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When is an Iron Condor Trade too Aggressive (Risky)?

A question from a loyal reader brings up a very important topic that I have not addressed.  I've mentioned that my personal choice is to collect ~$300 for a 13-week, 10-point RUT iron condor.  Stating that it's a comfort zone decision, I did not go into much additional detail.  Then comes this question, which is far more important that it may appear:

Hi Mark,

Wondering about $3 out of 10-point spread.  Please correct me: do you mean something like: puts you collect about $150 and calls collect the same $150, total $300/$1000 margin?

To me that is very aggressive, 30% premium collected out of $1,000 margin. Thank you for sharing.

Dauddy

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Hello Dauddy,

Yes, I collect ~$300 for a 10 point spread.  Margin requirement is $1,000 (but many firms allow you to use cash collected, reducing margin to only $700).

In my opinion, aggressive is not the appropriate term.  However, I understand that you are stating the obvious: Anyone who attempts to earn so much money from iron condor trades is taking too much risk.

'Risk" is a matter of perspective.

 

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At one extreme, consider the trader who sells very far OTM call and put spreads and collects a premium of $20 (after paying commissions) for a one-month, 10-point, iron condor.  The margin requirment is $980 and the trader's potential return on investment is 2%. 

Or, to translate this into a 13-week trade similar to mine, let's say he/she collects $60 (after commissions) for the same anticipated 2% per month return.

How would you define these trades?  Surely you would not consider them to be aggressive.  In fact, some traders consider this to be a very safe methodology and claim to use it to earn steady income.

We know that traders all over the world would love to have a fairly safe method for collecting 2% per month on a very consistent basis. It may take all the fun out of trading, but it would allow for very early retirement for anyone who has a reasonable sum to invest.  At this rate of return, account value doubles every three years.

So I ask – why is this not the investment method for a huge percentage of the trading population? 

You know the answer.  Because it doesn't work.  There are enough big market moves that the trader has two uncomfortable choices: 

  • Cover a dangerous position, paying $300 – $500 (depending on  the trader's exit plan), thereby losing between five and eight months of earnings
  • Hold and hope that the loss disappears and does not turn into a maximum loss of $940

Neither of these choices is fun to make.  My point is that this is an aggressive way to trade.  This is tilting at windmills and hoping that nothing terrible happens.  But, it's a continuous strategy and we know that something unwanted will happen.  And too often for this method to work over the long term.

Which is more aggressive, trading 13-week iron condors and collecting $60 or $300?

With my strategy/plan, I will lose $300 on an iron condor far more often than the FOTM trader.  Far more often.  However, I'll have some good (lucky) results and earn $250.  Not only that, but my maximum loss is $700, not $980. One more point:  I'll trade fewer contracts that the other guy.  If that FOTM trader wants to make any money, he/she must trade a bunch of contracts.  And that's where real risk enters into the discussion.

 

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There are professional traders who believe that collecting an even higher premium is the best and safest method for trading iron condors. The rationale is that the trader has smaller positions and any bad result is not going to wipe out the trader's account.  And yes, the number of wins is reduced, but consider this:  If you take in $500 to $600 as the initial credit, there's no urgency to make adjustments. I have  no experience managing these, but if time passes and the market is ever near the original starting price, I'd guess that the trade can be closed for a good profit.  Years ago there was a discussion of this topic on the Elite Trader forums (but I canot find it)

To make any decent money, the $60 premium trader must continue to build size in an attempt to grow the account.  A single disaster can easily destroy an entire trading career.

Risk can be defined as the most money that can be lost for a given trade.  It can also be looked at as the probability of losing any money on a given trade.  Or some combination.

I feel my risk is right where I want it to be.  My worst loss should be in the $300 range and my best gain is about $250.  Obviously the vast majority of my results fall between those ends.  I don't have any records of my trades because I own multiple iron condors at any one time and manage the account risk as well as the risk for an individual call or put spread.

This is not aggressive in my opinion.  However, if you would feel better trading iron condors with a $200 or even $150 premium, then that's what you must do.  There must be a premium level that provides the chance to earn enough – but with an accceptable level of risk.  However – opening the trade is just the first step.  Risk management is the factor that will determine how well you do over the longer term

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