The Hidden Dangers of Iron Condors

Avoid the overhyped option strategies that promise “consistent income” in all market conditions, writes one veteran trader, citing the foolish levels of risk that must accompany such strategies.

I have been asked by Tim Bourquin of MoneyShow.com about my thoughts on the so-called “income options strategies” that have been popularized in the past few years. Named so because they would return income “consistently” month after month, some Web sites say the strategy is simple enough to leave one’s job and begin trading for a living.

Reproducible Option Strategies for Consistent Income

The problem with cookie-cutter options strategies such as the iron condor (IC) is that they do not work in all markets all the time. You see, you can teach someone the mechanics of entering an IC, but it is a lot harder to teach someone when to enter the IC and when to exit it, for that matter.

What are the right market conditions? Even the advocates of such strategies would admit that "you enter the IC when the markets are going into a trading range." Now that is as difficult a forecast as there is. You’d require a complete course in technical analysis to reliably recognize a sideways market, let alone to predict one. This is hardly what I would call “consistent,” especially for the beginner.

You can choose to enter a wide IC to increase the probability of the short options in the IC expiring worthless, but then your risk/reward ratio becomes so large that you can lose a lot of your hard-earned cash in a violent move in the markets, and we have seen plenty of those since 2007.

"Consistency," or "income" strategies are often tossed around when referring to the IC and credit spreads because they have relatively low return but high probabilities of success. It is the unexpected—the so-called "black swan" events—that can really make your IC lose you a great deal of money. 

Most trading education programs teach a specific technique for a limited number of hours. The student gets excited and begins to trade the strategy without backtesting or paper trading it first, so that they could not have first studied every contingency.

Since there is no strategy that works all the time, the new trainee finds quickly that there are many situations for which they have not been properly trained, and they simply do not know what the right course of action is. The result is that, at best, the trainee abandons the strategy, blames the guru or the system as really not workable, and then they move on to the next educational program. 

High Risk/Reward Ratio

I have traded the IC as a complement to my PCCRC strategy, and it is really not worry free. (The PCCRC is the Put Call Calendar Ratio Combination, a “delta-neutral” and “vega-positive” strategy described in detail by the author in numerous articles on his Web site at OptionsVet.com.)

Ideally, you will trade it in an index ETF, like the S&P 500 Index ETF (SPY), rather than an individual stock.

To make an amount of money to pay your bills and live independently, you'd have to trade too much. Let's say you want to make $5,000/month, starting with an IC, such as this I entered in March 2011, on the S&P 500 large-cap index:

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This trade had a maximum profit of $690, so to reach my desired $5,000, I would have to enter seven or eight lots of this or another similar IC.

The risk in this trade, or your maximum loss, is $1310. A strong move in either direction and you could lose close to $10,000. Your risk/reward ratio is just too high.

The usual scenario is that you make your money if you are patient enough and knowledgeable enough to resist the temptation of exiting the trade prematurely. Anywhere between four and ten days before expiration, you exit the trade, but rarely with every dollar you expected to make. If you are successful, you make your money every month until that “black swan” event happens, which can take you back to square one after months of trading.

It is true that the IC tends to stay within a safe range most of the time, but you are risking $2 to make $1 in most situations, and you rarely get the entire $1 (see Max Profit/Max Risk = 52.67% in the table above).

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A Portfolio of Iron Condors?

Ideally, you would choose an index ETF, because indices do not to drop 30% overnight, as stocks might.

How are you going to diversify your risk? Are you going to enter an IC on the S&P 500 index, the Dow Jones index, and the Nasdaq? Well, that is not much diversification, really.

The stock indices usually move in tandem. Typically, the Nasdaq moves more violently, so you are more or less stuck with SPX. An IC of SPY options might be more costly in terms of commissions for the equivalent SPX position because the number of contracts would be ten times higher.

Doing a little paper trading with special attention to the commissions might reveal that the SPY IC’s take a lot of your expected profits as well. There are some trainers that even recommend buying cheap, out-of-the-money (OTM) put calendar spreads to protect against a move below the range, further adding to the commission expense. This is why I trade the SPX IC’s.

