Selecting Condor Strikes - A Study

[Condors]

As I have outlined in another thread, people who trade iron condors are usually taught to select short strikes at one standard deviation from the current price action.

As I am developing the conversation (to myself at this stage   Join in anytime folks, I know you're out there   ) I think extrapolating option volatility to "monthized" levels is not optimum.

What I want to do in this thread is select hypothetical strike levels, assuming that an iron condor is put on on the expiry Friday of the previous cycle. Some people like to initiate ICs with 2 months to expiry, so we'll have a look at that too.

I'll be using historic volatility, just so it can be automated.

I'll report on how these strikes are threatened or not as time goes by, to test how well this selection process works.

Note that this does not represent any trades I may be doing, it is just an exercise.

On the chart the red lines are 1 standard deviation (68% theoretical probability of staying inside).

The Blue lines are 1.28 SDs (80% theoretical probability of staying inside), which you would probably never get enough premium to trade.

The Green lines are at 0.6 SDs and represent what a low probabilty condor trader might select. It is presumed this trader is prepared to adjust more aggressively.

The top chart with heavier dotted lines is to represent a trade initiated 16 Oct with Nov expiry. (1 Month)

The 2nd chart with lighter dashed lines is to represent a trade initiated 17 Sept with Nov expiry. (2 months)

The 3rd chart lighter dashed lines is to represent a trade initiated 15 Oct with Dec expiry. (2 months)

Click to expand image.

[semuren]

Greetings Wayne:


Do you usually use a 1 SD short strangle for your ICs or do you use one of these other numbers?

I think this seems like a very interesting study.

Semuren

[Grinder]

This should be quite interesting.  I feel there are distinctive flaws with using SD for probabilities when selecting short strikes and therefore am not a fan. Yet it's promoted like gospel everywhere I look, will be interested in the outcome.

[Condors]

Greetings Wayne:


Do you usually use a 1 SD short strangle for your ICs or do you use one of these other numbers?

I think this seems like a very interesting study.

Semuren

Hey Semuren

Welcome 

I'm like Grinder in the post below your's.

I'm comfortable adjusting aggressively so write much closer in, sometimes starting with an Iron Fly and shifting the goal posts as the market unfolds.

It comes down to what a person is comfortable with however.

But we shall see what unfolds from this exercise as it progresses. I posted this on my blog as well... I got a comment from Mark Wolfinger that expressed doubt over the whole 1SD idea as well:

I don't accept that premise. I believe it's false.

It's basically what I'm trying to demonstrate real time.

I think people who like high probability condors should use some other criteria for picking strikes. Perhaps a topic for a separate thread.

All merely my own opinion of course and who knows... I might prove myself wrong. 

[Condors]

This should be quite interesting.  I feel there are distinctive flaws with using SD for probabilities when selecting short strikes and therefore am not a fan. Yet it's promoted like gospel everywhere I look, will be interested in the outcome.

Indeed!  

+1

[Fox]

Hi Wayne,

Fox from ASF here. This is a great study, which I have great interest in. Will follow this thread intently. Thanks for initiating this study.

As you may already be aware, I'm trying to adopt your low prob. fly technique in the Aussie market. I'm finding that contest risk is high and will probably need to seek greener pastures where contest risk is lower.

If you don't mind me asking, at what point would you advise adjusting a low prob. fly in the second graph ie. SigmaAnal2? If this was a fly that you personally put on, would you adjust when the underlying price touches the green line? Or way before the green line is touched, say 50% between the initiating underlying price and the green line?

The Blue lines are 1.28 SDs (68% theoretical probability of staying inside),

I think 68% is a typo. It should be 80%?

Fox.

[Condors]

Hi Fox

Welcome. 

I think 68% is a typo. It should be 80%?

Yes quite right. I got the 'bot to correct it.

Thanks for pointing that out.

Hi Wayne,

Fox from ASF here. This is a great study, which I have great interest in. Will follow this thread intently. Thanks for initiating this study.

As you may already be aware, I'm trying to adopt your low prob. fly technique in the Aussie market. I'm finding that contest risk is high and will probably need to seek greener pastures where contest risk is lower.

If you don't mind me asking, at what point would you advise adjusting a low prob. fly in the second graph ie. SigmaAnal2? If this was a fly that you personally put on, would you adjust when the underlying price touches the green line? Or way before the green line is touched, say 50% between the initiating underlying price and the green line?

My technique is to start of with the Iron fly or low prob Iron condor and to add to the position as the market develops. So I may have made several additional trades by that stage. The green line is not intended as any reference for adjustment, it is just an arbitrary SD that is less than 1.... just as an example.

With the benefit of hindsight, one can make all sorts of optimum adjustments. In real time, it is never optimum, so I hesitate to say where I "would" have made adjustments.

One point. With my technique you NEED tight bid ask spreads so the contest risk doesn't end up devouring any potential profit.

For me, that restricts it to the major indices. I've never tried it on individual stocks for the reasons you talk about. Not saying it can't work, but I've never tried it.

One danger of this study that I want to highlight is that we are going to have the benefit of hindsight, so what I'll try and do is present the forum with points of decision making. I.E. what goes through our minds when we're on the hard right edge of the chart.

Therefore, this will take some months to get any useful discussion from...

...but it won't prevent us waffling as nauseum in the meantime.  ;)

[Fox]

so what I'll try and do is present the forum with points of decision making. I.E. what goes through our minds when we're on the hard right edge of the chart.

That's a very good idea. Helping us with rational decision making thought processes without the benefit of hindsight is truly valuable. Besides, I'm a firm believer that superior psychology for trading is important for success.

