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The Biggest Risk In Iron Condor Trading

Iron condor trading is an incredibly profitable option trading strategy, especially for beginning traders.

Yet if you don't know how to manage your risk, you can end up getting blown out on a trade.

That's when the honeymoon phase is over.

Some traders adapt and overcome, getting over that hump and becoming even more profitable with iron condors.

For others, that's when they move on to another strategy.

(Hopefully you're in the first group!)

To be honest, it doesn't matter how many times I tell you this, it'll take that one trade where you get knocked around a little...

... that's when you'll start to pay attention.

Let's step through some of the huge pitfalls when it comes to the risk in iron condors.

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Don't Look at Iron Condor Expiration Outcomes

I know it's tempting to eyeball this chart:


And say to yourself:

"Oh as long as the market doesn't selloff 10% or rally another 5% then I'll be profiable."

Or maybe you say:

"Hey the probability of profit (PoP) is really high so this trade will be a layup!"

That's bad voodoo. You're just asking for the market to prove you wrong.

I won't lie to you... if you come into the market at the right time, those first few trades will feel great as the profits roll in.

But then something stupid happens.

We can blame China, or the Fed, or the Oil markets. Whatever.

And if you were planning on doing a "set and forget" strategy with this iron condor, you're gonna get smoked.

The Real Risk In Iron Condors

Believe it or not, iron condors are incredibly forgiving to the downside.

The premiums available on out of the money puts allow you to have more "wiggle room" in case the market sells off.

It's the upside risk where you get in trouble.

When you start off an iron condor trade, it's not a market neutral trade.

It's actually net short.

iron condor risk graph

That means if you put it on and the market rips to the upside, you'll start the trade in a drawdown.

No bueno.

How You Can Manage Iron Condor Risk

No matter what you do it's crucial that you have a plan before you enter the trade.

Ideally you make it as systematic as possible so you know at what point you will adjust the trade.

Here are a couple considerations:

Enter Iron Condors In Overbought Markets

This may seem counterintuitive but it works.

When the market is ripping higher it's actually a pretty good time to enter a new iron condor.

That's because the odds of reversion is higher, and the net short actually benefits your trade.

Also, there will still be plenty of premium on the put side because of option skew.

Unbalance Your Iron Condor

If you're concerned about the upside, just don't go full risk on the call spread.

Then, if the market continues to rip, you can add to the call spread at a much better basis.

Have an Adjustment Plan in Place

If the directional exposure becomes to great, you can simply use iron condor adjustments to work your position back down to a better risk/reward equation.

Remember, no matter what you need to have a plan. Iron condors are a dynamic risk strategy and if you can manage that risk, the profits will come flowing in.

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Does The Market Selloff With A Low VIX?

Like clockwork.

You get a selloff to shake enough people out and buy puts...

And once enough investors are hedged to the teeth or moved to cash, the market starts to rip.

From there, the early shorts get smoked, and then those who were in cash start to feel the FOMO (fear of missing out).

At some point, investors will stop buying puts, which leads to a low VIX reading.

The mainstream idea is that a low VIX means that there is a ton of complacency.

And that complacency means too many people are long the market.

And that the market is going to selloff.

The question I have for you is:

Are you sure about that?

The Baseline Data

The chart below shows us a distribution of the 20 day returns of the S&P 500.

So you take a day, look a month in the past, and look at the change.


As you can see, it's a nice big bell curve.

If you really want to nerd out, it's called a lognormal distribution.

What the SPX Does In a Low VIX

Here's where it gets fun.

We can compare the previous bell curve against a new set of data.

Basically, look for instances where the VIX is under 15 and then see what the returns are 20 days later.

Here's what we get:


If you're squinting your eyes to see the difference, here are some hard numbers:

Baseline (All SPX Data)

  • Average: 0.49%
  • Standard Deviation: 4.6%
  • % Under 5%: 10%

If VIX < 15

  • Average: 0.33%
  • Standard Deviation: 2.3%
  • % Under 5%: 2.1%

How The Market Actually Trades

Simply put, if you're looking for some kind of market collapse because the VIX is under 15... you're going to be disappointed.