I find it difficult to believe that anyone would use this strategy as the sole form of trading in their portfolio.

I would not risk more than 2% of my account in a single trade. It follows then that to make a “consistent” profit sufficient to generate an income to pay your bills (i.e. $5,000/month), you’d have to have a very large amount of capital or assume a larger risk.

If you take a risk that is beyond your comfort zone, the one-month period might seem interminable. This is particularly true for the inexperienced trader, unless they go through a long period of backtesting and paper trading. They will not be prepared for the emotional roller coaster that is the IC. For one entire month, they’d wonder if the market is going to close above or below the IC at expiration.

This is simply not a strategy for everyone, and there is definitely nothing consistent about it. A set of iron condors on the SPX, spread over weeks, are essentially the same trade, so the rule of 2% should apply to the complete aggregate of IC’s on the SPX or other indices, as they are all subject to the same potentially risky market moves.

So you’d need a $500,000 account to make $5,000 a month, or you’d need to increase your maximum risk per trade. In the end, the IC does not seem to be intended for most beginners, does it?

Implied Volatility and Fear

When implied volatility (IV) is high, your ICs will have a lower risk/reward ratio, but it is precisely during periods of high IV that you should be more scared.

That trade I entered in March was because the IV had spiked at the time. The markets have climbed since, and the SPX approached my top breakeven point, which is enough to make me very concerned. If this was the only strategy I had to trade the markets, I would be very scared that my “income” was going to be negative this month.

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That is not to say that an experienced trader might not have a set of rules of entry and exit that would take care of all my objections, but there will be nothing easy about it, of that I am sure.

Think of trading as a career. An IC course that lasts a few hours is not going to prepare you sufficiently for all the eventualities that may occur in real-time trading. Backtesting and paper trading are essential.

I have been trading options for nearly 16 years, and I would never recommend to anyone that they quit their jobs to trade any options strategy, let alone ICs, unless they have a big bag of money to go through bad periods during which their strategy is either not appropriate or fails altogether. Be aware that the money at risk can all be lost at or before expiration.

I use the IC as a hedge with the PCCRC because it is a strategy that takes advantage of declining IV, and an IC strategy is favored during low or increasing volatility. However, over the last several months, IV has become really low and the ICs have not been a good bet lately.

A final thought is that options trading is a career that is exciting and rewarding, but it requires much experience to realize its full potential. Preparation and opportunity is what makes a successful trader; it’s nothing that you can learn in a few hours of trading courses.

Warning: Stocks Will Collapse by 50% Saturday, 14 Mar 2015 08:27 AM

It is only a matter of time before the stock market plunges by 50% or more, according to several reputable experts.

“We have no right to be surprised by a severe and imminent stock market crash,” explains Mark Spitznagel, a hedge fund manager who is notorious for his hugely profitable billion-dollar bet on the 2008 crisis. “In fact, we must absolutely expect it."

Unfortunately Spitznagel isn’t alone.

“We are in a gigantic financial asset bubble,” warns Swiss adviser and fund manager Marc Faber. “It could burst any day.” 

Faber doesn’t hesitate to put the blame squarely on President Obama’s big-government policies and the Federal Reserve’s risky low-rate policies, which, he says, “penalize the income earners, the savers who save, your parents — why should your parents be forced to speculate in stocks and in real estate and everything under the sun?”

Billion-dollar investor Warren Buffett is rumored to be preparing for a crash as well. The “Warren Buffett Indicator,” also known as the “Total Market Cap to GDP Ratio,” is breaching sell-alert status and a collapse may happen at any moment. 

So with an inevitable crash looming, what are Main Street investors to do? One option is to sell all your stocks and stuff your money under the mattress, and another option is to risk everything and ride out the storm.

But according to Sean Hyman, founder of Absolute Profits, there is a third option.

“There are specific sectors of the market that are all but guaranteed to perform well during the next few months,” Hyman explains. “Getting out of stocks now could be costly.”

How can Hyman be so sure?

He has access to a secret Wall Street calendar that has beaten the overall market by 250% since 1968. This calendar simply lists 19 investments (based on sectors of the market) and 38 dates to buy and sell them, and by doing so, one could turn $1,000 into as much as $178,000 in a 20-year time frame.

