Among the most popular option trading strategies is the Iron Condor, which aims at making money from the passage of time or the decrease in volatility. The main advantage of this strategy and the feature that makes it so popular is its ability to manage risk effectively.

However, the typical setup with which Iron Condor is usually proposed and used has several problems that can undermine its long-term effectiveness. In this video, we analyze these problems and provide valuable tips to solve them and improve the strategy’s performance.

By watching the video, you’ll discover:
-What the Iron Condor is and how it works
-What the typical setup of this strategy consists of
-What the three main problems are with this setup
-Our tips on how to solve these problems to make the strategy more effective

Enjoy! 😎

Transcription

Introduction

Hey everyone and welcome back! Today we’re going to be talking about options and, in particular, one of the most popular options strategies.

I’m referring to the Iron Condor. So, if you’re interested in this type of strategy, stay tuned!

Alright, so why are we talking about Iron Condor?

Well, as I mentioned, it's one of the most popular strategies, so I'm sure it does interest many of you.

And then it's presented on the Internet, in various books, courses, as kind of panacea for all ills.

Instead, we'll see all together that, like all strategies, it has its pros and its cons.

Moreover, it seems to me that it’s also presented in a way that isn’t entirely accurate.

What I mean is that I think that this strategy fails to perform at its best with the typical setup it’s usually presented with.

What is the Iron Condor strategy

But let's go in order. First, what is the Iron Condor?

It is an options strategy consisting of four "legs," that is, four options, as we see in this chain.

It consists of two Call options and two Put options.

So, we have a Call credit spread and a Put credit spread.

So let's build it together. Let's create a new strategy. Here it is.

Let's sell a Call and at – let's say 100 points, for example – let's buy a Call, okay? We’ll limit the risk in case it goes up.

Notice that I used options from Delta10 to about Delta5 in this credit spread, okay?

It’s a spread of 100 points. The first option sold is at Delta10.

Let's do the same for the Put side. So minus one. 100 points. Plus one.

Here is our Iron Condor in the typical form in which it’s presented.

Note also the deadline: 30 days.

And this is the standard setup that you can find in several books and online presentations related to this strategy.

In this video, we’ll use options on the SPX index, which we know is one of the most liquid indexes in the world.

What is the aim of the strategy

But what is the purpose of this strategy? It’s to profit from the passage of time or a decline in volatility.

The condition is, of course, that the underlying asset remains within this range.

Let's go and try to simulate the passage of time. We have our green line, which corresponds to the profit and loss of the strategy until today.

If we continue for ten days or so, our profit will increase if the underlying asset stays within this range, so within this area.

And if we go even further, we’ll see that our profit area gets bigger and bigger, and then takes on this form at maturity.

The same thing happens when volatility goes down.

So typically, opening an Iron Condor is usually more profitable when it happens at times of high volatility provided that the underlying asset doesn’t have strong movements at those times that would take it out of our profit zone.

So, we understand that over time, Iron Condor benefits from a decline in volatility but loses when there are abrupt movements in the underlying or an increase in volatility.

Pros and Cons

So, what are the benefits of Iron Condor?

Well, aside from the aspects that characterize it, it certainly has limited risk.

So, in case of movements of the underlying asset, our loss, in this case, has a cap limited to about $8,800.

So compared to, for example, selling naked options, we can say that this is a more conservative strategy in the sense that the worst-case scenario is already predicted within the strategy.

Let’s now come to what I consider to be the most negative aspects of this strategy, as it’s usually presented.

It’s pretty evident from this structure that the profit is quite disproportionate when compared to the maximum loss that one could have.

So, the maximum gain is about $1,200, and the maximum loss is $8,700.

That’s definitely an extremely negative aspect.

When it comes to options, those who propose strategies often focus only on the high probability of success.

It’s clear that such a strategy has a high success rate, but the problem is that a single loss is enough to wipe out perhaps months and months of gains.

So, that’s the first aspect I don't like about this kind of setup.

So what’s the problem with this strategy? Well, the problem is that we sold options extremely far from the price of the underlying asset, at Delta10.

And that gives us a high success rate but also an extremely unfavorable risk-return ratio.

So personally, I prefer staying closer to the underlying asset and having a more balanced risk-return ratio.

Another aspect I don’t like in this kind of setup is selling credit spreads at a constant distance. In other words, 100 points for Calls and 100 points for Puts.

Why don't I like this?

Well, because volatility is very different for options... We know that not all options have the same volatility.

In fact, Puts typically have higher volatility. This creates a distortion, so the Delta of our strategy is negative.

