The Best Time To Trade Iron Condors, Part 1: Volatility Is Your Friend
When You Assume...
Itís fairly common for people to approach us with questions about the correct time to trade iron condors. One of the most common assumptions about condors is that they are only suitable for low volatility, non-trending environments.
This is an understandable assumption, but itís also totally false. The best time to trade condors is actually in high volatility environments, regardless of the trend.
There are two key points that you should take away from this article:
- Iron condors thrive in high volatility environments.
- Iron condors can be appropriate even in trending markets.
High Volatility Is Your Friend
We could talk about the nice, fat premiums that you receive when fear is high and the rest of the market is acting cowardly. However, letís think about the worst case scenario for any given condor - namely, a huge market move that blows past both your short strikes and your long strikes on one side of the trade.
A large market move usually means that youíve hit your maximum loss and your trade is busted. Needless to say, this is a scenario that iron condors traders must avoid to remain successful over the long-term.
Choose Your Trading Environment
There are two given market environments in which you can trade.
- Environment A: Characterized by pervasive lazy sentiment and low volatility readings.
- Environment B: Characterized by rampant fear - bordering on panic - and high volatility readings.
The question is: which environment is more likely to experience a trade-busting event?
You're probably thinking that the answer is Environment B.
SURPRISE!
The answer is actually Environment A. In the world of Environment A, no one is expecting a sizable move. Therefore, no one is pricing such a move into the premium of the options.
In the world of Environment B, however, everyone is already on alert. Extra premium has already been added to the marketplace. This premium allows traders to construct a position with much wider strikes than normal. Therefore, when the big move finally arrives, you have a much higher probability of weathering the storm.
To put it another way, condor traders are really volatility traders. As a result, there are four basic ways that their trades can shake out:
| Entry | Exit | Comment |
| Low volatility | Low volatility | Okay |
| Low volatility | High volatility | Danger! |
| High volatility | High volatility | Okay |
| High volatility | Low volatility | Nice! |
- The best-case scenario, from an IV perspective, is one in which IV is high when the trade is opened. That is followed by a volatility-crushing event sometime during the course of the trade. As a result, when the trader exits the position, IV is low.
- The next best-case scenarios are ones in which the IV environment is basically unchanged over the life of the trade.
- The worst-case scenario is one that starts in a low IV environment but ends in a high IV environment. We marked this as dangerous because a sharp increase in IV premium could cause your position to go "underwater". This could occur even if the price of the underlying doesnít move very much. It also means that your current position may not be pricing risk appropriately.
- Note: One other thing to point out about that little chart: the worst-case scenario only occurs when you trade during a low-IV environment.
Therefore, while itís counter-intuitive to trade iron condors when the rest of the market is stampeding for the exits, our analysis suggests that this is actually a great opportunity.
In fact, when handled properly, iron condors are one of the safest places to be during troubled times.
Continued In "Part Two: Ignore The Trend"...
Posted By: Condor Options
"About Condor Options
Condor Options is a research and trading firm specializing in market neutral options strategies. In addition to the free periodic reports published on their website, Condor Options provides a members-only trading newsletter focused on iron condor options spreads.
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