Over this entire sample, there have only been 25 instances in which the market sold off over 5% after the VIX was under this level.

You'll also see that both the average return and standard deviation are lower.

This makes sense. The largest rips higher happen after deeply oversold readings so you should expect a grind.

And with the standard deviation so low, it means that price movement will continue to compress.

If you're looking for a move lower, you better wait until we get some actual confirmation before you load up on the puts.

How to Trade A Low VIX

If you want one simple option strategy that profits in this kind of trading environment, you'll want to view this free video report I put together. 

I'll personally step you through a set of trading strategies that consistently outperform the market, and one strategy that works great when the VIX is low.

You'll also have the opportunity to get a premium trading course from me so you can build out a profitable trading system of your own.

Click Here To Watch

Four Charts You Need to See Right Now

Over the past few days I’ve been talking about the live class that I’m doing this weekend.

I’d like to pull back the curtain a bit more and show you what I’ve been working on.

When you deal with options, profit comes not just through price but also through time.

That means backtesting looks a little different when you’re trying to find a winning strategy.

When you’re taking an investing approach, you want to find a way to own stocks at the best prices possible, without missing on too much upside.

That’s where this phrase comes to mind:

“Simple, but not easy.”

I’ve been hard at work developing models that give investors the results they desire without having to second guess themselves.

Here’s what I mean…

This is a chart that shows the 10 week returns distribution on a well known stock:


And here are the distributions when I look for a very specific signal.


See the difference?

The downside on the second chart has a lower frequency. This is where it makes sense to get bullish.

That’s where your edge is as an investor.

How about these two charts:

The first is from the S&P 500 when a certain signal triggers:


Pretty ugly, right?

That’s a lot of downside action.


Here is what the returns on the S&P 500 look like when that signal reverses:


The lesson here is to use the signal not as an obvious buy point, but instead to slowly scale in because once that signal flips, the downside is done.

Here’s where it gets fun…

If you can combine backtesting with key option strategies, you’ve got a formula for massive success in your investing career.

Pretty cool, right?

If you want to get the training and the backtests this Saturday, all you need to do is sign up using the button below.


I look forward to seeing you at the training!


The Next Ugly Move In Oil Stocks

I don't think there's been enough bloodletting yet.

Sure, the last few months have been ugly for oil stocks... and odds are we won't experience the same kind of nasty downside action that we saw late last year.

Yet there haven't been enough fundamental catalysts to justify oil stocks starting a new bull market.

We need more dividend cuts, more dilution through secondaries, and more pain for investors before this is all over.

Given the fact that many of these oil stocks have seen aggressive rallies since January, now is a time to consider some new downside trades.

A Quick Look At Oil

The major reason that many of these stocks have bounced has been because oil has stopped collapsing.

The premise here is simple:

If the price of oil is lower than your cost to pull it out of the ground, you're in trouble.

And if you can't generate enough cash to finance your outstanding debt, you're in more trouble.

That was the overall driver for many of the leveraged oil stocks last year.

That story hasn't gone away, it just has subsided because oil has seen one of its strongest moves in a very, very long time.


If oil starts to rollover and if we start to see downside catalysts, that selling momentum could pick up very soon.

How to Trade It

Put Buys On Leveraged Oil Stocks

With this large countertrend rally in oil, now is the time to consider a strategy of anticipating dilutive events in oil stocks that are still in a position of weakness in the market.

Kinder Morgan (KMI) is a great example.


A year ago, the stock was in the 40s.

2 months ago, the stock was headed to the single digits as investors puked up their shares. Odds are the company will have a dilutive event sooner than later, and that tends to hurt the share price of the stock.

These broken oil companies will be forced to raise cash not to finance growth, but just to survive.

The main risk here is that some of these companies could find strategic alternatives... going private (not likely) or a buyout from a firm like XOM. Because of that asymmetric risk, it's best to consider some put buys that limit your risk.

The KMI Jun 15 put is currently priced at 0.50.

Considering the implied volatility of KMI options has been holding around 60% since it's collapse, these puts are relatively cheap and could offer a good payout if oil softens and we see a secondary come into play.

Investing in the Majors Will Be Easier

If you do want to take a shot with some long oil stocks, then it makes sense to go with larger market cap stocks with better balance sheets.

