Iron Condors and the Greeks

Hello Mark.

1.  Last week I traded an iron condor on Apple (January and February expiration) at 350/360 on call side and 290/300 on put side.

Past Monday, the prices of all four options, January expiration, went up for no apparent reason!  My January positions started showing big losses.  February positions were fine for same company and same strike prices.  What happened?   

The implied volatility for January options increased.  You opened your positions when implied volatility was at its low point.  Because iron condors are positions with negative vega, they lose value when IV increases.  That's what happened to you.  If IV moves downward again, you will recover the losses quickly.  Otherwise, it's going to take the passage of time (without a concurrent stock move) to recover.

Today, both January and February iron condor went up in prices, and again I see big losses.  I thought time erosion and call spread would help me.  

There is more than one greek.  Each contributes to the value of an option independently of the others. 

Theta is your friend.  You earn a small amount each day.  However, that is being offset.  Gamma is the enemy.  If the stock moves too far, then you get short deltas quickly (on a rally) or get too long (on a decline). 

Vega is the culprit you right now.  Vega measures the dollars earned (or lost) every time the implied volatility moves higher or lower by one point.  Right now it is moving higher.

When the market falls and the put spread moves against you, the call spread will NOT decrease in value fast enough to compensate for the loss in the put spread.

It truly upsets me that you thought that selling a call spread for a smallish premium would ever be enough to completely offset the loss on the put side when the market declines.  Sure it helps, but never enough,  The IC strategy is not designed to have one winner to offset the loser.  It is designed to win when the market is not very volatile and doesn't move too far – as time passes. [And there is no need to wait until expiration to grab your profit]


Is it possible for me to calculate option prices, independently? 

Independently of what?  The market determines the prices.  The market determines whether you earn a profit or take a loss.  No you cannot calculate option PRICES independently.

What you can do is calculate a theoretical value for any option. You can make an estimate of where you think the options should be trading.  That calculation may give you the confidence to hold your trade, but it will be your opinion vs. the collected opinions of the rest of the world.

To make the calculations requires that you input an estimated future volatility for each option (that's all four of them) into an option calculator.  Not an easy task for anyone, let alone a rookie trader.  Estimating future volatility is very difficult.  Dare I say impossible for the vast majority?  It is better to allow the marketplace to generate the option values. Then you can make trades that you deem suitable.

You may not have planned it, but you decided it was a good idea to get short AAPL vega at the time you opening the iron condor position.

What happened to you and your trade is that you chose to own negative vega at a bad time.  Not much you can do about that now.

2. My broker, thinkorswim, does not charge commission if I buy back short options if they are worth 5 cents or less.  Is it a good idea to take this offer? 

Yes.  I approve of reducing risk whenever possible.  Paying 5 cents is cheap insurance.  If there is just one day to go prior to expiration, then that's different.  There is no urgency to pay the nickel at that time.  But I love to pay that price (and more) to exit. I am also happy to pay commissions to eliminate the risk.  Free commissions make it a no-brainer for me.

3.  How do I know where (in stock, equity or ETF) a pro like you invests in iron condor? 

You cannot know.  Nor should you care, except perhaps to see it as an example.

There is no 'best' premium to collect and there is no best strike price to sell.  Nor is there a best time to enter the trade – unless you are a strict adherent of technical analysis.

You (honestly, I am not making this up) want to own a position that makes you, comfortable.  If you try to guess which position makes someone else comfortable, how is that going to do you any good?  You would not know when that pro makes an adjustment or exits the trade.  You must find trades that please you.  Sure you can read about what I do, but there is no good reason for you to attempt to do the same. But think about this:  You have no idea whether I am struggling, doing ok, or making a ton.  Not am I going to tell you.  It is completely irrelevant.

4. [A later follow-up to the original e-mail conversation] I can see that options pricing is lot more complex than I imagined.  I thought that earlier I place trade for next month, I get better price.  But that is not true.

It is true as far as theta is concerned. However, there are other factors that influence the price of options.

Here is the bottom line for you:  You clearly jumped into trading a strategy with no clear understanding of how it works.  That's fine when trading in a paper-trading account, because that's one good place to learn all about the trades being made.  But when using real money it's just foolish to think you can trade now and learn later. 

I find it very sad that you are in this position.  What is your hurry?  You have the rest of your life to trade and now is the time for learning.



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8 Responses to Iron Condors and the Greeks

  1. Bob 01/05/2011 at 5:47 AM #

    Greetings Mark,
    I know you choose the Iron Condor as you don’t try to predict price direction and I really get that. I was curious on your insights into volatility and forecasting it. Do you monitor VIX/RVX and current implied volatility on the options in the wings when you select a position? Or do you still select a comfort level based on Delta while just observing Vega with an cautious eye as to the position’s negative vega level? What range of Vega fits your comfort zone and what level is the red flag to consider not opening that position?
    Thanx for your time and insights.

