Previously posted at InvestorPlace (formerly) OptionsZone
Could you comment on my line of reasoning for the role of volatility in options pricing when choosing strikes of Iron Condors or
As a rule of thumb,
implied volatility of any underlying stock or index increases when the
underlying is down – much more so when it is down a lot in a short time.
steady increase of the underlying shrinks implied volatility.
Say an index is at 330 and has been moving up and down for
some time between 305-310 and 345-355 zones. I want to trade an IC at
290/300 put side and 360/370 call side, say 5 contracts, 2 months out.
As a scenario, if the underlying rises steadily, the short call spread comes under pressure, but only gradually. The price increase for
that call is offset by the implied volatility seeping away.
Not so for the put side. If this index dropped at a similar pace, it would come with a rise in implied volatility. The short
put spread would rise more rapidly in price.
This makes protective actions
expensive, say buying a 305 put or closing the
entire put position.
Would it be recommendable to set up IC's that seem
asymmetric at first glance? Above example, choose 280/290 puts, or even lower. In terms
of the probability that either the short put or short call is touched,
this position would actually be more symmetric.
I feel making my IC
asymmetric offsets the asymmetry of volatility.
Is this a recommendable general rule or do I miss anything?
The slightly longer version of Chris' comment can be found by clicking here.
1) Yes, as a general rule of thumb, your observations are accurate.
2) I have mentioned the idea of asymmetric iron condors previously. The way I see it, most traders want to own a market neutral position when opening IC trades. And most people assume that being delta neutral fits the bill.
However, there are alternatives.
It's perfectly reasonable to elect to be 'distance neutral.' That means the short put and the short call are equally far out of the money, regardless of delta. The iron condor may appear to be asymmetric, but that is only true if you look at deltas.
Another choice is to be 'dollar neutral.' That means the trader collects an equal premium when selling the call spread and the put spread.
Then, there is the idea you are suggesting. I would call that 'risk neutral.' Making your best guess as to how the market will price the options (i.e., guess what implied volatility will be), choose an iron condor so that you lose the same number of dollars if and when the iron condor moves up or down by a certain amount (points, percentage, or standard deviations).
Chris, it's fine to set up an iron condor that meets your criteria for owning a neutral position – and especially a position that fits within your comfort zone.
There is even the opportunity for a 'bias neutral' iron condor in which you allow a market bias to dictate whether you accept more risk on the put side or the call side. This is not really 'neutral' but if you have a market opinion, this is one way to play it.
Symmetry is often in the eyes of the beholder. If you believe the position meets your criteria for risk and if you manage risk according to those criteria, these asymmetric iron condors should help make your trading more efficient.