Therefore, this will take some months to get any useful discussion from...

...but it won't prevent us waffling as nauseum in the meantime.  ;)

I'm all for waffling . There are far more frivolous topics on the internet and TV. Besides, giving live interpretations and opinions as the price movement unfolds will allow us to share your insights. A bit like John McEnroe commentating as Federer and Nadal battle it out. Looking forward to your commentary.

[Condors]

In the other thread on volatility I am developing a line of thought that says we should view the various volatility measures with full realization of their limitations. I haven't added to that thread for a few days, but will get on to it soon.

This thread is sort of along the same lines as it pertains to selecting strikes for ICs.

Have a look at the GOOG chart below. It is the November expiry example initiated in September. Already the price has moved about 1.5 standard deviations, so sans any adjustments, this IC would be hurting.... real bad. 

But have a look at the lower pane, it is the 30 day realized volatility. It accurately reflects the "day to day" volatility of GOOG, yet does not reflect what has been a significant move. In fact if you look at the cyan trend line in the HV plot, it has decreased while the trend in the share price has clearly accelerated

Option volatility does not price in trendiness,only daily changes, hence this is a clear example of the folly of the 1SD hypothesis.

(Please note that there was a lot more fat on the options than HV indicated, due to the upcoming earnings and in a real life situation, if silly game enough, one might have written further out)

Also, this and the likes of AAPL, RIMM etc really shows why condors are not such a good strategy around earnings.

[Fox]

The GOOG example you gave in the previous post is pretty much what I experienced with CBA in Oz. It was post earnings in my case, but the same pattern was in play ie. declining vol but increasing trend in underlying price.

Also, this and the likes of AAPL, RIMM etc really shows why condors are not such a good strategy around earnings.

This would be one less headache to worry about if playing with index options, I would imagine.

[Grinder]

This would be one less headache to worry about if playing with index options, I would imagine.

that & many other reasons why I don't bother with ICs on stocks.

[Condors]

Our 1 standard deviation 30 day Nov condor strike is under threat folks, what are we going to do?

Do we bank on a bounce, or do we hedge?

(Our low prob condor trader would have already been pro active).

[Fox]

Do we bank on a bounce, or do we hedge?

This is where I start tearing my hair out. As I am not an exponent of technical analysis, I can't be certain of a bounce.

I typically move the left goal post further left to make myself delta neutral, grit my teeth and bear with locking in a loss, painful as it may be.

[Condors]

Ahhhhh, so the GDP #'s save the 1sd strike.

Fox, I hear what you are saying. Every inch of my logical self was saying that SPX will bounce from there. But the risk aversion part of me was saying - Thank Christ I don't trade condors that way.

Not saying others can't cope with sitting on their hands or adjusting this position, just saying it ain't for me.

[Fox]

Hi Wayne,

I go bald by now after having pulled out whatever hair I have left after the bounce. I feel like a dill for not taking a risk and sitting on my hands. I take comfort that this is what you would have done too. Your stellar records of well managed flies and low prob ICs is what I wish to emulate.

Fox.

[Grinder]

Looking at the chart reminds me of why i don't trade like that anymore, the breach of the strike would have already put the position under water and it's very difficult to repair a boat thats taking in water when you don't have the tools. Thats what IC traders face when they don't fully understand the greeks. I would have made an adjustment a long time ago with either a hedge or a partial roll.

[Condors]

Looking at the chart reminds me of why i don't trade like that anymore, the breach of the strike would have already put the position under water and it's very difficult to repair a boat thats taking in water when you don't have the tools. Thats what IC traders face when they don't fully understand the greeks. I would have made an adjustment a long time ago with either a hedge or a partial roll.

Exactly.

Today's action takes us ITM on the (virtual) lower strike on The Nov 30 day condor. Not only would the position have manufactured some nasty deltas, VEGA would be making it hurt real bad.

An adjustment locks this in.

*$%*  that!

Our two month condors are still OTM though, but the December expiry strategy is being threatened and vega will be greater.

[Condors]

A quick update.

Our one month 1SD November condor is out of the danger zone and is pretty close to the sweet spot... that is if the trader managed to sit on their hands and watch the lower short strike go in the money last week.

At this stage it looks as though the Nov expiry will be a good one for the 1SD hypothesis... if not for some anxiety when ITM.

As I've said earlier in the thread, one swallow does not a summer make and this thread will need to run for several expiry cycles to get anything useful from.

Once again, This is no suggestion on how to trade condors, it's just a study. As mentioned, I do NOT trade condors this way.

[Fox]

Our one month 1SD November condor is out of the danger zone and is pretty close to the sweet spot... that is if the trader managed to sit on their hands and watch the lower short strike go in the money last week.

Welcome back from your travels, Wayne. Hope you're somewhere where the weather is nice and the option hours will not keep you sleep deprived.

I did not sit on my hands and adjusted to keep delta neutral. So, playing catch up now. This somehow feels like the arcade games of the eighties whereby the target keeps eluding you. You move the joystick further left and the target moves further right, and vice-versa. In the meantime, you keep feeding coins to stay in the game.

The kids good with the game either have lighting fast reflexes or have an uncanny ability to guess future direction of the target.

Making a call as to when to adjust is really hard for me. It's either too soon or not soon enough.

[Grinder]

Know what you mean Fox, was that way for me for quite sometime. It will make more sense overtime. Remmember, you don't want to be locking in sizeable losses. Think about offsetting your positions with others that benefit from different greeks, it can assist in keeping you position moving along whilst the market sorts itself out.