Iron Condors are Both: Directional & Volatility Play

Continuing on a theme covered by Jared at CondorOptions:

"One of the primary problems with option selling strategies… consistent profits can
easily be wiped out by those [occasional] large periodic jumps in realized
volatility.  The most obvious way to begin
addressing that problem is to opt for risk-defined option spreads like
condors and butterflies in lieu of straddles and other naked positions."

As an owner (sell call spread and sell put spread) of iron condors, it's easy to consider this position as a bet on market direction – specifically the lack of a significant move in either direction.

But an iron condor is a position that's short vega, and that means as the market's implied volatility (IV) increases, the iron condor trader tends to lose money.  Not only because of a market move that jeopardizes one leg of the position, but also because when IV increases, the value of the IC increases.  And that results in a loss.

Traditionally, you may have considered the sale of a straddle or strangle as  the most obvious method for 'selling volatility'  because such positions are short vega.  Not only that, but they present the possibility of unlimited losses – something avoided by investors who pay attention to risk management.  Option traders who want to get long or short vega are used to thinking in terms of those straddles/strangles.

As Jared mentions, trading iron condors is one method for going short volatility without being forced to take the risk of unlimited losses.  Nevertheless, significant losses are still possible, despite the fact that they are limited.

As mentioned above, most iron condor traders think in terms of market movement and believe they own positions that are predicated on the belief that the market will not trade outside of a specified range before the time comes to close out the position.  But iron condors represent more than that. They are also negative vega plays.  And the part that I don't like is that is essentially a double or nothing bet.  When IV remains low, the markets tend to be non-directional and the iron condor trader wins twice.  The price of the position declines as time passes, but it declines faster as IV declines.

The obvious corollary is that when the market tends to make big moves (especially when that move is lower), the IC trader loses twice: once to the big move and the second time to an increase in implied volatility.

When you trade iron condors please be aware that it's also a volatility play.  If you don't want to own negative vega, there are positions you can own that have positive vega.  If you own some vega-rich positions, it offsets some, or all, of the negative vega risk associated with iron condors.  One such position is the calendar spread.


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