Editor's Note: Sean Hyman Reveals His Secret Wall Street Calendar in This Controversial Video, Click Here.

“But this calendar is just one part of my investment system,” Hyman adds. “I have also designed a Crash Alert System that is designed to warn investors before a major correction as well.”

(The Crash Alert System was actually programmed by one of the individuals who coded nuclear missile flight patterns during the Cold War so that it could be as close to 100% accurate as possible). 

Hyman explains that if the market starts to plunge, the Crash Alert System will signal a sell signal warning investors to go to cash.

“You would have been able to completely avoid the 2000 and 2008 collapses if you were using this system based on our back-testing,” Hyman explains. “Imagine how much more money you would have if you had avoided those horrific sell-offs.”

One might think Sean is being too confident, but he has proven himself correct in front of millions of people time and time again. 

In a 2012 interview on Bloomberg Television, Hyman correctly predicted that Best Buy would drop down to $11 a share and then it would rally back up to $40 a share over the next few months. The stock did exactly what Hyman predicted.

Then, during a Fox Business interview with Gerri Willis in early 2013, he forecast that the market would rally to new highs of 15,000 despite the massive sell-off that was haunting investors. The stock market almost immediately rebounded and hit Hyman’s targets. 

“A lot of people think I am lucky,” Hyman said. “But it has nothing to do with luck. It has everything to do with certain tools I use. Tools like the secret Wall Street calendar and my Crash Alert System.”

With more financial uncertainty than ever, thousands of people are flocking to Sean Hyman for his guidance. He has over 114,000 subscribers to his monthly newsletter, and his investment videos have been seen millions of times.


Read Latest Breaking News from Newsmax.com http://www.newsmax.com/Finance/MKTNewsIntl/stock-market-crash-warren-buffett-indicator/2014/10/03/id/598461/#ixzz3UT0d9njK
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The Missing Piece of Iron Condor Option Trades

ron condor option trading can be profitable but most traders miss an important piece of the strategy. Learn what that is fromKerry Given.

A very popular option strategy these days is the iron condor, but you may be missing a piece of what makes this successful.  My guest today is Kerry Given to talk about that.  So Kerry, iron condor is a very popular strategy, but I think maybe some traders may be missing a really key piece of this.  What is it?

It is how you manage the trade.  Unfortunately, a lot of people find that they read a book or somebody teaches them how to put on the condor and they think wow-this is a great trade-and it is fairly simple to put on.  Unfortunately, the worst thing that can happen to you is you put on the first couple for the first couple months and make money; but then the market drops or else runs up very strongly and you can lose an awful lot of money.

I know you have to adjust in part of that management.  How do you adjust an iron condor?

Well generally speaking, the best adjustment that I know of that I use personally is to buy a long call or a long put in the next month out; so if the market is trending up like it has been lately, for example, and it is pressuring your call spreads, then you go out to the next month and buy a call.  I usually buy one of those calls for every ten condor spreads that I have.  Then what happens; if the market continues to move up, your call spreads are losing money but your long call is gaining money; so it moderates your risk and moderates your losses while you are waiting for the market to either pull back or slow down.

And should that long call that you go out and buy be the exact same strike price as part of the spread?

Well generally speaking, I start with the strike of the short option and I also start with one option for every ten condors.  I actually experiment with options analysis software to look at what seems to be the optimum because generally speaking, if you bring that strike down a little more in the money, you get a stronger hedge; but what you also sacrifice is some of your positive theta in your trade, so you have to find the balance.

What software do you use to do your analysis?

I use Platinum, but OptionVue and a lot of the brokers' Web sites, now have very good options now with the software where you can do the same thing.

Options Trading With The Iron Condor

Most investments are made with the expectation that the price will go up. Some are made with the expectation that the price will move down. Unfortunately, it is often the case that the price doesn't do a whole lot of moving at all. Wouldn't it be nice if you could make money when the markets didn't move? Well, you can. This is the beauty of options, and more specifically of the strategy known as the iron condor.

