Good question here from inside the VTS community. Our friend David asks:
“I’ve noticed that the IWM tracks the RUT very closely so my question is, when our iron condor trades use the RUT, can I just use IWM instead?”
So great question, and this will certainly go on my list of future video topics to really flush out a full response to, but let me highlight a couple of the reasons this is probably not a good idea.
First, yes these are virtually identical as far as price movements go. The IWM is an ETF that tracks the Russell 2000 index (RUT)
There’s two main reasons why the RUT is a better choice. There’s others as well including settlement differences, no dividends, early assignment issues, but the two main reasons for today are:
1) The RUT is a cash settled index which gets favorable tax treatment. 60% of profit can be declared as long term capital gains so it’s more efficient in the long run. Anytime we can find ways to dodge the tax man we should take advantage.
2) Trade fees. When you trade an iron condor you pay a commission for the trade itself (assume 7.00$) and then you also pay per option contract (assume 0.50$ per contract)
The price of the RUT is 10x higher than the IWM meaning we only need to open 1/10th the number of contracts to represent the same trade size. What effect does this have on a 25,000$ trade?
RUT: 10 contracts x 4 because it’s an iron condor
trade commission: 7.00$
40 total contracts: 20.00$
cost to close the same trade: 27.00$
round trip trade fees: 54.00$
54.00$ / 25,000 = 0.22% of trade value
IWM: 100 contracts x 4
trade commission: 7.00$
400 total contracts: 200.00$
cost to close the same trade: 207.00$
round trip trade fees: 414.00$
414.00$ / 25,000 = 1.66% of trade value
So trade fees on an IWM Iron Condor can cost approximately 1.4% more than if you use the RUT. Target profit each month isn’t much more than 1-2% anyway so this 1.4% additional expense is a huge drag on long term performance.
Here’s what it looks like if I add 1.4% extra fees to the VTS Iron Condor results:
Clearly it’s in our best interest to avoid these additional fees, and executing trades on the RUT means we can reduce the total number of contracts by a factor of 10 and maximize our efficiency in the long run.
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