor instead of trading the iron condor.

      Choose the same strike prices you are using (or want to use) for the iron condor
      a) Instead of selling the call spread, but the put spread with the identical strikes/expiration
      b) Sell the same put spread that you planned to sell.
      c) You now own a put condor

      Assuming a 10-point iron condor, you would be paying a debit of $8 instead of collecting a credit of $2 (for example). At expiration, you hope the spread moves to $10. Same risk, same reward, but stupid from the point of view of being forced to pay exercise/assignment fees come expiration.

      Who is that broker? Let’s publicize their ignorance. Let me guess: They are also charging too much in commissions.

      NOTE: Buying the put spread is equivalent to selling the call spread – same strikes and expiration. That’s what you are doing to get the iron condor equivalent.

      Regards

    • JeffC 03/22/2011 at 10:12 AM #

      FYI… thinkorswim allows limited-risk option positions in retirement accounts. Selling iron condors in a retirement account is not a problem. I’ve done it.

      • Mark D Wolfinger 03/22/2011 at 10:27 AM #

        Jeff,
        So does almost every broker. I suspect Robert is working with Fidelity.

        Thanks for sharing

        • Robert 03/22/2011 at 1:27 PM #

          It is Schwab. Unless I totally misread their rules it is practically impossible to do anything beyond the longs (including all kind of variations like long strangles), cash secured puts and covered calls.

          • Mark D Wolfinger 03/22/2011 at 2:14 PM #

            There’s this good news. You can probably switch to OptionXpress once the merger is complete.

            The fact that Schwab is far behind the times, coupled with the fact that options are becoming more and more popular, makes this merger ideal for them. But what I would ask is how did you get stick with this broker in the first place? No reply needed for that because they have a great many customers.

  2. Robert 03/22/2011 at 2:41 PM #

    The answer is simple. It was 401K with my former employer that got converted into IRA, I just did not move.

    • Mark D Wolfinger 03/22/2011 at 2:55 PM #

      It does make sense Robert
      Moving is too much trouble for most people. But if you plan to use options, they are not a good choice.

  3. Tristan Grayson 03/22/2011 at 8:47 PM #

    Might these also be advantages to selling cash-secured puts compared to covered calls?

    1. One doesn’t need to worry about being assigned because the option owner is trying to capture the dividend.
    2. IV skew may make puts most expensive than equivalent calls, at least for some stocks?
    3. If dealing with a non-tax deferred account, perhaps it simplifies the wash sale & IRS straddle provisions?

    • Mark D Wolfinger 03/22/2011 at 10:35 PM #

      Tristan,

      On re-reading your comments, I see that adding a comma or two gives your sentences a completely different meaning.

      1 One doesn’t need to worry about being assigned when writing covered calls.
      The call writer should have been aware of the chance of losing the dividend (via assignment) when the position was opened.

      FYI: Put owners tend to exercise deep in the money options the day that the stock goes ex-dividend (and not one day earlier – as call owner may elect to do). Then they sell the stock (via exercise) – after the dividend.

      2) If (as is likely) you are referring to the call with the same strike and expiration as the put, then a big ‘NO.’ Absolutely not. The put and call prices must be tied together or else there would be a ‘free-money’ arbitrage available for the person who buys one call, sells 100 shares, and sells one put. The position is known as a ‘reversal’ or a ‘reverse conversion.’

      The only time the scenario you mentioned occurs is when it is impossible to borrow the stock, and thus it cannot be sold short.

      3. I know nothing of the tax laws. Sorry.

      Regards

      • Tristan Grayson 03/24/2011 at 2:23 AM #

        1. Sure, covered call writers need to be aware of the possibility of assignment at any time, but I just meant that some some writers are very careful to attempt to roll before their short calls go ITM, to prevent losing the dividend. Whereas, cash-secured put writers are not at risk for losing the embedded dividend due to assignment.

        2. Ah, “hard to borrow”, makes sense, though in practice I sometimes see non-‘hard to borrow’ cases that seem to be real? For example AKAM Apr11 39 C Bid/Ask is 0.54/0.57, and AKAM Apr11 39 P is 2.80/2.85 (time value: 0.47/0.52).

        Thanks.

        • Mark D Wolfinger 03/24/2011 at 8:08 AM #

          Tristan,
          Rolling before the short call goes in the money makes no sense to me – when we are talking about covered call writing.

          Calls are not exercised for the dividend just because it is ITM. There are other criteria: The delta must be essentially 100, the time premium must disappear, the cost of the corresponding put often is of concern.

          I’ll repeat one of my favorite beliefs: Far too many traders roll positions far too often and lose far too much money in the process. Rolling ONLY makes sense when the new position is good, desirable and the old position is no longer comfortable to hold. I do not understand why holding an ATM covered call is bothrsome for dividend seekers.

          Regards

          • Tristan Grayson 03/25/2011 at 7:14 PM #

            I read a few of your online articles about when call owners should exercise to capture the dividend. It sounds like it makes sense, but I can’t reconcile this information with other material I read online such as:

            Person A:
            “I find, if a covered call has even a penny less than the dividend being paid, I can be assured of exercise.”

            Person B:
            “I recently shared with a friend my frustration over early covered call assignment at ex-div. I have been called out early several times. The most recent time was on CTL. I had a call over a month out that was assigned early. That nice dividend was gone.

            My friend put me in touch with a Dow Jones Newswire reporter who is writing a Wall Street Journal article on call volume spikes at ex-div….and the guy on the short side of the call.

            He asked me to post his info for anyone who would like to tell of their own experience and frustration.”

            Person C:
            “You sound like you want have your cake(the time premium) and eat it too(the dividend). I think you should accept it as a virtual certainty that you will be assigned when coming into x-date if the time premium remaining is less than the amount of the dividend. Why would you expect that the holder of the contract you sold(the buyer) not want the dividend for himself? Since that person is usually a market maker (with a very low cost of doing business, including cheap commissions and a low cost of margin capital) you will usually be assigned.

            If you get to just before x-date and you think you will be assigned you can always enter a spread order to roll the option to one less likely of assignment.”

            Person B:
            “I’ve traded CC’s for a long time but new to trading for the dividend income.
            The CTL option was over a month out so I really didn’t think much about early assignment. I won’t make that mistake again.”

            Person D:
            “For stocks with large dividends, a call-holder will often exercise the option in order to capture the dividend. This will be done when the option is in-the-money and the Intrinsic value plus the forthcoming dividend exceeds the time value of the call.”

            Perhaps these call owners are being exercised, but not for the reasons they think and only Wolfinger is correct? Thanks.

          • Mark D Wolfinger 03/25/2011 at 7:22 PM #

            Tristan,

            Wolfinger is not the only one who is correct. However, the people whom you quoted are mistaken. This is not an opinion. This is an easily demonstrable fact. I’ll go into more details in a separate blog post on Monday.

  4. Stuart 03/27/2011 at 10:40 PM #

    Mark

    Another reason to sell an IC is that the spread is tighter on an OTM put spread than an ITM call spread so when it comes to exiting the trade you have to give up less to get the put spread filled than the equivalent call spread.

    • Mark D Wolfinger 03/28/2011 at 7:50 AM #

      Stuart,

      I also find it more efficient to trade lower priced (OTM) options than ITM.

      Thanks