The Merits of Buying Iron Condors

Condor Options, as you may suspect from its name, is a web site that stresses the use of iron condors.  In fact, they go so far as to offer a list of 'the top 5 reasons every investor or trader should use iron condors.'

I agree with them, to a point.  I believe that anyone who understands how to use options can benefit from iron condor strategies (sell one call spread and sell one put spread).  In fact, I've posted on this topic more than on any other and trade iron condors for my own account.  To be successful over the longer term, it's important to practice careful risk management when trading iron condors – or any other option strategy.

There's a detailed description on how to trade iron condors in The Rookie's Guide to Options.

Condor Options also tells us that a trading system must have an edge, because "if you don’t know where your profits will come from, you certainly shouldn’t expect to have any."  IMHO, that edge can come from many places:  a well thought-out strategy; the ability to predict market direction – based on a good track record; or taking advantage of the special properties of options. 

One such property is the implied volatility.  Option pricing depends on many factors, but implied volatility is major.  IV has been decreasing recently, and if you believe that will continue, then buying iron condors is one way to capitalize in that IV decrease.

If you believe IV is going to reverse and head higher, you can buy iron condors with insurance.

It's a new year, and a time for new resolutions.   It's an opportunity to begin trading with discipline (assuming you have not yet done so).  And for me, it's time to add to my iron condor positions.

Good trading to everyone.

202

5 Responses to The Merits of Buying Iron Condors

  1. Jim Lindor 01/02/2009 at 3:43 PM #

    Hi Mark,
    I get the impression that most option traders don’t use stop loss orders. If a person is not able to monitor the markets closely during the day, does it not make sense to use a stop loss order to protect against large adverse moves? I’m referring to ICs and credit spreads.

  2. Mark Wolfinger 01/03/2009 at 5:45 PM #

    Hi Jim,
    Yes, it makes sense to use stop-loss orders. But not with options.
    If you want to enter a stop-loss order on an option position, then place the stop loss on the price of the underlying stock or index. You definitely do NOT want to place such an order on an option – and especially on an option spread.
    Let’s begin with the spread: credit spread or iron condor. First, what prices would be used? Pay the offer on your short leg and sell the bid on your long leg? That’s suicide. If the markets widened for any reason, the stop would be triggered and you would get a horrible fill. You might even end up buying a spread for more than its maximum value – i.e., you may buy a 400/410 call spread for more than $10. Never never allow that to happen to you.
    If you used the mid-point between the bid and ask prices to trigger a stop-loss closing order, would it be a market order (a disaster with wide markets) or a limit order that may not get filled?
    Don’t even think about it.
    Suppose you want to use a stop loss on a single option. That’s bad also. A sudden change in implied volatility could easily trigger your stop.
    Don’t even think about doing this either.
    If you want to use a stop loss, then you must base it on the underlying reaching a specific price. But, then what? Market order – knowing you will get a horrible fill – based on wide bid/ask spreads.
    OK, then a limit order? What would that limit be? How can you know – in advance – how much to bid to close? Use the midpoints? Ok, but you are not likely to get filled.
    This is treacherous when you are unable to monitor the trade. A better solution might be to trigger a buy (call or put) to protect the position. Buy a call when the underlying rises to a certain level. Buy another if it moves higher.
    I don’t know what’s best. Options were not designed for stop loss orders when the bid/ask spreads are not narrow.
    Mark

  3. piazzi 01/04/2009 at 11:38 AM #

    Hi,
    Just stumbled on your blog while googling about stop loss with options. Have been reading back post for a few hours now, and am hooked 🙂
    I was googling for a specific question, however
    Could you tell me if you have written a post about how to set stop losses with options.
    I have many years of trading, a few years with options and so far have been managing stops on a case by case approach abefore the end of the day. I would like to know if there are ways to set a stop and forget about it during the trading day.
    bets regards,
    piazzi
    http://markettime.blogspot.com/

  4. Mark Wolfinger 01/04/2009 at 12:52 PM #

    Hello,
    See the reply just above your question.
    I have NOT posted about stop loss orders, but here’s the best advice I have on the topic. I must mention that I don’t like using stop loss orders for options due to the specifics mentioned above. But,
    1) Set the stop loss based on the stock price, not the option price.
    2) Because option prices change over time and as other market conditions change, I know you want to set these daily, but for others with in a similar situation, it’s not a stop and forget. You may want to change your stop loss price at least weekly.
    3) If the option is a single option, you can use a market order to close the option position when the stock’s stop loss is triggered. With wide bid/ask spreads, you probably will not like the price you get for your trade. But, if you feel that a poor poor execution is better than continuing to hold the risky position, then you can do this.
    4) Ask your broker if they can help. Perhaps they will get the trigger (from the stock price) and then be able to send in some option order – other than a market order. I doubt they do this, but you can ask. Also ask if there is a special fee for this service.
    5) I really hate a stop loss on a spread (see previous reply). I have no idea how you can make this work at a reasonable price. If the markets ever settle down and the bid/ask spreads narrow, you may be able to use market orders. But you cannot do that now. Thus, your choice is a limit order that may not fill, or a market order.
    What limit price to choose? Perhaps the bid/ask midpoints at the time of the trigger. Perhaps a morning estimate on what it would you would like to pay to close the position – if the trigger were hit?
    Mark

  5. piazzi 01/04/2009 at 1:30 PM #

    Thank You, Sir,
    Excellent!
    piazzi
    http://markettime.blogspot.com/