Debate: Trading Iron Condors is a Death Wish

Hi Mark, have you read this ET discussion about Iron Condor trades?

I found Maverick's post specially interesting (and clear :-)) I'd like to know your opinion about it.




I was a big fan of Maverick (the TV show, starring James Garner, that first aired in 1957). 



I had not seen the recent ET forum, but, I respect Maverick.  It is difficult to argue with his point of view.  Nevertheless, despite the soundness of his argument and the difficulty that traders encounter when using iron condors, I believe that managing risk makes all the difference.  I am attempting to do what he believes cannot be done:  Enter into a trade using a specific option strategy – without a mathematical edge.


Directional trader

I trade much the same way as a directional trader.  I open a position that wins when the market goes my way (nowhere) and make trade decisions – as necessary – to manage risk when the market moves.  Don't misunderstand me.  Trading with a theoretical edge is the best way to go.  However, it is commission intensive because these trades involve trying to make small sums from a large number of spreads.  I'm not willing to play that game.

My initial and adjustment trades sometimes may be made without any theoretical, mathematical edge, but it's the same for a stock trader who buys shares that the market considers to be fairly valued.  If the stock moves his way, the trader profits. 

I agree that making an adjustment is a 'different trade,' but argue that it's okay to add a second trade to the original.  I am not claiming, nor am I trying to profit, by trading a single golden strategy.  To earn a profit, risk management skills play a vital role.  More vital than trading without an original edge.  That feels right to me, even when the quants find my argument to be trivial.

Traditional investing involves trading stock, with adjustments.  Traders scale out of a trade as prices rise, locking in profits and reducing risk.  That's one form of 'adjusting.' 

Some add to a losing trade by purchasing more shares on a decline (many experts hate that plan), and that's adjusting.  The investor knows that this one way to manage risk.

Iron condors may be a losing strategy if the positions are blindly held through expiration every time.  Holding to the end is not part any rational trader's plan. We plan to make adjustments at some point.  We hope not to need the adjustment, but hoping solves nothing.

Here's how I see it. I cannot affect how the market moves.  Sometimes it's gentle and sometimes it's violent.  Often it's between the extremes.

I earn good money when lucky.  That means time passes, the market is gentle, and I exit the trade early.  I earn better than 10% per month on these trades.

When I get unlucky and the market is violent – and by that I am referring to a huge overnight gap – then I lose.  There is nothing to be done except manage the losing trade efficiently.  If I own insurance, I may not lose very much, or I may earn a profit.  But let's assume there is no insurance.

We seldom get an overnight move that destroys a position.  When the markets are volatile, there is almost always time to act.  And worst case scenario – when  a downside disaster occurs, IV is so high that any ITM put spread can be repurchased at a price that is nowhere near the maximum value of $10.  Of course, the bid/ask spreads would be horribly wide in this scenario, but the patient (not panicked) trader can get trades made at reasonable prices.  To be in that non-panicked mode, it means the trader's position sized properly and a non-devastating loss has taken place.

Traders may lose 100 to 150% (i.e., $300 to $450 after collecting $300 for the original trade) when there is a gigantic move.  I have't encountered this situation during the years I've been trading iron condors.  The last such move occurred after 9/11 in 2001.  The May 6 'flash crash' of 2010 was an outlier not because of the big move, but because it was impossible to trade – unless you had entered orders earlier.

In 2008 the volatility did not occur as an overnight move, and there was time to act.

When markets are more volatile than I want them to be, or when they steadily march in one direction, even without being volatile, then adjusting is a huge part part of the successful trader's plan.

Many times adjusting a trade adds to the final profit. The position has lost money, but the new, adjusted position is one I am willing to hold.because it has a good risk/reward profile.  I don't believe a trader should make an adjustment, just to do something.  A trader must want to own the new position. Holding bad trades in an attempt to recover losses is a sure path to blowing up a trading account.

The winning trader makes an adjustment by adding protection, reducing delta, reducing gamma, and definitely reducing the probability of losing additional money.

Again, Maverick's point of view makes sense. But I find that over the years I earn good money when I behave.  Note – when I behave.  When I act with good discipline.  No trader can expect to do well over any extended period of time when taking too much risk or ignoring his/her personal trading rules.

When I have losing months, it's because I stubbornly fail to make the adjustments that I know are necessary or when I hold positions into the front month.  I know from experience that avoiding front-month positons works for me.   I know it, but I often find a reason why holding is okay 'this time.' 

