Tag Archives | limited loss

Implied Volatility and Standard Deviation

Hi Mark, I have a few questions i hope you can answer.

1. Isn't holding a naked long call (as a result of locking in a profit or plain buying outright call) in general a bad idea? Reason I think so is because of the nature of IV: it mostly falls when the underlying is rising. So you have short theta and a big long vega moving against you.

And holding a naked put seems logical and natural.

2. Can IV be really considered as a Standard Deviation for a stock price? Same reasons to ask – why would a stock probability to be at a certain price range shrink just because the market moved higher? Why would it widen in case of a fall?



1.You are correct.  A rising stock price usually means that IV is falling.  Thus, any gains resulting from positive delta are diminished by losses from declining vega. Most novice call buyers miss that point.

You believe that it feels 'natural' to be short the put option and collect time decay. I also prefer to be short options (as a spread, never a naked option) because of time decay. However, I don't see anything 'natural' about being exposed to huge losses by selling naked options.  There is  nothing natural about that. [In further correspondence, you admit to having a big appetite for risk – and under those circumstances, selling options would feel natural].  Hedging that risk feels more natural to me – and that means we can each participate in the options world, trading in a way that feels comfortable.

However, the majority of individual investors – especially rookies – find that owning long calls feels natural: Limited losses and large gains are possible. That combination appeals to those who don't understand how difficult it is to make money consistently when buying options.  The chances of winning are not good when the stock must not only move your way, but must do so quickly. 

More experienced traders believe it makes sense to sell option premium, rather than own it.  Please understand: that is not a blanket statement.  There are many good reasons (hedging risk is primary) for owning options, but in my opinion, speculating on market direction is not one of them.

The problem with holding a naked (short) put option is that profit potential is limited and potential losses can be very large.  In addition, when the stock falls and you are losing money because of delta – IV is increasing and the negative vega is going to increase those losses. Although positive theta helps reduce losses – the effects of theta are often less than those from vega and delta.

Even though long calls and short puts are both bullish plays, they really serve different purposes.  Traders who want to own calls are playing for a significant move higher, while put sellers can be happy if the stock doesn't fall.  Put sellers have a much greater chance to earn a profit, but that profit is limited.  Selling puts is not for the trader who is looking for a big move or who wants to own insurance that protects a portfolio.

2. Standard deviation is a number calculated from data – and one of the pieces of data required is an estimate of the future volatility of the stock.

Yes, it appears that a rising market results in a smaller value for the standard deviation move, but in reality, SD decreases because the marketplace (and that is the summary of the opinions of all participants – the people who determine option prices) estimates (as determined by the prices and IV of options) that future volatility will be less than it is now.  You are not forced to accept that.  You may use any volatility number that suits to calculate a standard deviation move.

If you argue that it doesn't make sense for a mathematical calculation to depend on human emotions and decisions, I cannot disagree.  However, to calculate a standard deviation, it just makes sense to use the best available estimate for future volatility. Most traders accept current IV as that 'best' estimate.  That does not make it the best, it's just a consensus opinion.

If you prefer to use your own estimate to calculate a one standard deviation move, you can do that – as long as you have some reason to believe that your estimate is reasonable.


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Low Premium Iron Condors: Follow-up; A Real World Story

Adding my 2 cents to Tom's comment about the low credit, high probability newsletter
condor service: I traded these based on newsletters advice for
over a year and did great. Few adjustments, "easy" money, and I had big

Every month I did well, I allocated a little more of my capital,
and a little more, etc. That all ended in March when the market
crept and crept up to my strikes with low volatility and I found almost no
way out.

The newsletters were of no help and I found out first hand how
quickly a 5% gain can turn into a 50% loss. Then add to the fact that an unlucky
settlement took away another 10%.

Couldn't sleep, slaved over the ticker,
kept putting on additional credit spreads as the newsletters suggested
to help lower some of the loss which only made things worse.
Lost $50,000 in a matter of a week. Had almost an 85% gain up to that
point, but a 50%-60% loss of my account (built up with earlier profits) hurt.

Came out negative after everything.
Look at ALL those newsletters results for March. I know many that changed the way they show results to hide their 50% – 100%
Its not worth the sleepless nights, biting nails, upset stomach when
that 10% of the time you lose money comes along.

I believe in condors, but I go much longer term with farther out
strikes, higher credit, and wider spreads and just adjust casually when
needed – which is not much. I will NEVER go back to front month, low
credit condors again and would warn others to do the same … IMHO



I'm very sorry to hear of your experience. Thanks for sharing. Do remember that we each have our own comfort zones, but I'm in agreement with your preferences.

One item in your note deserves special mention.  It is common practice to 'protect' the call (or put) half of an iron condor by selling extra put (call) spreads and bringing in additional cash.  This idea is unsound, in my opinion, and is at the very bottom of my list of possible adjustments. 

First, the cash collected is never enough to make a significant difference.  In other words, as the problem situation gets worse, the cash collected is dwarfed by the ongoing losses.  But that's not the worst part.  If the market suddenly reverses direction, there is a string of newly opened spreads than can turn what was a truly horrible situation into a catastrophe.  I'm not suggesting that traders shouldn't open new spreads in an attempt to move the position back towards delta neutral, but three conditions must apply:

  • Collect enough cash to make the trade worthwhile
  • Cover farther OTM spreads to avoid the humongous loss
  • Only make the trade when it creates a position you want to own.  It is not mandatory to be delta neutral

As mentioned, I am not a fan of these low-credit iron condors (or credit spreads).  There is no doubt about it, winning often is fun.  Boasting of a 90% win/loss ratio attracts attention.  Newsletter writers boast of their fantastic results.

However, being a winner over the longer term is even more fun. One piece is missing from the boastful stories, and that's a description of what happens the other 10% of the time – when there is no profit. 

There are really only two methods that the newsletter writers can follow.  They can manage risk – by whatever method they choose – or they can close their eyes and accept a very high % win rate over the longer term.

Let's assume a service recommends selling a five-point credit spread and collecting $0.25 when the delta of the short option is five.  This is referred to as a 95% probability trade (definition: The spread will finish out of the money 95% of the time). 

a) No adjustments

If the trader wins 19 times and collects $25 each time, the gain is $475.  If the maximum loss occurs one time in 20 trades, the loss is $475.  [Yes, it is possible that the loss is less than the maximum]

Conclusion: This is not a statistically viable strategy.

b) Adjustments

How about the writer who adjusts?  This trader no longer has 19 winners.  How many wins are recorded depends on the adjustment method.

The good news is that there are no $475 losses.  There will be fewer wins and more losses, but no disasters.  Unless we know the adjustment point for the trader, this is just a guess, but let's assume three losses of $100 and 17 wins at $25 each for a net profit of $125.  Over 20 trades, that's $6.25 per trade, or a 1.3% return on the $475 margin requirement for the trade. 

That's not a bad result.  But it's not sexy, it is not hype material.  It's not the type of returns that a newsletter wants to publicize. 

If I thought I could manage other people's money and earn a steady 15% year after year, I'd advertise it.  But, that's not my business.  I'd rather teach others how to manage risk and trade options.



Honest bit of self-promotion:  This blog has a decent following, but I'd like to reach a wider audience.  If you find these posts to be worthwhile, please help spread the word by tweeting about them or mentioning on other social media.  Many thanks. 

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