Iron Condors: The road to riches or the path to trouble?

When I sit at my desk and write a book or blog post, I do some research and tell my story. However, when interacting with traders, either through blog commentaries, email exchanges, or live interactive discussions, I get a much better picture of the real world.

Many interesting questions arise. Some are easy to answer, while others can be discussed at length in a book chapter or webinar.

One of the topics that draws attention is the desire to estimate how much can be earned by a trader and whether it is a reasonable goal to quit a job and become a successful professional trader. This was the topic of a recent blog post at my premium web site (this post is available at no cost).

Another topic of discussion involves how easy or difficult it is to make good money when trading iron condors. I’d like to share some of that discussion, and surprisingly the major emphasis is not on risk management.

If you are an iron condor trader, then you are aware that the past few months have been pretty good for most traders. The market has moved up, down and up, but never too far, and not too quickly. I suppose that statement is a bit too broad. Anyone who chose strike prices that were not far out of the money may have run into trouble. But those who believe in selling options with a delta of 10 or less probably had a bunch of consecutive winning months. And that’s exactly what happened to some traders with whom I have been in touch.

Trader A recognized that this is a new strategy in his arsenal and wants to know how long it should take before he gets a good feel for his true earnings power when using iron condors. He is happy to have closed six consecutive winning trades but wants to know how many such trades it takes to provide confidence that the results are representative of future expectations.

This is truly a remarkable experience for me. I almost always find a different attitude when a new strategy provides excellent profits. The traders tend to believe that they happened onto a winning strategy. But more than that, the usual feeling is that they are exceptionally talented when it comes to managing a portfolio of those trades. They fail to recognize that the market has been very kind to iron condor traders, and that happens from time to time. The more common result is for the markets to be sufficiently volatile so that iron condor traders encounter very risky situations. That’s when they will be tested to determine how talented they are.

I’m very proud of this trader A. He recognizes that things cannot be this easy. He asks how many such trades he must see before he gets a good feeling for risk and potential profitability. In reply, I told him that it’s not the quantity that matters. Instead it’s the variety. When he finds himself making important risk management decisions – and making them in a manner that truly cuts risk – then he can have confidence that he has the talent to succeed. But not until then.

Of course, there is nothing wrong with having a bunch of winning trades and retiring before facing the inevitable challenge of working with money-losing trades.

966

4 Responses to Iron Condors: The road to riches or the path to trouble?

  1. mark 05/11/2011 at 12:11 PM #

    well said unfortunately losses are the most powerful teacher of that lesson

    • Mark D Wolfinger 05/11/2011 at 12:25 PM #

      Mark,

      For the most part, people must suffer the losses themselves before the lessons mean anything. Very sad.

      Regards

  2. Robert D. 05/12/2011 at 12:03 AM #

    Mark,

    I would assert that It’s helpful to think of an iron condor in terms of its component credit spreads. If you’re deciding whether to trade an IC of given strike prices, ask yourself:

    1. Do I want to sell the put spread having the low strikes I’m considering?

    2. Do I want to sell the call spread having the high strikes I’m considering?

    If you answer “yes” to only one of those questions, then sell only that spread, or consider different strike prices for the second spread. Another advantage to this approach is that you can easily leg into the IC by selling the second spread at a more appropriate time. (For example, your initially bearish outlook may have become more neutral.)

    Conversely, for an existing iron condor position, if you determine that your underlying has moved too far for comfort in one direction, the simplest way to adjust that position is to buy back the spread on the vulnerable side of the trade, leaving you short the opposite spread. I think this “modular” approach to the iron condor helps a trader stay attuned to this position’s flexibility.

    My question is: Do you think I’m overlooking some subtler aspects of an iron condor by simplifying it in this way?

    Thanks,
    Robert

    • Mark D Wolfinger 05/12/2011 at 7:54 AM #

      Robert,

      I suppose there are always going to be more subtle aspects of anything we do. However, I take your approach with one modification.

      I prefer to enter the position as one trade (I am not referring to how the orders are placed). I prefer to look at the risk profile for the entire iron condor and be certain that it, as a four-legged spread, is suitable. That includes comfort with the strikes. etc.

      Once I own the position, it is no longer an iron condor. I am short one call spread and one put spread and I manage them separately. I add the greeks when considering portfolio risk, but I examine each of these items separately: the risk graph, comfort zone, how far OTM each is from the short strike (and my exposure to loss), cost to exit.

      Yes, when ‘vulnerable’ [are we playing bridge?] take care of that side of the iron condor. That’s the focus. However, in my opinion, once any adjustment is made, that’s the time to look at the other side and decide whether it pays to keep that side open. Many times the answer is ‘yes.’ However, it may cost a bit more than you want to pay to exit – but is the risk/reward worth keeping the position? You may now be far from neutral (considering entire portfolio) and may prefer to adjust that winning side to bring in more cash (and not by selling extra spreads). That would be by closing and moving the spread to one that is CTM. This specific step is controversial to me. I can see good arguments for getting near neutral, but I see better (for my comfort zone) reasons to get out of this side and do nothing else.

      I like your approach. It is what I do and what I teach.

      Regards