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Home Forex

The benefits of using Iron Condors in options trading

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February 11, 2022
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The benefits of using Iron Condors in options trading
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Some of the benefits of trading Australian options over American options are less time decay, and implied volatility is often lower. When traders choose Iron Condors as their strategy, they benefit from both of these elements with a higher probability of success than using other positions such as Vertical spreads, Strangles or even Butterflies.

An Iron Condor spread, in options trading, involves short OTM Put and Call contracts at a specific strike price with a further long OTM Put contract a little below and a further long call contract a little above.

There is significantly reduced time decay

Time decay increases as the expiry date approaches, so the time value of the options in an Iron Condor drops much slower than other strategies. It protects sharp moves in either direction.

Implied volatility is usually lower

Implied volatility depends on several factors, including short term market sentiment and expected price movement. During heightened periods when traders expect prices to move quickly, higher levels of implied volatility are priced into options, making them more expensive for all strategies to buy. An Iron Condor strategy defends against this by being short both high and low implied volatility contracts, thus reducing costs while still providing benefits from reduced time decay.

Iron Condor spreads have a higher probability of success

A study from TastyTrade found that in a historical test from 2005 – 2015, ITM and OTM call and put options had a likelihood to expire within their respective money 90% of the time. However, an Iron Condor spread had a likelihood to expire with all four contracts at least one point ITM or OTM 93% of the time.

Drawdowns are smaller

Iron Condors provide a more efficient way to trade with the lower risk per position due to not being exposed to both high volatility and directional moves simultaneously, which happens when using Vertical spreads, Strangles or Butterflies.

Requires less capital

The required margin for a Strangle is four times higher than for an Iron Condor with the same expiration and strikes. A Vertical spread requires twice as much initial margin as a similar Iron Condor position.

See also  Why you should be using Evotrade for Forex Trading

Slippage is reduced when opening or closing positions

Slippage is the distinction between the price at which you execute an order and the price of where you could have filled it. Slippage occurs more often when highly volatile markets, especially news events or announcements, and can quickly cause significant directional moves.

Iron Condors do not require constant monitoring

It’s easy to forget that one of your trading strategies is open if you’re focused on other positions, which is why some traders like to close their trades before they expire naturally. A further benefit for Iron Condor traders is that even if they don’t explicitly close their trade before expiration, there will be less chance of sudden unexpected changes in market conditions due to reduced time decay.

You can reduce risks

By choosing the right strikes and expiration date, traders can reduce their risks by:

  • Choosing a situation where one side of the trade is likely to expire within 24 hours and therefore has little or no time value.
  • Choosing expiry dates that cannot move out more than 45 days in either direction from current levels.
  • Keeping initial margin requirements low through selecting contracts with favourable Vega values.

Different risk/reward profiles for different trader types

Some traders prefer using strategies such as Strangles that have high potential returns and involve additional risk due to the broader range of possible outcomes. For other traders who prefer lower risk strategies such as Butterflies, Iron Condors allow them to still use options with a wide range of expiry dates and strikes while still limiting their risk.

Traders can use hedging techniques to reduce risk further

Iron Condors also allow traders to hedge one side of their position with a further Iron Condor on the opposite side. These trades, called Reverse Iron Condors, can be used as insurance so that regardless of other market developments, you are still protected against sharp moves in volatility or price direction.

Tags: options trading
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