One of the biggest differences between Option Pit and other mentoring services is the way we teach our students to approach trading. While many firms out there teach traders to throw the same trade on every month, we are teaching traders to make decisions. We teach our traders to take the same approach, not enter the same trade. Below, is an example of how I teach my option mentoring students to approach iron condors.
While implied volatility has fallen a bit from where it was on Friday, volatility skew, or smile has stayed elevated to a level that has caused iron condors to be a somewhat wider, and pay a touch more, both on the upside and the downside than the last time VIX got to 17%. I decided to look through the four major indexes for a possible iron condor candidate. I eliminated NDX off the bat because it is too heavily weighted in AAPL, GOOG, and a few other stocks (they should really call it the NASDAQ 5 + 95 names that don't really matter). Next I eliminated the OEX because it only had 20 point strikes. One thing I have found is that dollar for dollar, the tighter one can make an Iron Condor, the higher the per dollar return-this is because of skew's affect on downside puts.
After eliminating the OEX and the NDX we were left with 2 candidates, the SPX or the RUT. First we looked at the SPX:
I liked that 20 day HV was much lower than both 30 day implied volatility and 60 day implied volatility. What I didn’t like was that 60 day implied volatility was low relative to where IV has traded over the past few months.
Next I looked at the skew; it was nice and steep, trading at about 150% of ATM IV. Interestingly and actually bad for a condor, the further out one went the steeper the curve got. Unlike normal, the steepness was not uniform at all, it was somewhat exponential. Back in my floor days, we used the Sabre Model to model skew. This very steep curve would be caused by 'pump' and 'tilt.' This is a detraction because it causes our long put on the downside to be even more over priced than our short put (normally they would be equally over priced or in vol terms, which, because of the extra vega in the short makes the spread better).
Based on the vols, an iron condor didn't look bad, but didn't look great either. Because of the weird skew and somewhat low volatility, the delta's (thus values) of the downside puts were extremely tight. After I set the iron condor up the way in proper fashion the SPX trade had a 75% chance of success that was only giving a credit of about 1.60, at least 40.00 less than I would expect this trade to pay out. Usually steep skew is good for iron condors, but not when it has a crazy slope.
SPX was out; did this mean I had to do a RUT condor? No, if the RUT was garbage as well, I would have simply skipped condors for the day. Here is the RUT analysis:
First, like SPX, the RUT IV is nicely higher than the realized volatility. What I liked more about the vol , was that the IV was not at the same low level relative to where it had been in trading in past few months. While they are certainly not high by any means, it was not near the 2006 levels that I was looking at in the SPX.
Next I reviewed the skew:
While it was not low; at around 140% of ATM IV I was not doing back flips. However, I noticed that it didn’t have the same extreme pump and tilt as our SPX trade. Also, remember that 140% of 23% is a lot higher volatility than 150% of 14%. Normally, I hate this product, but for once, the IV's were at a decent level, the skew had the right steepness and shape, and the underlying wasn't flying around. If the price was right I might have a winner.
Upon setting up the trade to in proper fashion, I was presented with a trade that had odds of success of about 74%, yet paid out 2.15, a yield of 27.4% on my money. If I could get executed at that price this trade actually had a few pennies in edge in it! Normally, I do not like the Russell 2000, but in this case I felt compelled to enter.
Win or lose, I will have set up the trade the right way, using a systematic approach to trade selection (very different from a system trade). While winning is not for certain, I am certain that I entered the most favorable April iron Condor of the four major indexes.
Right now, we are trading an OEX iron fly in the AM Pit Report (which you can register to see, for free, here). During the mid day report we are working with this condor along with a few other trades. Right now we are running a special rate for the first month, you can find out more by emailing us info@optionpit.com
Follow us on twitter @optionpit
Graphs from LiveVolPro
