2. Tactics II – Volatility & Time Iron Condors

3. Sideways and Volatility Strategies
Iron Condors
Butterflies

4. The Basics
An Option is the Right to Buy (or Sell) a Stock at a specific price over a set period of time
A buyer pays (debit) for this right and the seller receives the money (credit)
All options in the market are created by a transaction between a buyer and a seller, the total number of contracts at any one time is called Open Interest
Calls are the right to Buy a Stock at a Specific Price
Puts are the Right to Sell a Stock at a Specific Price

5. The Basics
The Strike is the price of the Stock that the Buyer will pay if they Choose to exercise the Option
In the case of a Call Option with a strike of 35 the buyer has the right to buy that stock from the seller for $35
If the price of the stock has gone above $35 it makes sense for the Option holder to exercise his right and get the stock for a cheaper price than the current market
The same goes for Puts, just in the opposite direction

6. What makes up the Price of an Option – Part 1
Intrinsic Value – If the stock is currently trading above (or below) the strike price then the difference between the strike and the current price is called intrinsic value
Time Value – The seller needs to get something for his commitment to this contract for a period of time. The time value is normally calculated from the return on a risk free trade for the same period as the options life.
Rule of Thumb – The closer you get to Expiration the smaller the Time Value left in the trade. This is called Theta Decay.

7. Implied Volatility What makes up the Price of an Option – Part 2
Risk – Every Seller of Options wants to make money and to protect themselves against Risk.
A Risk Premium is added to the price of the Option based on the sellers analysis of the chance that the Stock will go past the Strike before the expiration of the Option
If the stock moves a lot then the Risk is High and the Option Price goes up
If the stock does not move much then the Price of the Option will be lower
Upcoming events such as Earnings or a FDA announcement will increase the Risks and the Price of an Option
This is referred to as Implied Volatility

8. Implied Volatility can be High or Low
Implied Volatility can be over priced or under priced
Option Writers may have written too many options and are not interested in selling any more
There may be rumors or other vague risks in the market driving IV up
Large funds may be taking protective positions driving Options prices higher
Sometimes Options Traders just want to reduce their positions, driving the prices down
Understanding Implied Volatility gives you an Edge

9. A note on Time Decay
Time Decay (Theta Erosion) increases dramatically as you approach the expiration date of the Option
The last 30 days of an Option’s life sees the Time Value of an Option decay to almost nothing

10. Iron Condors as an Income Strategy
So What Do We Do?
Iron Condors as an Income Strategy

11. Iron Condor Basics Why do we trade Iron Condors?
We expect a Stock Price to stay within a specific Range
We are looking to take advantage of High IV and Premium to capture profits
Iron Condors give us specific limits to our Risks
We are taking advantage of Options’ natural tendency to be overpriced
Iron Condors are High Probability and Consistent Trades

12. What is an Iron Condor What is an Iron Condor The Basic Trade
Sell a Call Option at a Strike above the current price of the stock (Out of the Money)
Protect ourselves from a large loss by buying a Call Option at a higher Strike price
Sell a Put Option at a Strike that is lower than the current price of the Stock (Out of the Money)
Protect ourselves from a large loss by buying a Put Option at a lower Strike price

13. Targeting a Stock
Look for Options with a high IV relative to their normal price movement
Make sure there are no risky events coming up
If the difference in IV and Historical Volatility is extreme find out why – too good to be true?

14. Finding the Strikes
I use a Delta Neutral approach and Short Term Options
Look for an options series that expires between 20 – 40 days out (rule of thumb)
Find the first Call Option with a Delta between .10 and .15
This is you Short Call for the Iron Condor
Use the next Strike up for your Long Protective Call
Find the first Put option with a Delta similar to the Call’s Delta
This is your Short Put Option
Use the next Strike down as your Protective Put Option
There are lots of variations on this, but it is a good place to start

15. Analyze the Trade
I have a spreadsheet to specifically analyze Iron Condors
Enter the Information on Current Price of Stock, Strike Prices, Expiration of Options and Costs of the trade
Estimate the Forecast Volatility of the Stock
Forecast Volatility is one of the most important aspects of this analysis
It is a prediction of how much the stock price is likely to move between the trade entry and the expiration of the options
This estimate drives the Expectancy calculation for the trade
Expectancy tells you if you have an edge in the trade

17. Look for the Following
Expectancy needs to be positive – this means you have an edge in this trade
I look for a % Daily Expectancy to be above .5%
Higher is better, but beware of ones that are too high
Above 3% daily expectancy is likely to be too good to be true, find out why
Look for a Max Return Probability to be as high as possible
Better than 75% at least (rule of thumb)
High 80’s to 90’s is good
This is your probability that the trade is going to make the max profit

18. Placing the Iron Condor Trade
Try to get filled at the midpoint price
Have patience
Have a minimum amount you are willing to take and do not go below that. The odds get worse quickly when you don’t get the credit you expect

19. Goal is for the Options to all expire worthless
You keep your full credit
These need to be watched and adjusted periodically