I am confident that traders who 'get it' have the ability to adjust, protect portfolio value, and trade iron condors.  If a trader adjusts well and maintains discipline 100% of the time, then trading iron condors is acceptable. 

The bottom line is that results are up to the trader, not the strategy.  [I recognize the difference between the methods of a quant and his gigantic computer power and financial backing, and ourselves, retail traders.  The quant does get to trade with edge, but still must trade with discipline.  LTCM and 2008 hedge fund blowups demonstrate that to be true.] 

When we display discipline and the correct psychological attitude to be a good trader, the chances are high that we make good money. I don't blame the iron condor strategy when a trader fails to make it.  Itt's the trader's skills that determine success or failure.


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16 Responses to Debate: Trading Iron Condors is a Death Wish

  1. Steve 12/14/2010 at 3:11 PM #

    I took a look at the ET board.
    Maverick seems to be a typical know-all, ‘expert’ with a low opinion of everyone but himself.
    He simply cannot accept that ‘retail’ traders could possibly make money without putting in the ‘1,000 times’ more effort that he does.
    I don’t believe anyone here said trading ICs was easy but, just maybe, some people quietly go on making a nice return with it.

  2. Fran 12/14/2010 at 3:17 PM #

    Hi mark,
    let’s quote the classics. 🙂
    “The main cause of trading failure is a lack of an objective edge in the marketplace, trading random patterns that have never been tested out for success.”
    Brett N. Steenbarger, Ph.D.
    Can we change “patterns” for “strategies” or “hedge trades”?
    Maybe, in any case I agree with you that this is a good topic to debate about.
    Thanks (again)

  3. Mark Wolfinger 12/14/2010 at 4:38 PM #

    Yes, some people make a nice return.
    I believe Mav is right on this: Trading iron condors as a buy and let it expire strategy will fail.
    I’d wager that those who do well know when to make adjustments and when to exit.

  4. Mark Wolfinger 12/14/2010 at 4:41 PM #

    I cannot argue with my favorite doctor/trading coach.
    I’m making the assumption that we have all traded enough iron condors that it can be considered as a ‘tested’ methodology.
    It is far more risky than some believe. That’s the big problem.
    Thanks for sharing.

  5. dave 12/14/2010 at 5:04 PM #

    my problem with his post is on your link is he rips a perfectly good strategy as ineffective by giving examples of those that are ineffective trading it which is bogus. it is like me saying “day trading is a losing game” . Sure for a number of people but there are many sucessful day traders. It is the same way with condor and the truth is i dont view the condor as b all end all volatility strategy of over priced and under priced options. It is some times a non directiona l strategy. I do beleive it has it’s place and the trader needs to uncover the environment where it is most effective. Thats not 12 months a year it maybe 4-5 months and thats the time to trade it we need to be flexible. thats what makes me profitable i am not married to 1 strategy but adjust with the market

  6. Mark Wolfinger 12/14/2010 at 8:44 PM #

    Hello Dave,
    Thanks for sharing. I share your point of view on flexibility. My problem is not knowing in advance whether it’s a good time for iron condors or whether I should trot out an alternative strategy or two.
    Good advice. Thanks

  7. sandeep 12/14/2010 at 10:56 PM #

    Interesting discussion. Maverick talks about the fair value of the vertical spreads. I have been wondering about that recently.
    For a real life example, at this moment the Jan SPY 119 Put and the Jan SPY 128 Call both have a probability of expiring in the money of 25%. Yet the Jan 119/118 Put spread is about $0.17, but the Jan 128/129 Call spread is $0.25. I would have expected that with both short strikes having the same probability of expiring, the vertical spreads would cost about the same, but this is not the case. Furthermore, it seems to me that the Call spread is probably reasonably priced (25 cent credit for 25% probability of expiring) but the put spread offers a poor reward for the amount of risk entailed. I am guessing that trading this condor or its equivalent would probably be a losing proposition over the long term, for the reasons maverick points out.

  8. Mark Wolfinger 12/15/2010 at 4:10 PM #

    I am having difficulty putting my reply into words. I’ll reply on Friday.

  9. sandeep 12/15/2010 at 9:44 PM #

    I do understand that different options will have different prices based on the implied volatility of the option – but I would have thought that with options having the same probability of expiration that the put options would be more expensive because of the negative skew in option pricing that we usually see. I am a novice, but my presumption is that we are seeing a positive skew in the option prices in this example because we are looking at a fairly short time horizon (January) and all the movement in the underlying has been to the upside recently.
    Thanks again, I look forward to any insights you have to offer.