Exxon Mobile (XOM) is the best example of this.


They've got enough cash to weather this kind of ugliness in the oil markets. It may not be all roses, but they probably will never have a problem with debt issuance and their business model will survive.

The technicals align with this idea. While the rest of the oil patch was getting obliterated, XOM made a higher low this year. Same for Chevron (CVX).

Furthermore, it's actually very difficult to get exposure to oil. Oil exchange traded funds (ETFs) have issues with futures rollover and many of them will continue to structurally underperform as long as the oil markets are in contango. It's easier to just buy a company and collect the dividend.

If you're looking for an ETF, then XLE is going to be your best bet as 30% of the total size in the ETF is just XOM and CVX.

Pairs Trade ETFs

One trend I expect to continue is the outperformance of XLE relative to OIH. The balance sheets are better and there are less risks involved with the larger companies.


Any time this relationship stretches to the downside, consider starting a position.

Put Sales Post Secondary

Once you see some kind of ugly fundamental catalyst, the downside momentum will generate higher option premiums and a good opportunity for longer term investors.

Of course, there's always the possibility that a stock just goes to zero. That's the risk you're playing with.

You could consider buying calls to limit your downside, but then you run the risk of the stock just going sideways and nothing happening.

Should You Buy Calls Because Goldman Sachs Says So?

A note from Goldman is out today suggesting that now is the best time to buy S&P 500 calls in over 20 years.

That's quite a bullish call, right? It sure sounds like they're sucking people into the long side after the markets have already seen a strong move.

Yet there is more to the story than a simple long/short bet.

Taking Apart the Call

Goldman has a risk pricing tool that shows the expected range of the market, both to the upside and downside.

It's not about being bullish or bearish but it shows us the expected standard deviation of price movement.


The VIX operates in a similar manner. If the VIX is at 15% that means the expected movement over a year's worth of trading is 15% higher and 15% lower.

It's statistical expectancy over a timer period. Can the market go higher than that? Yeah. Can it go lower? Sure. But that's the current risk pricing available.

Now, if you have an indicator showing you that the odds of upside movement is greater than what the options market is pricing in, then you take that bet.

Why This Is Showing Up Now

Let's talk quickly about option skew.

Not all options have the same risk pricing. That's becaouse the majority of investors are scared about downside movement.

That means the normal action in the options market is for investors to buy puts and sell calls.

Think about what just happened. The market hit correction territory earlier this year, and we've seen an incredible squeeze back to SPX 2000.

It's the same on the Russell 2000... it's currently 7% above the average price over the past month:


So if you're an investor and you're still holding stock, and you want to continue to hold that stock, what do you do right now?

You sell calls against your position. Because we're running hard into key resistance levels and the market is quite overbought on the short term.

Too Many Leaning One Way

If you have a bunch of people selling calls, that drives down the premium available in out of the money options.

I can "feel" this in the market right now because on many stocks I'm looking to short, selling call credit spreads isn't offering the best risk/reward.

It's a crowded trade.

With call premiums so low, that means the expected risk pricing to the upside is also very low.

It makes sense for Goldman's reading to be extreme, because we've seen extreme price movement and investors are using that as an opportunity to reduce their basis in the markets.

Now, is that the right call? Possibly. It's also possible that all those people who are shorting calls get squeezed even higher. That's what I'm expecting in the market.

That's a decent bet to take right here.

How To Use This Information

If you managed to buy the dip and have good positioning on in stocks, then it doesn't offer good risk/reward anymore to sell a ton of calls. The premiums aren't there.

Instead, consider some alternatives.

Call conversions - sell your stock, buy some upside calls. It takes a ton of capital off the table and still allows you to profit if we squeeze higher. Because call options are so cheap relative to potential upside expectations this is a reasonable setup.

Sell puts - sell your stock and sell some puts. Ideally you get a little more juice to sell as investors are buying puts and you are taking the other side. Synthetically it's the same kind of risk as a covered call but it offers a little better risk reward

Risk reversals - sell puts and buy calls at the same time. This will give you stock-like exposure and you can take advantage of the "cheapness" in the options market

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