Coming back from vacation today, several of my options mentoring students were wondering whether the iron condor might make some sense right now. My answer was, well it makes more sense than a butterfly, but I have to do some analysis of what the IV surface looks like, to start here is a look at 60 day IV:
Right now, 60 day IV is at its highest level since the end of August 2010, however, unlike the end of August, it appears to be at the beginning of a big upswing instead of at the end of one. To really get a decent comparison of the IV surface it might make more sense to look at 60 day IV on August 11th, the beginning of the major upswing.
The IV structures are very similar; I thought it might be interesting to point out the vol of the put that is the same percentage out of the money as our current 10 delta put:
Here is then:
Here is now:
Notice that while the IV's are pretty close, the downside is actually a touch higher now than it was in August. One should not lose sight of the fact that this is, in absolute terms a much greater volatility than August. Bascially a vol of 30% on 1090 is about 50 points less absolute movement over a year than 30% of 1255.
Now to condors:
This higher vol allows for a very wide condor, the May condor I was looking at was more than 300 points wide, yet could return a credit that had a risk of 4 to 1. That is not bad odds if one considers that there were trader's (not Option Pit students mind you) looking at condors 2/3 of that size a little more than a week ago. This condor could lose (more likely to the upside than down), however, looking at the risk reward, I would be willing to stick my toe in this murky water. I simply cannot resist the chance to sell into this.
Would I go crazy, NO! I think we will see a possible uptick in IV from here, but it doesn’t make sense to sit on the sideline like a 2nd rate benchwarmer. Traders that see opportunity should be willing to set up smart protected condors that have edge (key word, protected).
I would point out that I would still hedge some of this vega, not sure units make the most sense here, but VIX or VXX set up the right way (you have to be a student of mine for that info) might make some sense.
In the end it is all about risk reward, if I think Japan is going to melt down, the SPX is going to see the wrong side of 1000. If I think there is going to be major problems, SPX might see the wrong side of 1100. If I think things are bad, but will get worse, we could see the wrong side of 1200. In all but one of those scenarios, a condor does not have a side get touched. In scenario 3, hedging should solve the problem. The real risk is that in the scenario where the problems are over, and the market rallies 50 points in the next 2 weeks.
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Graphs from LiveVolPro
