Investors are regularly on the lookout for the best options trading strategies to use during periods of high implied volatility, something that we’re seeing right now.
In general, my favorite strategies leverage a quant-based approach that uses probabilities, not emotional leanings, to dictate trades.
There are some strategies that I like to use that may be foreign to more novice traders, but it’s incredibly useful to understand some basic strategies to hedge existing positions or to take advantage of elevated premium levels due to current market fears.
Today I’m going to focus on the latter, with an options trading strategy that has no directional leanings and thrives in high-volatility environments. Out of all the strategies I use, short strangles and iron condors allow me to make high returns on a consistent basis in any market environment. I plan on discussing the power of the short strangle in an upcoming article, but today I want to talk about iron condors, with a potential trade idea.
Iron condors using highly liquid ETFs are one of my favorite defined risk, non-directional options trading strategies in a high implied volatility environment. And there is no doubt that we are currently in a high-volatility environment. In fact, we are in a volatility bull market. Just look at the chart in the VIX below. The VIX, otherwise known as the investor’s fear gauge, represents the level of risk, fear, or stress in the market. When the VIX is high, so is options premium. And since most options professionals prefer to use options-selling trading strategies, like an iron condor, when volatility is high (because we can sell options as inflated prices) now is the perfect time to take a look at a potential trade. A trade that will allow us to make 15% to 25% over the next 30 to 45 days while the market struggles with uncertainty.
Sample Trade: Iron Condor S&P 500 (SPY)
Let’s say we decide to place a trade in the highly liquid S&P 500 ETF (SPY) going out roughly 30 days until expiration.
The expected move, also known as the expected range, is from roughly 337 to 380 for the November 11, 2022 expiration cycle, or 6% to the upside and 6% to the downside over the next 30 days.
In most cases, my goal is to place the short strikes of my iron condor outside of the expected move to increase that cushion of 6%, thereby increasing my probabilities of success. I prefer to have my probability OTM, or probability of success around 75%, if not higher, on both the call and put side.
Expiration Cycle and Strike Prices
Since I know the expected range for the November 11, 2022, expiration cycle is from 337 to 380, I can then begin the process of choosing my strike prices.
The low side of the expected range is, again, 337 for the November 11, 2022, expiration cycle, so I want to sell my short put strike just below the 337 strike, possibly lower. In this case, because volatility is inflated I have the ability to go well below the 337 put strike and increase my probabilities of success on the downside, by choosing the 315 put strike. Statistically speaking, a very conservative approach to the trade and it increases my margin of error.
Now, once I’ve chosen my short put strike, in this case the 315 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 310 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 again, with SPY trading for roughly 359, the underlying ETF can move lower roughly 12.2% over the next 30 days before the trade is in jeopardy of taking a loss.
As to the call side, the high side of the range is, again, 380 for the November 11, 2022, expiration cycle, so I want to sell the short call strike just above the 380 strike, possibly higher.
The 400 strike fits the bill. By choosing the 400 call strike I am able to give myself a cushion of 11.4% to the upside over the next 30 days.
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 405 strike.
Again, it’s all about the probabilities when using options-selling trading 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 $85 (315-400) and SPY trading for roughly 359, the underlying ETF can move lower by 12.2% and higher by 11.4% over the next 30 days before the trade is in jeopardy of taking a loss.
Here is the theoretical trade:
Simultaneously…
- Sell to open SPY November 11, 2022, 400 calls
- Buy to open SPY November 11, 2022, 405 calls
- Sell to open SPY November 11, 2022, 315 puts
- Buy to open SPY November 11, 2022, 310 puts
We can sell this SPY iron condor for roughly $0.68. This means our max potential profit sits at approximately 15.7% over the next 30 days.
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 400 calls and the 315 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 $0.68, I would look to buy it back when the spread reaches roughly $0.35 to $0.20. 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 1 to 2 times my original premium. So, in our case, when the iron condor hits $1.30 to $2.
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, 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.