Today we are going to look at the weekly iron condor trade for income.
Iron condors are one of the best structures for investors to generate income while also being a risk-based strategy.
This article examines the weekly iron condors trade for income.
We will then contrast the benefits and costs of trading in more frequent weekly iron condors versus monthly iron condors.
The goal of an Iron Condor is to take advantage of the risk of variance premiums without having an opinion on the direction of the underlying asset.
This structure can be placed in different ways like straddle or strangle with options.
The problem with both trades is that if the position moves against you, you have unlimited risk. In contrast, an Iron Condor limits the risk.
Therefore, it is more suitable for conservative investors.
As we’ll find out, this limited risk is even more important in short-term trades.
Before we start, click here for my. to obtain free 10-part Iron Condor Guide.
Now let’s talk about whether or not choosing weekly Iron Condors is a good strategy.
If iron condors benefit from the variance risk premium, it only makes sense to place trades where this variance risk premium is most pronounced.
From the graph below, we can see that the theta decay is highest in ATM options and is approaching expiration.
An important point now is that theta decay and risk of variance premiums are not the same thing.
Theta is the expiration of an option if the price of the underlying security does not change.
Variance risk premiums are the long-term overvaluation of implied volatility relative to the realized volatility.
These two things are not the same!
For more on that Read here.
While they are not the same, research suggests that the risk of variance premiums are highest for shorter maturity options when theta is also the highest.
That has to do with gamma and the risk of jumping.
By selling options with shorter maturities, we are selling options with the highest gamma.
This can be dangerous in bare short positions.
Because a sharp realized move can leave an investor with immense losses for only a small premium.
While some investors say they will hedge, you cannot hedge overnight or intraday jumps when trading individual securities.
Fortunately, we have a risk-defined trade in iron condors, so we can take this gamma risk and still limit our losses. This allows us to avoid over-security and sleep peacefully at night.
The main disadvantage of trading iron condors on a weekly basis is the transaction costs.
An iron condor has 4 legs.
To place weekly trades, over a thousand legs must be opened over the course of a year.
That’s a lot of commission!
Not to mention the position needs to be closed.
While the entire position can be closed and rolled, these are another thousand legs that need to be closed.
Allowing a position to expire can make sense, but it can lead to that Risk of assignment when the security is near a strike.
This often happens when trading shorter term options.
Since the expected range is much lower, traders expect that the security will often be near one of the strikes.
Not just only Commissions expensive, but slippage, or the extra price that is between the middle of the Bid-ask spread, enter the game.
This can be a problem especially with the long condor wings, which are sometimes widely spread.
Another problem can arise from the structure of the iron condor itself.
If there is a large, realized move and the security lands out of its wings, the exposure shifts from short volatility to long volatility, as shown in the chart below.
Initially we placed a trade that wanted to be short volatility and now we are on the red arrows long volatility! At this point we can close the trade early.
This in turn increases the transaction costs.
After all, we simply have the time to spend executing these trades.
With someone trading longer term monthly options, they can afford to have their portfolio run.
In contrast, someone acts on someone weekly iron condors is almost always traded.
For most retail investors, trading iron condors with a term of at least one month is more suitable and less stressful than trading weekly options.
However, if you want to trade iron condors on a weekly basis, here are some basic rules:
- Never systematically trade weekly iron condors on individual stocks. The variance risk premiums are not only lower for individual stocks than for indices, transaction costs and slippage are also higher.
- Consider trading Cash-settled indices. When trading indices such as the SPX, where options are settled in cash, there is no risk of assignment if the security is close to the underlying strike price.
- Consider selling over the past weekend. Instead of placing your weekly trades on Monday, place them before the Friday close of trading. This takes advantage of the variance risk premiums over the weekend which was historically higher than during the week.
- Don’t hedge too much. validation is especially important when placing trades. Even so, excessive hedging due to the extreme gamma of short-term options can destroy profitability, especially since trades are already frequent enough. You bought the wings for a reason. Think of this as your maximum loss.
Weekly trading in iron condors can help you take advantage of the highest risk of variance premiums.
It also offers a defined risk structure that prevents serious losses and reduces a certain gamma risk of options with a shorter term.
Nevertheless, due to multiple legs, the transaction costs can often be higher than the variance risk premiums themselves.
This makes trading indices the most suitable for a systematic weekly iron condor strategy.
Alternatively, longer-term trading monthly options can achieve comparable returns after taking into account increased transaction costs.
Disclaimer: The information above is for For educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are unfamiliar with exchange-traded options. All readers interested in this strategy should do their own research and seek advice from a licensed financial advisor.