Track That Trade 110613

These trades were made very early this morning, Jun 14, 2011
Note: Size is too large for out portfolio.

NDX = $2241
VXN = 20.22 (volatility index for NDX)

Bought iron condor: NDX Aug 2025/2050P; 2375/2400C

Bought call butterfly: NDX Aug 2025/2212½** /2400

      **Sell equal quantity of 2200 and 2225 calls


Hoping to compare these two strategies side by side. The goal is to gather some information on volatility skew.

The Trade

figure 1

Iron Condor

Bid/Ask Market: $4.20 to $11.50; midpoint is $7.85. Assume fill @ $7.50 credit

[Reminder: these trades are made in a paper-trading account where I am forced to pay the offer and sell the bid to get any fills. That is unrealistic and I prefer to make an assumption of filling at a price that is near the midpoints.]

[Double reminder: These trades are for educational purposes. They are not recommended and I do not own these positions in my personal account.]

Maximum Profit: $750 per iron condor
Maximum loss: $1,750 per iron condor


Note: This position is not a true butterfly. In a butterfly spread, the trader sells two of the strike price that is midway between the options bought. In this case there is no option at that price, so I sold equal numbers of the option on each side of that mythical Aug 2212½ call. This is essentially the same as the butterfly – especially when the wings are so far apart.

Bid/Ask Market: $59.30 to $85.40. Midpoint is $72.35. Assume fill @ $73

The Greeks

figure 2

Delta of Options Sold: Put: 17; Call 20.
[These delta were 18 and 19 when I made the erroneous trade yesterday. I kept the same strike prices when making the trade today]

Note that these delta are too high for the truly conservative trader. If that describes you, and if you want to follow this trade in your own paper-trading account, consider making the same trade using strikes prices that are 25- or 50- points farther OTM. Remember that the wings of the butterfly spread would change but the middle strike(s) remain the same.

Maximum profit: $10,200 per butterfly.

    Maximum value is $175 when NDX is between $2200 and $2250 at expiration. The lower-struck (bullish call) spread would be worth $175 (2200 minus 2025) and the higher-struck (bearish call) spread would be worthless. Subtract the original $73 cost from $175 to calculate the maximum gain.

Maximum loss: $73

The risk picture

figure 3

The payoff is potentially large and tempting. However, we must remember that markets move and no matter how wide the profit zone appears to be, the edges of that zone can be breached rather quickly.

figure 4

Being short delta in a rising market doesn’t feel good, but there is no need to be apprehensive at this point. We are short a ton of vega and that is the major risk factor at this point in time. We are not short much gamma (2) and there is a nice-looking time decay. Of course, that comes with owning a position that is too large for the portfolio.

A declining VXN (>5% by day’s end) certainly helps the value of the trade.

Time: 10:11a, June 14, 2011

figure 5

Implied Volatility

We captured the implied volatility at the time the trade was made (figure 2). In, each trade, we own the wings, i.e., the 2025 and 2400 strikes.

The difference is in the options sold. In the iron condor we sold options near our long options, and each is far OTM. In the butterfly, we sold CTM options. Let’s compare the implied volatility (IV) of the options that were sold s part of this combined trade.

I’m using data supplied by Interactive Brokers. [The other images all come from using Interactive Brokers’ trading platform.]

Trade Plan

a) Risk Management. This risk management plan is to use the traditional methodology. If we decide one side of the trade warrants risk reduction, we’ll take appropriate action. Depending on market conditions, there are two basic choices: I’d prefer to choose a method not previously used. However, there is much to be learned from managing risk with one of my preferred methods and then zeroing in on the details of why I chose one strike instead of another. I know that you are anxious to see more in the way of details, giving a better opportunity to truly understand why one specific adjustment strategy is valuable and how to get the most out of it.

I understand that urge to learn quickly. But please remember that we are in a process together and there is a ton of ground to cover.

b) Skew study. I’m hoping to be able to see the volatility skew undergo considerable change to much flatter or much steeper. The accepted theory is that iron condors are best opened when skew is steep and butterfys when skew is flatter. One important factor that I have yet to discover is just how much ‘better’ one is than the other. I have no feel – in terms of dollars – what kind of monetary difference this makes.

June 17, 2011

I thought it may be beneficial to look at the risk graph for the iron condor and butterfly separately.

8 Responses to “Track That Trade 110613”

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