Hope the trading is going well. I've visited your blog from time to time and always enjoy the way you explain the world of options, especially when it comes to iron condors. It is this topic I am writing to you about, as I have been trading these for quite some time and find they compliment my trading style.
Whenever I discuss my options trading with others I tend to find myself justifying the way I trade options. This isn't a concern to me as I am confident in how I go about my business and don't feel the need to argue my case. However, a recent discussion I had with a trader who works as a broker for a large trading firm was insistent that all the "pro traders" trade volatility only and go either long or short volatility and believe credit spreads, condors, butterflys etc… is just gambling.
Seeing that you have been in the business a lot longer than myself and have also been a MM and now educator, I would like to know how you view this argument and how you would respond? I value your opinion and would appreciate any feedback.
It's reasonable for different people to have different points of view on specific issues. Politics, for example.
Some situations are known to be true, based on a large amount of evidence. Yet there are those who choose not to believe the evidence and form their own conclusions. The fact that global warming is a result of human actions, for example.
Is trading iron condors gambling? I don't believe that there's room for two positions on that issue, but it requires a lengthy reply.
- All attempts to make money by buying something (or selling it short) and then selling it to someone else at a higher price, is gambling. After all, there's no guarantee of earning a profit (winning the gamble) and there's always a chance of taking a loss (losing the gamble). That seems to be a good definition of gambling.
- If you buy a poker hand, a parimutuel ticket (horse racing), some real estate, art, stock or option, you are – by definition – gambling. Real estate agents charge enormous fees, auction houses charge fees to both the buyers and sellers, stock brokers charge smaller fees, while others (race tracks and casinos) take part of the pot. Those fees reduce the chances that you can win. But, despite the odds, we play.
- We invest. In fact, the prudent investor rule is a legal doctrine that guides investment managers, and one of its tenets is that the prudent investor should own a diversified stock portfolio. There's virtually no one who would suggest that it's right for the prudent investor to gamble, and investing in the stock market is accepted as an intelligent and necessary thing to do.
- Some gambles are simply bad bets – buying a lottery ticket for example.
- Here's a question for the trader who challenges your investing choices: Is it gambling to buy stocks? You say he is a broker for a large trading firm. I doubt he will tell you it's gambling to own stocks.
- If you own stocks, my opinion is that owning collars is a conservative, intelligent option strategy for investors who prefer to concentrate on preservation of capital, rather than on maximizing profit potential. Ask your broker buddy what he thinks of collars. If he has any understanding of collars, he will give that strategy a vote of confidence. If he doesn't, then there's not much you can say. You can try to learn why he disapproves of a conservative strategy that is as far away from gambling as an option trading individual investor can get.
- If he agrees that collars are a conservative play (and not gambling), then you've got him. The put credit spread (of which he disapproves) is a collar – i.e., it's equivalent to a collar and has the same risk and reward profile.
- Selling a put spread is part of an iron condor. The other part is selling a call spread, and that's equivalent to selling a collar. Thus, your so-called gambling trades are composed of buying and selling collars – one of the most conservative option strategies available. If your trader tries to tell you that collars are ok, but that iron condors are a gamble, then be prepared to wow him by whipping out pencil and paper and proving that an iron condor is just two collars (If you require help, post a request).
- And here's some news you can share with him: Not all professional traders trade volatility, and only volatility. That's a very risky business – in other words, it's gambling. The volatility swings of 2008 offer proof of just how right you must be when 'playing volatility' – or else you can get clobbered. I no longer have many ties with professional trading firms, but the two with whom I have ties trade neutral – all the time. And that means delta neutral, gamma neutral, theta neutral, and vega (the volatility component of an option's price) neutral. They do NOT get long or short volatility. That's just too much of a gamble.
Thus, if we ignore the fact that many of our activities are a gamble (walking across the street involves the risk of being hit by a bus or car), and that prudent investing represents an acceptable level of gambling, then any option strategy becomes more of a gamble when the trader ignores risk. Thus, my assertion that trading iron condors is not gambling is based on the assumption that the trader has good risk management skills.
P.S. Let me know how the conversation goes.