  2. Mark Wolfinger 01/05/2011 at 7:59 AM #

    Yes, I monitor RVX, and to a lesser extent, VIX.
    I recognize that IV of the wings is important, and is something worth using when choosing specific trades or perhaps the timing (i.e., wait when skew if flat).
    However, I have scaled back on my trading due to time constraints that for my own trading I use the less efficient, and probably less profitable, concept of entering the iron condor trade when delta, premium available, and my overall comfort with the position are satisfied.
    In other words, I have become less of a professional trader and spend my time writing the blog, Expiring Monthly and preparing the Premium site.
    Bob, these are good questions. I assume by ‘range of vega,’ you are referring to ‘range of IV.’
    When RVX is less than 20, I do not enjoy being short RUT vega.
    I take one of three actions: One is to cut position size. When more confident (how can one ever be confident when predicting?) that IV is not going to continue getting crushed, I add OTM calendar spreads. That means trading some double diagonals with my iron condors.
    I do not overload. I trade with a portfolio that begins vega neutral. My goal – is to avoid being short too much vega. So, if the position gets long or short vega, I am not likely to be in a hurry to neutralize. Delta and gamma are another matter and must be watched more closely.
    As an alternative, I buy extra options as protection. Similar to the kite spread. When I deem the cost to be reasonable, I like owning extra options. [But beware as expiration nears]
    My excuse is lack of time, and the fact that I prefer doing other things. If I were a younger, full time trader, I would be incorporating ideas that I know are beneficial (things I did not know when I was younger) – such as paying more attention to skew. That would mean avoiding the iron condor when skew is flatter.
    When RVX >35, I max out. That means I trade as many iron condors as I feel comfortable trading. It does not mean that I use every available penny of margin (that’s never a good idea).

  3. Gus 01/05/2011 at 11:32 AM #

    I agree, never a good idea to max-out margin, always start with a small position size in case adjustments are needed. Just like Roulette’s Martingale System, always start with the lowest posible bet and double the size if wrong, it can’t fall on red or black forever; in our case it can’t go up or down forever. IC trading looks a lot like roulette, probability, risk-reward, etc. The options edge over roulette is expiration and theta.

  4. Mark Wolfinger 01/05/2011 at 12:04 PM #

    Hello Gus,
    One reason for ot maximin out on margin is to allow room for necessary adjustments.
    I am an opponent to the Martingale system. While I agree that the market cannot go in one direction forever, it can easily go long enough to wipe out a finite trading account. Or ‘the markets can remain irrational longer you you can remain solvent.’
    Yes, expiration puts an end to the position and theta is the reason we play the game, but please consider the idea of using adjustments to make the positions safer and more likely to turn a profit. I find that adjustments are not be be feared, but as an opportunity for profit.
    Thanks for the contribution. There are always conflicting options and each side should get to be heard.

  5. Gus 01/05/2011 at 2:48 PM #

    What are you going to offer in your premium site?

  6. Mark Wolfinger 01/05/2011 at 3:04 PM #

    I’ll post an updated plan for the premium site as soon as I can. I’m updating it right now.
    Thanks for asking

  7. Robert 01/11/2011 at 10:47 PM #

    Hi Mark,
    I’m a beginning trader, and I’m trying to distill the most useful trading practices from the mountains of information available online and elsewhere. I have read articles about theoretical option values, and how one should try to sell “overvalued” options and buy “undervalued” ones. However, you seem to suggest that making such value determinations is more subjective than objective.
    Have you implemented this kind of analysis, and if so, have you found it to be beneficial? I’m just wondering how much to focus on this aspect of identifying good trades.

  8. Mark Wolfinger 01/12/2011 at 8:28 AM #

    Robert D,
    There is so much information – and yes, it’s overwhelming.
    If you are GOOD at estimating how volatile the specific stock is going to be in the future, then you can calculate the value of each option and buy undervalued and sell overvalued. How in the world are you going to do that?
    Sure that’s a good plan, but you cannot estimate volatility and you cannot tell which are cheap and which are relatively expensive. Anyone who tells you that you can do it is lying to you. That idea is for people with sophisticated mathematical models and fast, expensive computers.
    I do ZERO of that now. When I worked for a trading firm for a few years in the 80s and 90s, we did try to trade that way. And it is good to have an edge. I’m not knocking it. But I have no idea how to get that edge becasue I don’t know how volatile stocks will be going forward.
    Today, it’s not possible – at least for me, and I suspect the same for you.