  10. sandeep 12/15/2010 at 10:19 PM #

    I just went back and checked the implied volatilities of the spy options. The implied volatilites of the out of the money puts are all higher than those of the calls as one would expect – so my theory does not seem correct.

  11. Marty 12/16/2010 at 9:07 AM #

    Maverick’s theory that IC traders will fail long term is flawed because it’s built on several bad assumptions or logical fallacies.
    1) His point that the verticals must be entered on the right side of “fair value” can only be applied to IC positions held to expiration. As you mentioned, when the trader’s goal is to close the position – in whole or in part – prior to expiration, this “fair value” argument falls apart.
    2) ICs must be a bad strategy because hedge funds don’t use them. Therefore, not only is Maverick privy to the confidential trading strategies of every hedge fund on the planet, but as we all know hedge funds never trade strategies that lose money or exclude worthwhile strategies. They are perfect. Pardon me if I disagree.
    3) Maverick himself can’t get them to work so obviously they won’t work at all. Does that even deserve a response?

  12. Mark Wolfinger 12/16/2010 at 9:52 AM #

    1) Fair value is based on the assumption that you trade the position at that fair value and then make that trade an infinite number of times. When you get fair value, and assuming the pricing models are accurate (which we know they are not becasue they undervalue the tails of the curve), then you break even. That’s fair value.
    2) Yes, that’s a poor argument.
    3) I don’t know if he has ever traded them – because of his opinion.
    4) For me the value in iron condor trading comes from adjusting the positions, and I’m willing and eager to sue them.
    Thanks for sharing

  13. Marty 12/16/2010 at 10:09 AM #

    1) I agree with that definition, and it seems the only way to perform the infinite trade analysis is by assuming the trader will hold through expiration. That’s the big “flaw” in some of the pricing models that allows this trade to work in real life by legging out or adjusting.

  14. sandeep 12/16/2010 at 10:38 AM #

    I was wondering if you might have any general comments on managing a calendar trade that is moving into the money too quickly. Without going into specifics, I initiated the trade with a bullish bias (which is still the way I want to play the trade) and placed my strikes out of the money. This is a wide calendar (6 month difference between short and long dates). The underlying has moved rapidly and is now already at my short strike in just the first week.
    My plan is to cover the short strike now and roll to a higher strike, later month for credit and allow the long call to run – basically just turn it into a diagonal, and try to always keep the short call out of the money.
    I am just wondering if there is anything flawed in my logic. Also, as I am fairly new to this blog I am not sure whether quetions like this regarding trades are welcome or not. If not, please excuse me and disregard the post.

  15. Mark Wolfinger 12/16/2010 at 1:38 PM #

    Hello s,
    1) All questions are welcome and I’m hurt that you think I would ignore your question. However this does bring up a point. These questions and answers are designed to help solve a problem, not to give lessons.
    Thus, comments on managing a calendar spread is surely a large enough topic that it cannot be answered as a reply to a comment. In fact it’s enough for a book chapter.
    2) But there is no reason to attach your question here – to a post that is already several days old – and is off topic. There is little chance that many people will see it.
    3) I do reply to help the questioner, but surely you understand that I want an many people to read it as possible. That way we both get something out of the exchange. Thus, unless it’s related to a specific post or continues a string, please post all questions to the latest blog post.
    4) Back to your problem:
    A 6-month calendar spread, bullish bias or not, is a play on volatility. Shorter-term calendars are much less so. It is not a bullish spread – as you can plainly see.
    If you want a bullish trade, choosing a long-term calendar was not the way to go.
    If I were you, I’d exit right now. And because most people look at the P/L when deciding whether to exit, be certain to exit if you have a profit.
    Your current trade is no longer bullish becasue the short is ATM. That is not what you want.
    I don”t like your plan. True you always collect a cash credit, but you may have to go far OTM to do that. What’s the point?
    If you want a bullish spread, buy a bullish spread that doesn’t require so much activity on your part. Buy a spread that does not threaten to lose money when the stock rallies. Own a trade that makes money on the upside. It really is that simple. You have made this far too complicated.
    A calendar is inappropriate for just the reasons that occurred. The stock rallied more than you anticipated.
    If you continue to sell near-term or 2nd month OTM options, you may face the same situation again. I know what you are doing. You are looking for the jackpot. See short option expire as stock continues to rise. Going for the jackpot is not best, as you see right now. You should be looking at a nice profit, instead you have a problem.
    When bullish trade a bullish spread

  16. Mark Wolfinger 12/16/2010 at 5:03 PM #

    Right. Edge is great, but skill can compensate. Good luck is even better.