What's wrong with Iron Condors

[Cache Landing]

Quote from newwurldmn:

I'm not sure where this discussion is going, but it seems like it's headed someplace unproductive.

Iron Condors have a place in trading. But they aren't the magic solution. Every trading strategy that I have seen over the last 10 or so years has a market dynamic where it works and where it doesn't.

I don't think the right criteria to determine if a strategy is sound is "random entry." If there is a trading strategy that passes muster by this criteria I would like to know what it is.

Most investors don't beat the market as measured by some index. Most investors do however make money. Buying stocks has a positive expectancy but not necessarily alpha. Whether the right benchmark to determine a strategy is beating the market or beating zero (positive expectency) is based on the goal of generating wealth.

Transaction costs and taxes are always a drag on investing and trading and I agree with you the less you trade (in size and frequency) the more likely you are to make money. The rake does hurt.

I agree with you that brokers talk up iron condors for commissions. They also talk up buywriting and other strategies for the same purpose. They also talk up technical analysis like it's really easy to trade. It's all pretty shady.

But that doesn't mean that iron condors don't have a place. In many situations, the higher commissions are offset by other factors such as lower risk capital/balance sheet usage.

I think this is going somewhere unproductive because we are sort of making two different points that are only somewhat crossing paths.

I should clarify that my comments were made to demonstrate that iron condors inherently have a negative expectancy. That is not to say that a trader cannot trade them profitably, just that they are not inherently profitable.

My point about random entry was to show that they do in fact have a negative expectancy, as do all options. I'm not at all trying to suggest that random entry is a requisite of a sound strategy, only that it is a means to identify whether an certain instrument is inherently value positive.

Iron condors could have a place, as long as those trading them aren't trying to make a case for them being inherently profitable.

Interestingly, I was about to present a graph demonstrating the concepts I've been explaining when I made a couple observations that lead to a bit more testing and I believe I've found a certain set of conditions that would prove to generate alpha quite nicely under all conceivable market conditions. Using vertical spreads as a core methodology. I might actually divert some capital from my current strategy to do a bit of real money testing on this theory.

 

[Eliot Hosewater]

Quote from Cache Landing:
Interestingly, I was about to present a graph demonstrating the concepts I've been explaining when I made a couple observations that lead to a bit more testing and I believe I've found a certain set of conditions that would prove to generate alpha quite nicely under all conceivable market conditions. Using vertical spreads as a core methodology. I might actually divert some capital from my current strategy to do a bit of real money testing on this theory. [/B]

Are you going to tell us?

 

[jtrader33]

Quote from sle:


The test I always suggest (and you can do it yourself in 10 min) is to check fair variance realization for S&P. Simply download VIX and S&X index data for the past 20-30 years. For each day calculate 20 day forward looking variance for S&P (from that day 20 days forward, sum squares of returns and divide it by 20) and subtract it from from the square of the VIX index for that day.

sle- suppose one wanted to take an exercise like this a step further to estimate the costs of wing protection when selling atm convexity. do you have a rule of thumb for estimating iv say at -2,-1,+1,+2 sigmas away from atm...assuming the -1 sig strike = atm strike - [atm strike * ( atm iv / sqrt(12))]...when looking at vix/vxo historicals? i know it's crude but getting reliable otm iv data can be tough.

 

[RichardRimes]

Quote from Flotilla:


Professional traders focus on risk and amateurs focus on profit... ]

+++

 

[Cache Landing]

Quote from Eliot Hosewater:

Are you going to tell us?

Not sure yet. I should probably spend a bit more time tweaking the inputs as I haven't been trading many options for a few years now. If I'm correct, these conditions would present about 12 times each year. Sometimes there might be a span of about two months with no trade.

Win:Loss should be about 8:1
Reward:Risk should be about 1:2
Algorithm was rather simple and could be automated

What I'm hung up on right now is whether it is better as a directional volatility trade, in which case the bear call vertical is most appropriate. OR is it better as a pure volatility trade, in which case a variance swap is much more useful and less convoluted.

The bear call vertical would allow for interim scalping opportunities as the favorable conditions occasionally persist for a couple weeks at a time, during which time the vertical would be fluctuating in value. These scalps are pure alpha and would be nice. Also, sometimes the UL would move hard in a favorable direction, which would allow early exit at close to max profit.

OTOH, the variance swap would decrease the need for any delta hedging and significantly reduce transaction costs. Although scalping would be significantly reduced and it would be more of a hold till expiry type trade. But the variance swap would would change the above r/r to look something more like;

W:L --- 2.5:1
Reward:Risk --- 1:1

Much to consider.

 

[sle]

Quote from bs2167:

sle- suppose one wanted to take an exercise like this a step further to estimate the costs of wing protection when selling atm convexity. do you have a rule of thumb for estimating iv say at -2,-1,+1,+2 sigmas away from atm...assuming the -1 sig strike = atm strike - [atm strike * ( atm iv / sqrt(12))]...when looking at vix/vxo historicals? i know it's crude but getting reliable otm iv data can be tough.

Sorry, i am being a bit dense here. The original test was to sell vix (which is ATM variance swap), so you are short gamma across all strikes.

If you have the data for ATM 1m month implied, there is a gimmic oto get SK10 (or whatever skew measure you use) from VIX and that, if that's what you are asking.

Do we actually want to move this to a freshly-started vol trading thread?

 

[jtrader33]

Quote from sle:

Sorry, i am being a bit dense here. The original test was to sell vix (which is ATM variance swap), so you are short gamma across all strikes.

If you have the data for ATM 1m month implied, there is a gimmic oto get SK10 (or whatever skew measure you use) from VIX and that, if that's what you are asking.

Do we actually want to move this to a freshly-started vol trading thread?

Yeah sorry, should have clarified that I was switching gears a little from your original exercise. Essentially what I was getting at was: say I have historical OVX and div adjusted OEX prices and wanted to see how various structures performed in different environments, I'd need to have some proxy for skew (i'm a little rusty on the calcs, but i think OVX is okay to use as an ATM vol for a hypothetical 30 day option) in order to price the otm legs.

You're right, it probably is time for a new thread...I'm leaving at close for vacation so didn't want to start it then walk away. If there isn't one going when I get back, I will put it up.

 

[Cache Landing]

Quote from sle:



Do we actually want to move this to a freshly-started vol trading thread?

Yes

 

[Cache Landing]

Quote from sle:

.....sell vix (which is ATM variance swap)............

Sle,

I think you should clarify this statement, as the two (short VIX and short a variance swap) are not functionally equivalent.

 

[sle]

Quote from Cache Landing:

Sle,

I think you should clarify this statement, as the two (short VIX and short a variance swap) are not functionally equivalent.

Short spot vix (the index itself, which is nothing but a fair variance swap), not futures (which are forward variance). My original suggested "test" was to use VIX index to figure out fair variance and test it against the realized variance in S&P.