Sunday, May 3, 2009

Condor Sweet Spot

In retrospect May expiration cycle turned out to be great for iron condor traders. The decreasing realized volatility as well as decreasing Implied volatility the market experienced over the past month or so have been just what the IC doctor ordered.

SPY IC example:
Trade Inception: Beginning of April
SPY @ $85
95-99 Call Spread @ $.36
75-71 Put Spread @ $.38
Net Credit = $.74
Max Rewar d= $.74
Max Risk= $3.26


Decreasing Implied Volatility: Iron Condors are a negative Vega trade. As such, they profit as Implied volatility falls. From an implied vol standpoint, the ideal scenario would be to enter when IV is high, and then have it plummet once you're in the trade. Remember as IV falls, option values fall. As IV rises, option values rise.

Suppose you opened a May IC on April 2nd on the SPY. My personal preferance for IC's is to enter about 4-6 weeks out (April 2nd puts you 6 weeks out from expiration). At the time Implied Vol, as measured by the VIX was around 42. Since the VIX closed at 35 on Friday, we've seen a nice 7 point or 16% decrease since April 2nd. That is obviously an environment that would have beneficial for short vega trades such as the Iron Condor

Decreasing Realized Volatility:
In addition to being negative Vega, the Iron Condor is Delta Neutral and Negative Gamma. As a result, the quieter (low realized vol) the underlying stock the better. I essentially want the stock to go dead in the middle of the Iron Condor range. The first chart below shows the SPY 30 day HV (the blue line) was around 45% about a month ago and is currently hovering around 36%.





1. SPY HV was 45% 1 mo ago
2. SPY HV is currently 36%

Now, whether or not we continue to see the $VIX and realized vol of the SPY diminish remains to be seen. Obviously me telling you what happened in hindsight is SO much easier than using foresight to predict how the market plays out in the next month. However, if I had to take a bet, I would rather be in the camp saying the VIX will be sideways to higher in a month rather than lower (particularly if the market finally does put in a deep retracement as typically market down = VIX up).

Bottom Line: If you were wondering what type of environment would be ideal for iron condor traders you just saw it over the last month.

Tyler-

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