I know that of all our strategies here at VTS, the Iron Condor strategy is likely the one that the least number of people participate in thus far, but I do hope that over time that will change.
These days when people talk about trading volatility, often times they are referring to the Volatility ETP’s such as XIV, SVXY, or ZIV. And while that’s definitely an exciting new segment of the market and we’ve profited handsomely from it in the last several years, it’s very far from the origin of volatility trading.
I’ll tell a story in the coming weeks about the first recorded “option trade” in history. Spoiler alert, it’s way earlier than you think but even if we’re talking about modern option trading, that still dates back to the 1970’s so it’s been around a lot longer than volatility ETPs. I started my career trading derivatives and I still have over 30% of my private portfolio dedicated to it. Not all of it is suitable for a subscription newsletter, but the VTS Iron Condor strategy has been a staple of my personal portfolio for many years and it is suitable for less active investors to learn with and dip a toe in the options pool.
2017 was a rough year in general for what’s called “delta neutral iron condors” because it involves selling option premium. At the risk of sounding like a broken record, 2017 was some of the lowest volatility in history. For Iron Condors specifically this is a really dangerous time to be opening new trades so we needed to be ultra selective of the positions we took.
In a typical year the strategy will be allocated to trades roughly 70% of the time. However in 2017 the strategy only held positions about 40% of the year, well below average.
Our win / loss ratio was actually quite good with 5 winning trades and 2 losing trades. Unfortunately one of the losing trades suffered a larger loss than normal due to the underlying Russell 2000 moving very strongly upward. Essentially we got hit by those two words that strike fear into investors: Gap Risk. Nothing can be done when that happens, you just respect the stop-loss, take your lumps and move on. Fortunately we’ve only had a few losing trades in the last couple years:
Today though I thought it would be more useful if I tried to actually show why selling Iron Condors in low volatility environments is so dangerous.
Here’s what an Iron Condor on the SPX would look like if we opened one now (yesterday Jan. 9th). Remember I typically target roughly 90% probability of profit, so on a 25$ strike gap we’re targeting around 2.50$ premium collected.
Is that a good trade?
Remember we close out our option trades way before expiry to reduce Gamma risk so those break even prices mean nothing. All that matters is the daily stop-loss lines I’ve highlighted with red. The greeks do change daily so we always have to preface any analysis by saying “if all else is held constant” but looking at that chart we will get stopped out at a 5% loss if:
SPX rises by 2.25%
SPX falls by 2.04%
That is just way to small a margin for error. 2% moves could happen in 1-3 days if we get any kind of positive or negative news at all. 2% is nothing, so that’s not a trade that I would ever open.
Why such a small margin for error? Well the implied volatility on the S&P 500 is only 10.32% right now. That might be the 21st percentile of readings in the past 52 weeks, but that’s in the low single digit readings for any normal year.
With so little premium to sell right now it provides almost no insurance against market movements in either direction. It’s iron condor suicide to be selling them right now as it would be a very high risk trade. Now unfortunately high risk doesn’t stop a lot of other traders out there from trying anyway, and sometimes taking high risk trades actually pays off in the short-run. But there’s no doubt that in the long-run for Iron Condors, higher volatility is safer.
Looking forward: Iron Condors have been around for decades and they will be for many more to come. There is no urgency at all here and we will remain patient and only get back into Iron Condor trades when there is enough implied volatility to provide enough insurance against market movements.
The VTS Iron Condor Strategy still makes up a 25% allocation in the Total Portfolio Solution:
Current VTS Total Portfolio Solution Allocations
VTS Aggressive Vol Strategy – Optional replacement for higher risk tolerance investors
VTS Conservative Vol Strategy – Optional replacement for lower risk tolerance investors
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