Volatility Continues to Offer Exceptional Trading Opportunities

Volatility Continues to Offer Exceptional Trading Opportunities

volatility-iron-condor

Back on February 16, with implied volatility heightened, I discussed a potential iron condor trade in the S&P 500 (SPY).

At the time, as posted, we sold the iron condor for $0.85. Now the spread is worth roughly $0.50, for a 7.5% return. Not bad for a few weeks, especially when you consider our probability of success on the trade was over 85% at order entry. But SPY is currently sitting right in the middle of our range of 400 to 470, and with only 16 days left until expiration the prudent move (in my opinion) is to take some profits off the table and look towards another trading opportunity which I will discuss below.

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Make Money in This Market

Volatility continues to remain high across the board. In fact, volatility in SPY has increased over the past few weeks. Moreover, the IV rank and IV percentile of SPY remain high, which means there are plenty of opportunities to use a variety of different options selling strategies. It just depends on your bias, if any, at the time of the trade. And again, regardless of your bias, options selling strategies are the way to go. I would argue they are always the preferred choice, unless IV is historically low, but I digress.

As I’ve stated numerous times in the past, as volatility increases (or at least remains above normal levels), trading opportunities increase, which opens up the options playbook significantly.

Iron condors, among other credit spreads (bear calls, bull puts, etc.) using highly liquid ETFs, are one of my favorite defined risk, non-directional options strategies in a high implied volatility environment.

The strategy consists of a short call vertical spread (bear call spread) and short put vertical spread (bull put spread).

Sample Trade: Iron Condor (SPY)

The IV rank and IV percentile in SPY continue to be inflated, hitting extremes with an IV rank of 99.6, a level not seen in years.

As a result of the inflated premium, now is the perfect time to start selling some premium in SPY, and most of the highly liquid ETFs like DIA, IWM and numerous others.

SPY-implied-volatility-IV-rank

Let’s say we decide to place a trade in the highly liquid S&P 500 (SPY) going out roughly 30 days until expiration.

With SPY trading for roughly 437.50, the expected move, also known as the expected range, is from roughly 412 to 460 for the April 4, 2022 expiration cycle.

SPY-expected-move-april-4-2022

In most cases, my goal is to place the short strikes of my iron condor outside of the expected move. Moreover, I prefer to have my probability OTM, or probability of success around 75%, if not higher, on both the call and put side.

Choosing Expiration Cycle and Strike Prices

Since I know the expected range for the April 4, 2022 expiration cycle is from 412 to 460, I can then begin the process of choosing my strike prices.

Put Side of the Iron Condor:

Bull-Put-spread-SPY-iron-condor

The low side of the range is, again, 412 for the April 4, 2022 expiration cycle, so I want to sell my short put strike just below the 412 strike, possibly lower.

As you can see above, the 385 strike with an 86.68% probability of success fits the bill. In fact, it is a very conservative approach to the trade, which is almost always my preference.

Now, once I’ve chosen my short put strike, in this case the 385 put strike, I then begin the process of choosing my long put strike. Remember, buying the long put strike defines my risk on the downside. For this example, I am going with a 5-strike-wide iron condor, so I’m going to buy the 380 strike.

Again, it’s all about the probabilities when using options selling strategies. The higher the probability of success, the less premium you should expect to bring in. But as long as I can bring in a reasonable amount of premium, I always side with the higher probability of success, as opposed to taking on more risk for a greater return.

So, with SPY trading for roughly 437.50, the underlying ETF can move lower roughly 12.0% over the next 32 days before the trade is in jeopardy of taking a loss.

Call Side of the Iron Condor:

The high side of the expected range is, again, 460 for the April 4, 2022 expiration cycle, so I want to sell the short call strike just above the 460 strike, possibly higher.

bear-call-spread-SPY-iron-condor

As you can see above, the 465 strike with an 87.90% probability of success fits the bill.

Once I’ve chosen my short call strike, I then begin the process of choosing my long call strike. Remember, buying the long strike defines my risk on the upside of my iron condor. For this example, I am going with a 5-strike-wide iron condor, so I’m going to buy the 475 strike.

As a result, I am going to sell the 465/470 bear call spread and the 385/380 bull put spread, together known as an iron condor, for roughly $1.05. But, before I place the trade I want to choose the bull put portion of my iron condor.

price-iron-condor-SPY

Again, it’s all about the probabilities when using options selling strategies. The higher the probability of success, the less premium you should expect to bring in. But as long as I can bring in a reasonable amount of premium, I always side with the higher probability of success, as opposed to taking on more risk for a greater return.

So, with a range of $80 (385-465) and SPY trading for roughly 437.50, the underlying ETF can move higher by 6.3% or lower by 12.0% over the next 32 days before the trade is in jeopardy of taking a loss.

Here is the theoretical trade:

Simultaneously…

  • Sell to open SPY April 4, 2022 465 calls
  • Buy to open SPY April 4, 2022 470 calls
  • Sell to open SPY April 4, 2022 385 puts
  • Buy to open SPY April 4, 2022 380 puts

We can sell this SPY iron condor for roughly $1.05. This means our max potential profit sits at approximately 26.6%.

Again, I wanted to choose an iron condor that was outside of the expected move and has a high probability of success. This is why I sold the 465 calls and the 385 puts.

Remember, when approaching the market from a purely quantitative approach, it’s all about the probabilities. The higher the probability of success on the trade, the less premium I’m able to bring in, but again, the tradeoff is a higher win rate. And when I couple a consistent and disciplined high probability approach on each and every trade I place, I allow the law of large numbers to take over. Ultimately, that is the true path to long-term success. I’m not trying to hit home runs. I understand the true, consistent opportunities, particularly when seeking income, come with using high probability options strategies coupled with a disciplined approach to risk management—the latter being the most important.

Managing the Trade

I typically close out my trade for a profit when I can lock in 50% to 75% of the original premium sold. So, if I sold an iron condor for $1.05, I would look to buy it back when the spread reaches roughly $0.50 to $0.25. However, since we are so close to expiration, I might ride the trade out until it expires worthless, thereby reaping a full profit. As always, the market will dictate my actions.

If the underlying moves against my position I typically adjust the untested side. Most roll the tested side, but all research states that rolling the untested side higher/lower allows me to bring in more premium and thereby decrease my overall risk on the trade. Moreover, I look to get out of the trade when it reaches 2 to 3 times my original premium. So, in our case, when the iron condor hits $2.10 to $3.15.

Of course, the aforementioned numbers will change drastically if I’m able to sell a bear call spread over the next several days. Stay tuned!

Ultimately, position size is the best way to truly manage a trade. We know prior to placing a trade what we stand to make and lose on the trade, and therefore we can adjust our position size to fit our own personal guidelines. Iron condors are risk-defined, so it’s important to take advantage of their risk-defined nature by staying consistent with your position size for each and every trade you place. Remember, it’s all about the law of large numbers.

As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.

Comments

  • Nice write up.

    Looks l like you are going for 20% the width of the strikes. Why not go for the 1/3rd per the tastytrade backtesting? Is it just risk tolerance?

    • Andy C.

      Lee,

      Thanks for writing in. It truly depends on my goals for the trade. In a high IV environment I prefer to go out as far as I can using probabilities over premium. I hope this helps. Don’t hesitate to post any other questions you have regarding the topic.

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