Is There Such a Thing a A Relatively ‘Safe’ Iron Condor Position?

We all recognize that this market's been volatile, but yesterday morning I read a blog that provided some eye-opening statistics.  In discussing the frequency with which the stock market moves 5% or more in a single day, Barbara notes that such moves occurred:

  • 27 times during the 50 years from 1950 through 2000
  •  7 times during the next 6 years
  • 20 times during the first 9 months of 2008
  • 22 times during Oct and Nov 2008

"These days, we're hitting the threshold more than half the time."

Five percent move every other day!  To me, the stock market is no longer for investors.  It has become a gambling casino. 


What does this mean for investors?

Because so many people are dependent on the stock market for their pensions and other retirement benefits, if this condition is not remedied, the outlook for anyone planning to retire within the next 20 years has become worrisome.

I've read reports that 'all will be well' and that there has never been a 20-year period during which investors did not earn a profit in the stock market.  Those statistics have become meaningless when the world has changed, and only serve to encourage those who have been battered by the market debacle to remain invested, and hope for the best.  

Please don't take the above as a suggestion to sell an investment portfolio.  That's a very personal decision.  It's merely my expression of uncertainty, and hedging positions with conservative options strategies may be an appropriate choice for many of today's investors.


What does this mean for option traders?

Day traders love the volatility and the opportunities such volatility affords.  That's not for me.  I have nothing against such methods, I just lack the necessary skills.

My concern is: How can an iron condor trader, or any premium seller survive?  What does one have to do to have a position that feels safe?  Let's look at some  numbers.

Tuesday, RUT closed at 442 and RVX (the implied volatility for RUT; similar to VIX and the S&P 500 index) is 74.  Because I refuse to hold short option spreads later than Thursday of expiration week, there are now 16 days remaining before I must close any December option positions (I hope to close sooner).  That means a one standard deviation move is 68 points.

Std Dev = S*V*SQRT (t)

S = stock (index) price

V =  Implied volatility (as a decimal)

t = time, in years; or calendar days/365


Thus, there's approximately a 16% chance that RUT will finish below 374 and another 16% chance that RUT will finish above 510.  There's little comfort in those numbers.  I have no interest in new December positions and prefer to open Jan or Feb iron condors.  But, no position is relatively safe.  It pays to own insurance, or reduce risk by trading fewer options. 

Looking for a potential January iron condor, in which the options I sell are two standard deviations out of the money, here's what I find:  With 44 days remaining, RUT @ 442 and RVX @ 74, I'd be forced to choose the following Jan position:

  • Jan RUT 200/210 put spread (205/215, if it were available)
  • Jan RUT 670/680 call spread

These options are so far out of the money that the calls have no bids and the puts are both low priced options.  No reasonable iron condor can be constructed from these options.  That means I must choose a position that is closer to the current RUT price, or find a different strategy during these volatile markets. If willing to write options that are 1.5 std dev OTM, I could create an iron condor by selling:

  • RUT Jan 260/270 put spread

  • RUT Jan 610/620 put spread

The bad news is that these options are not priced attractively for my comfort zone.  Dilemma.  In reality, I'm choosing options that are CTM (closer to the money) and I compensate for risk by owning extra strangles and/or trading small size.  It's a treacherous world for premium sellers.

This post is a lengthy way of saying that any iron condor can quickly move into the money and this strategy is still viable – but only for  nimble traders who understand how to mitigate risk.  I'm still trading these iron condors, but I treat risk with great respect.

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4 Responses to Is There Such a Thing a A Relatively ‘Safe’ Iron Condor Position?

  1. Jim Lindor 12/06/2008 at 9:56 AM #

    Hi Mark,
    I’ve been thinking about this post for several days. I don’t understand why the high volatility is not pumping up premium enough to offset the extra risk.

  2. Mark Wolfinger 12/06/2008 at 8:44 PM #

    Option premium is very high. In fact, it reached all time high levels recently (VIX did not exist in 1987 when it would have been approximately double the recent highs.)
    When pricing options, it’s an estimate for future volatility that determines option prices. I suppose option prices reached a level that either attracted sellers or failed to attract enough new buyers to push prices even higher. Although option volume set yet another all-time record this year, over the past month or two, volume has declined on a year-to-year basis.
    Bottom line: Options were priced where buyers and sellers met – and it turned out that the markets were even more volatile than predicted by option prices.
    That seems to be a reasonable result.

  3. Robert 12/18/2008 at 10:37 AM #

    Mark,
    I generally open my Iron Condor positions about 10 weeks before expiration. I generally try to close out the “good side” spread when it gets below $0.30, and immediately open a new one at closer strikes for an additional credit. Occasionally, like right now, I have an IC that has hovered near the center of my profitable range for several weeks. I haven’t had a significant opportunity to close and replace either side, but the price of the entire position has dropped considerably. Very nice.
    I’m thinking about closing both sides. Being a conservative trader, I would prefer to minimixe my exposure to the vagaries of the market. I’m willing to forfeit some “opportunity profit” to lock in a gain. However, when I have a very cooperative IC with an underlying price nowhere near either the call or the put spread, I have a bit of inner conflict about leaving high-probability potential gain on the table.
    Here’s my question: Based on your experience, are you ever willing to close out the enitre IC early? I’m visualizing a little table that says… If there are ___ weeks remaining, I’d be pleased if I can close with a ___% gain.
    I suspect you’ll start with a reminder that decisions of this nature must be driven by my own comfort/pain threshhold. But, I’m interested in gaining more insight into YOUR perspective on money management in the described situation.
    Thanks for the excellent blog and I look forward to your comments.

  4. Mark Wolfinger 12/18/2008 at 10:29 PM #

    See tomorrow’s post (1/19/2008) for the reply.
    thanks for the question.