How to Take OffIron condors sound complicated, and they do take some time to learn, but they are a good way to make consistent profits. In fact, some very profitable traders exclusively use iron condors. So what is an iron condor? There are two ways of looking at it. The first is as a pair of strangles, one short and one long, at outerstrikes. The other way of looking at it is as two credit spreads: a call credit spread above the market and a put credit spread below the market. It is these two "wings" that give the iron condor its name. These can be placed quite far from where the market is now, but the strict definition involves consecutive strike prices.

See: Option Spreads Strategies
A credit spread is essentially an option-selling strategy. Selling options allows investors to take advantage of the time premium and implied volatility that are inherent in options. The credit spread is created by buying a far out-of-the-money option and selling a nearer, more expensive option. This creates the credit, with the hope that both options expire worthless, allowing you to keep that credit. As long as the underlying does not cross over the strike price of the closer option, you get to keep the full credit.

Figure 1

With the S&P 500 at 1270, one might buy the September 1340 call option (black dot below point 4 on the above chart) for $2.20, and sell the September 1325 call (black dot above point 3) for $4.20. This would produce a credit of $2 in your account. This transaction does require a maintenance margin. Your brokerwill only ask that you have cash or securities in your account equal to the difference between the strikes minus the credit you received. In our example, this would be $1,300 for each spread. If the market closes in September below 1325, you keep the $200 credit for a 15% return.

To create the full iron condor, all you need to do is add the credit put spread in a similar manner. Buy the September 1185 put (black dot below point 1) for $5.50, and sell the September 1200 (black dot above point 2) for $6.50 for another $1 of credit. Here, the maintenance requirement is $1,400 with the $100 credit (for each spread). Now you have an iron condor. If the market stays between 1200 and 1325, you will keep your full credit, which is now $300. The requirement will be the $2,700. Your potential return is 11.1% for less than two months! Because this does not presently meet the Securities And Exchange Commission's (SEC) strict definition of an iron condor, you will be required to have the margin on both sides. If you use consecutive strikes, you will only have to hold margin on one side, but this clearly lowers the probability of success.

SEE: Policing The Securities Market: An Overview Of The SEC.

Tips for a Smooth FlightThere are several things to keep in mind when using this strategy. The first is to stick with index options. They provide enough implied volatility to make a nice profit, but they don't have the real volatility that can wipe out your account very quickly.

But there is another thing you must watch out for: you must not ever take a full loss on an iron condor. If you have been paying attention and are good at math, you will have noticed that your potential loss is much higher than your potential gain. This is because the probability that you are correct is very high. In the above example, it is more than 80% on both sides (using delta as a probabilityindicator that the market will not close beyond those strike prices).

To avoid taking a full loss, if the market does what it normally does and trades in a range, then you don't need to do anything and you can let the whole position expire worthless. In this case, you get to keep your full credit. However, if the market moves strongly in one direction or another and approaches or breaks through one of your strikes, then you must exit that side of the position.

Avoiding a Bumpy LandingThere are many ways to get out of one side of an iron condor. One is to simply sell that particular credit spread and hold the other side. Another is to get out of the whole iron condor. This will depend on how long you have left until the expiration. You can also roll the losing side to a further out-of-the-money strike. There are many possibilities here, and the real art of the iron condor lies in the risk management. If you can do well on this side, you have a strategy that puts probability, option time premium selling and implied volatility on your side.

Let's use another example. With the RUT at roughly 697, you could put on the following iron condor:

Buy September RUT 770 call for $2.75
Sell September RUT 760 call for $4.05
Buy September RUT 620 put for $4.80
Sell September RUT 630 put for $5.90

The total credit is $2.40 with a maintenance requirement of $17.60. This is a potential gain of more than 13% with an 85% probability of success (again based on the delta).

The Bottom LineThe iron condor option strategy is one of the best ways for an option trader to profit from an insignificant move in the price of an underlying asset. Many traders believe that a large move upward or downward is needed for them to make a profit, but as you've learned from the above strategy, handsome profits are possible when the price of the asset does not really move far. The structure of this strategy may seem confusing at first, which is why it is used primarily by experienced traders, but don't let the complicated structure intimidate you away from learning more about this powerful trading method.