Iron Condor Option Trading Mini Course Part Two

Part Two: Philosophy of the Iron Condor

Incase you missed Part One: http://optiongenius.com/blog/iron-condor-option-trading-mini-course/

Stocks move up and they move down. Very rarely do they move in only one direction for an extended period of time. Since most of the time, stocks trade in a range, why don’t we make money from the range, instead of trying to determine if they are going up or down?

That in essence is the philosophy of the iron condor spread. No need to determine which way the market will move, because within a 30-50 day time period chances are that the market will stay in a range. Over time, it may move in one direction. But in a short period of time it probably won’t.

So let’s sell options that are far out of the money, which have very little probability of hurting us, and make money by selling time. As days go by, the options lose value, the markets go up and down, and we profit.

Iron condor spread trading is non-directional trading. An iron condor trader does not need to know which way the market is going. It helps if he does know, but my opinion is that no one can accurately predict over and over which way the market is going or where it will go to.

So when people ask me what I think of the market, I tell them “I don’t know”. And as an iron condor spread trader I don’t really need to know. As long as it gets to wherever it is going slowly, my iron condor spread trades will make money.

Two Types of Condor Traders

There are two major schools of thought when it comes to the Iron Condor spread trades. The first school says that the condor spread trade is a strategy that works on its own. In other words, no adjustments are needed. If you let it do its thing, over time the trade will make money.

The other school of thought says that you should adjust your condor spread trades when they get into trouble.

I fall into the second school. I don’t like losing money and taking a max loss on a condor trade by not adjusting it can be a depressing event.

By adjusting a condor, I mean to make changes to the original position to impact the trade. There are many different adjustments possible, and I will cover them later in this mini-course. By adjusting the trade, you give yourself an even better chance to make money. But every time you do an adjustment, you reduce the maximum yield you can make on the trade.

What Probability Do You Want?

Once an iron condor trader has decided if he will adjust or not, he must decide what probability of profit he wants to aim for. Does he want 60%, 70%, 80% or more? Based on this number he will pick his strikes (options to sell). The further away from the money, the greater the chance that the iron condor spread will make money, but the lower the yield and the greater the max loss.

I like to be in the 80% probability range.

Another way to influence the probability is the amount of time to be in the trade.  A trader can be far from the money, with a high probability of profit, and a higher than normal yield, but only if he stays in the trade longer.

For example, an iron condor that is entered 50 days to expiration has more yield and option premium than one entered 25 days to expiration.  But those extra 25 days add risk that something could happen in the market to hurt the position during that time.

How to Determine Strikes

When it comes to strikes, again we have two schools of thought.

One group of traders uses technical analysis to determine which strikes to sell. They look at the charts, find the support and resistance levels and whatever other technical indicators they use and sell strikes that they feel give them the best chance of making money.

Iron condor spread trades

The other group, of which I belong, use statistics and math to determine which strikes to sell. By using statistics you can set your strikes to have a high degree of confidence that your strikes will be safe. For example, you can set your strikes one standard deviation away from the money, or two standard deviations away. These deviations are calculated, using option prices, the volatility of the underlying, the time left to expiration, and several other factors.

Option trading strategies

Whichever of these two methods you use, keep in mind that there is no guarantee that the market will not violate your short options. So even with a high probability of profit, you can still lose money.

Let’s move on to Part Three

8 Comments

  1. Jason Wingfield on August 18, 2010 at 5:01 pm

    I hadn’t considered using statistics over technical analysis. I’m interested in giving this a try in my demo account.

  2. Paul Bruno on September 25, 2010 at 4:59 pm

    One thing that needs to be mentioned in Condor trading are the large commissions, which can wipe out your profits if you end up making several adjustments. Can we talk about that?

    • Genius on September 28, 2010 at 2:11 pm

      I talk about commissions in the email course you can see in the top right corner of this page.

      If you have to adjust over and over and over then the commissions can eat away a lot of your profit. Keep in mind that the adjustment is not the goal. You want to just put the trade on, and let it decay and expire or exit with very little value. The adjustments are what allow you to stay in the trade when it goes against you. In normal circumstances you will not need to adjust much. (2010 has not been normal.)

      The type of adjustment also dictates how much you will spend on a condor. If the only adjustment method you know is to exit the whole trade and reposition, then you will be paying a lot. But if you can get by with just adding a long call or put, that is not commission intensive.

  3. Faizul on September 11, 2011 at 1:56 am

    Thanks for the tips Allen, really useful. I just wanted to know, are there more parts to this mini course yet to come?

    Hope 2011 has been good for you. Crazy volatility out there and a lot of ‘doom and gloom’ in the mainstream media

    Faizul

  4. venancio teves on April 17, 2012 at 11:47 pm

    Where or how can I obtain the the SD of the underlying, because I am not sure I can calculate accurately the SD myself. I thank you.

  5. P.N. Ranganathan, Ph.D. on December 13, 2017 at 4:53 pm

    Very clear, unambiguous and candid explanation! Pleasant surprise indeed! Regarding Stats:
    1) would like to know which particular statistic/s you choose (based on ‘N’ value and your goal) and why?
    2) Having taken courses as well as used Stats at work, I’ll be cautious in relying on them too much (famous quote in Stat text books: “there are lies, damn lies and statistics” 🙂 Regards..

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