iron condor - in the money probability

Discussion in 'Options' started by Ms Varima-Garch, Jun 4, 2009.

  1. hi. sorry about this simplistic thought, but here goes:

    when i buy an iron condor, isn't the cumulative probability of being in the money on at least one spread quite high? i mean as opposed to doing only one spread

    i mean, using hoadley's probability calculator, you can see that it may be 50-60% cumulative probability, where the premium is worth collecting

    i'm saying that: is it a safer bet to do only one spread, with a probability of being in the money of 30%, than doing two spreads, with a cumulative probability of being in the money of 50-60%? i mean 50-60% is basically 50/50, almost like a coin toss.

    sure you're collecting less premium, but you are less likely to be in the money, which seems like a better deal

    any comments?
  2. MTE


    There's no right or wrong answer here as the there's no edge per se in trading a vertical vs. trading an iron condor.

    Lower probability gives you greater return and vice versa. It is really up to you to determine what your preference is.
  3. stfreak


    I´m LMFAO!!!

    Either you are a quant and don´t see the wood for the trees or you just don´t understand basic probability calculus (but why the nick varima garch then??...)

    first of all, the very basic answer to your question is:
    don´t EVER cummulate probabilities of neutral spreads!
    that wouldn´t make sense at all (or have you ever seen a market, that traded through both sides of an iron condor???)

    the underlying can only go up or down, but never up and down at the same time.
    so when your c-leg of an IC has 15% probability of expiring ITM and the p-leg has 15%, what is the probability of your IC ending up ITM at expiry??
    right: 15%

    now compared to a credit - spread, which also has the probability of 15% of being ITM, the difference is 1.):the reward is lower and 2.)you have directional risk only on one side of the market (but thats why the reward of the IC is have directional risk on both sides)

    so just another trade off, no edge in an option spread.
    IC´s are pure vol_trades and credit spreads are vol/directional trades.

    you might have a look at this little article about IC´s I recently found:
  4. wrong. if you you think the events are mutually exclusive (vs independent), i.e., only one leg could be hit during the period, you should add them up. your probability of at least one leg being in the money is then 30%.

    see the hoadley tool

    and see for yourself, the probability of at least one target being reached (one of the two spreads going in the money) is high

  5. Incorrect, as V-G has already told you. The probabilities are additive.

    And yes indeed - I have seen the market trade through both ends of an iron condor. Where you are confused is that it can only FINISH with one side ITM.

  6. stfreak


    thats why I said "end up ITM".
    we are not talking about probability of touching.
    this would be a whole new story.
  7. ok, thanks for the input, food for thought, definitely . . . i'm really nervous about this condor thing, quite frankly . . .

    Mark, while we are on this topic,

    I have studied the discussion of iron condors on you blog:

    And was intrigued by the following statement you make:

    “I avoid trading front-month positions because they have too much negative gamma to suit my comfort zone.”

    You then go on to say:

    “Yes, they have the most rapid time decay - and that's the major deciding factor for most.”

    Can you please elaborate on that? I mean it’s so true!!


    P.S. I know there are several options blogs out there, but most authors fail to think clearly.

    Your blog is the happy exception. A MUST read for every options trader, beginner or otherwise, in my opinion.
  8. stfreak


    look, v-m, despite the tone in my previous posts being a bit harsh (I appologize), you should perhaps think about this:

    why do you want to trade an iron condor??
    an options spread is NOT a strategy, it´s a tool. there is no edge in selling an Iron Condor, just like there is no edge in shorting ES futures.

    you use an iron condor to translate your trading strategy into money and it does not matter if you want to exploit skew, risk premium (spread between IV and stat Vol) or perhaps you want to make a statement on the future range of the underlying.

    Managing an IC depends on your strategy you want to trade.

    Mark seems to trade the risk premium and adjusts accordingly.
    if you want to exploit the skew or do a 2 day short volty trade based on the VIX, you have to adjust in a completely different manner.

    it´s also said in the blog. the only way to profit from an IC is from trading volatility. Either stat_vol/IV or pure moves in the implied volatility.

    Do yourself a favour and get rid of the probability trading thing. just trading a spread because it has 70% probability of profit and "manage the risk" is inferior. if you sell the IC at 30% IV and hedge/adjust, there is no way around loosing money if the realized volatility is greater then 30%. Don´t forget, you have to pay for the hedges/adjustments or load up additional risk.

    if realized volatility is less then 30% and you hedge regularly, then you have a chance of making a profit.

    also, regarding to the probability selection criteria, you have to look at the expected value (which is probability of profit*max profit-probability of loss*max will see, that most IC´s give you negative EV) and not probability alone , second, where would be the edge in trading a trade off.

    as for the short gamma thing: gamma and theta are inversely related. the more theta you have, the more short gamma you get. so of course you get more short gamma, the more theta you have.

    Hint: for a deeper understanding get yourself a copy of options, futures and other derivatives by john c. hull.
    check the BSM - model and solve it for theta. you will see, that nothing is for free, then

    good luck
  9. Thanks for the plug.

    As freak has already mentioned, it's not complicated. Near-term options decay most rapidly. That's good for premium sellers.

    But, if they move against you - if an iron condor moves into the money (or threatens to do so) - the losses increase much more quickly for near-term options than for any other options. Why? because these options have more negative gamma.

    Thus, it's a comfort zone decision for me. Assuming you want to keep thing simple (freak's suggestions are fine, if you want to delve more deeply into options) you must decide whether you love the time decay more than you fear the gamma.

    More conservative investors take the more conservative approach - and that means not holding positions as expiration nears. There's nothing wrong with being more aggressive. The fact that I prefer not to own front-month positions should not influence your trading style.

    BTW, I often hold those front-month trades when exiting is not a simple process. I have too much June right now, for example.

  10. Mark, appreciate your thoughts on this. sounds like i need to make a judgment here, and choose between time decay and gamma. it won't be easy, but it doesn't have to be.

    i guess what it boils down to is that i have to find my own comfort zone here.

    #10     Jun 6, 2009