Wednesday, September 5, 2012

Trade Iron Condor Successfully in 2012

An Iron Condor is a popular options strategy deployed by a number of options strategists who prefer not to take any view as to where the stock market is heading. In this respect, this strategy is also known as a market neutral options strategy.
Some options strategists prefer to trade an Iron Condor using stocks. However, this is not my preference. As we all know, every listed company in the United States has to announce its earnings in every quarter. Depending on the announcement and the market expectation on such an announcement, the stock price may gap up or down and this could potentially upset the trade because of the short gamma.
As far as I am concerned, I trade this strategy primarily using a few optionable index products such as S&P 500 Index ("SPX"), NASDAQ 100 Index ("NDX"), S&P 100 Index ("OEX"), and Russell 2000 Index ("RUT") instead of stocks. Why is that so? This is because any price movement of a single stock alone should not result in a big movement on the related index. This statement is however subject to a caveat when it comes to 2012. Thanks to Apple Inc ("AAPL"), a very popular stock from the United States with great momentum in price action and strong fundamentals. From my latest research and to the best of my knowledge, AAPL represents approximately 4.5% of the total value of SPX and almost 20% of the value of NDX. In this regard, when trading this strategy using SPX options or NDX options for example, it becomes necessary to pay attention to the news and price movement of AAPL.
I guess you may also wonder why I have a basket on the index products on hand and some of you may even ask why I do not trade this strategy using a single index product such as RUT. This is a very good question. Indeed, a few years back, I traded this strategy primarily using RUT options and in doing so, I studied all the essential information pertaining to this index product, including the settlement process and the historical price movement in each expiration cycle of this index during the last decade. My belief then was that as long as I traded this strategy month after month, I would be able to make money consistently.
As I continue with my education in options trading, one of my mentors pointed out to me that the abovementioned trading style involving the use of only a single index product and trading in and out on a monthly basis would not serve me well in the long run. One reason is because of the implied volatility ("IV") skews. According to my mentor, a successful Iron Condor trader takes a serious view in looking at the prevailing IV skews to decide whether the index option in question is appropriate for the Iron Condor strategy. There could be some months of a year where the IV skews become too cheap for a trader to sell an Iron Condor. This was exactly the case for RUT options in the last few months. In other words, the RUT options were too cheap to be sold. Hence, I used other index products such as SPX and OEX for selling my iron condor instead.
Another step I used to do in the past was to focus on selling a 10 delta call option and a 10 delta put option. Even until now, I am aware that there are still quite a number of people who would construct their Iron Condor by purely following this "10-delta" rule. Once again, thanks to my mentor who pointed out that this is not the recommended approach because very often, there could be mispricing of options quotes. What do I mean by that? This means that we should not be blindly selling a 10 delta call option and a 10 delta put option in every instance. Instead, we should pay attention to the strike above or below the 10 delta options. Sometimes, even if we were selling a 9-delta option, we may be able to command a higher credit because of this mispricing behavior and thereby, improving our potential return on the Iron Condor.
In summary, for a trader to be successfully in trading Iron Condor in 2012, he has to keep a closer look on the changes to the IV skews of the options of the index products and remain flexible. He should also pay attention to this monster stock in the United States - AAPL too.

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