What does this mean? It means that we start with a strategy that has a bearish base, even though we know very well that the markets, the stock indexes, tend to go up in the long run.

So, that’s something to keep in mind.

With this Iron Condor setup, you often lose on the bullish side.

Why? Because as I mentioned before, we start at the beginning with a structure that is itself bearish.

This aspect becomes even more apparent when we move the Deltas closer to the price of the underlying asset.

So, this is the first aspect that I don’t like.

And I have no doubt that you’re wondering how you can have a structure that is genuinely Delta-neutral that is, a structure that has no bias, that is actually market neutral.

Well, you have to sell the Put options at a greater distance than the distance between the Call options.

So, that’s called “Unbalanced Iron Condor”, and we see that we are now approaching the Zero Delta.

We are still not very accurate. Let's try to fix it again.

point 90, point 36. Here, this is a structure that is balanced in itself.

So, if we wanted to open an effectively market-neutral Iron Condor, we would have to do that.

In other words, we would have to sell Put credit spreads farther than Call credit spreads.

Another aspect I don't like about this setup is the 30-day maturity.

It’s often explained that a 1-month maturity is used because options tend to expire more in the last month of their term.

Well, you see, that’s not always true. Actually, it applies only to a particular type of options, which are ATM options.

We can see it best in this graph.

ATM options, namely those on the gray line, tend to decay more in the last month.

However, this isn’t true for the In-the-Money options and the Out-of-the-Money options.

Indeed, Out-of-the-Money options do precisely the opposite.

They have a higher decay before 30 days, and from 30 days on, that decay slows down.

So you understand that when we sell Delta10s with 1-month maturity, we do precisely the opposite of what should be done.

And not only that. Another aspect that makes me want to work with longer maturities, for example, is related to Gamma.

Gamma is a second-degree Greek value of options, which is, to simplify it, the curvature of the “At Now” curve.

So, the greater Gamma is, the greater the curvature of our current payoff and the more unstable the strategy is.

It just doesn’t take too much movement in the underlying asset to go into loss.

When we work on short expirations we'll always have a high Gamma, which means that our strategies will be much more unstable than other strategies with long maturities.

That makes us monitor the strategies and intervene more often, and that's something that I honestly don't like very much.

But I don't know, maybe that’s just a little bit more of a personal aspect.

Strategy automated backtest

At this point, I want to show you a little backtest that was done using an automated options backtest platform called "Get Volatility."

In the test, we’re selling an Iron Condor at Delta10 versus Delta5, duration 30 days held for 15 days and closed with a 75% profit.

As you can see, the strategy is profitable but, from 2018 to date, it made a very small profit.

And not only that. It’s visible during the Covid period how this strategy has thrown away months of profit, although not particularly important, in a very short time.

Then it was able to recover just because we were in a period of high volatility. So, Iron Condor certainly benefited from being opened during periods of high volatility, and it took us four years, or almost five years, to be back in profit compared to the initial value.

So, over the long term, the strategy isn’t particularly successful, at least not with these rules.

Final thoughts

Now, that said, I'll leave you with a suggestion: if you’re truly interested in Iron Condor I’d advise you to work, if you’re working at 30 days, with options closer to Out-of-the-Money.

I’d even advise you to extend the expiration, so work with longer expiration dates precisely because that gives you more time to intervene.

So that you aren’t forced to sit in front of the monitor all the time to manage the strategy.

Not only that, always remember that our Iron Condor structure would be inherently unbalanced if we opened it with strikes… with credit spreads with the same distance between them, between Call and Put.

So, the ideal is to open an Unbalanced Iron Condor to have a strategy that is market-neutral.

And last but not least, the most important piece of advice perhaps is always test before you go live with a strategy.

It’s imperative to test what would have happened in the past if you had applied specific trading rules.

And that's exactly what we do here at Unger Academy.

The systematic approach to markets is essential, whether automated or not.

We need to have rules and we need to know how our strategies have performed in the past.

So, if you’re interested in learning more about systematic trading, we're going to leave a link in the description of this video.

There is a free presentation by Andrea Unger, through that link, where he introduces you to his trading method, the Unger Method, which he used to win the World Cup Trading Championships four times.

You can also go and get the best seller "The Unger Method,” covering only the shipping costs, and also through that link you can go and book a free strategy consultation with a member of our team.

And that is all for today, guys. Thank you so much for watching.

Please leave a Like if you enjoyed the video, and also subscribe to our channel too!

And with that, I will see you soon in our next video, until then, bye bye!

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