The Retail Trader versus the Pro

Iron condors are very popular trades among retail traders. These days one can hardly go to a cocktail party and mention the word options without hearing someone tell a story about an iron condor on which he’s made a bundle of money trading. Strangely, no one ever tells stories about trades in which he has lost a bundle of money.Two of the strengths of this strategy that attract retail traders are its limited risk and high probability of success.

Another draw of this type of strategy is that the iron condor and the other wing spreads offer something truly unique to the retail trader: a way to profit from stocks that don’t move.In the stock-trading world, the only thing that can be traded is direction—that is, delta. The iron condor is an approachable way for a nonprofessional EXHIBIT 10.9 Iron condor adjusted to strangle.$Premium Delta Gamma Theta Vega 110 80 put $0 0.000 0.010 0.000 0.020 110 100 call $210 0.960 0.360 0.130 0.550 Net spread cost $210 0.960 0.370 0.130 0.570 Wing Spreads 205 to dabble in nonlinear trading.

The iron condor does a good job in eliminating delta—unless, of course, the stock moves and gamma kicks in. It is efficient in helping income-generating retail traders accomplish their goals. And when a loss occurs, although it can be bigger than the potential profits,it is finite.But professional option traders, who have access to lots of capital and have very low commissions and margin requirements, tend to focus their efforts in other directions: they tend to trade volatility.

Although iron condors are well equipped for profiting from theta when the stock cooperates,it is also possible to trade implied volatility with this strategy.The examples of iron condors, condors, iron butterflies, and butterflies presented in this chapter so far have for the most part been from the perspective of the neutral trader: selling the guts and buying the wings.

A trader focusing on vega in any of these strategies may do just the opposite—buy the guts and sell the wings—depending on whether the trader is bullish or bearish on volatility.Say a trader, Joe, had a bullish outlook on volatility in Salesforce.com (CRM). Joe could sell the following condor 100 times.

Sell 100 February 90 calls at 17.40
Buy 100 February 95 calls at 13.75
Buy 100 February 115 calls at 3.80
Sell 100 February 120 calls at 2.55
Total credit 2.40

In this example, February is 59 days from expiration. Exhibit 10.10 shows the analytics for this trade with CRM at $104.32.As expected with the underlying centered between the two middle strikes, delta and gamma are about flat. As Salesforce.com moves higher or lower, though, gamma and, consequently, delta will change. As the stock moves closer to either of the long strikes, gamma will become more positive,causing the delta to change favorably for Joe. Theta, however, is working against him with Salesforce.com at $104.32, costing $150 a day.

In this instance, movement is good. Joe benefits from increased realized volatility.The best-case scenario would be if Salesforce.com moves through either of the long strikes to, or through, either of the short strikes.The prime objective in this example, though, is to profit from a rise in IV. The position has a positive vega. The position makes or loses $400 with every point change in implied volatility.

Because of the proportion of theta risk to vega risk, this should be a short-term play.If Joe were looking for a small rise in IV, say five points, the move would have to happen within 13 calendar days, given the vega and theta figures.The vega gain on a rise of five vol points would be $2,000, and the theta loss over 13 calendar days would be $1,950. If there were stock movement associated with the IV increase, that delta/gamma gain would offset some of the havoc that theta wreaked on the option premiums.

However, if Joe traded a strategy like a condor as a vol play, he would likely expect a bigger volatility move than the five points discussed here as well as expecting increased realized volatility.A condor bullish vol play works when you expect something to change a stock’s price action in the short term.

Examples would be rumors of a new product’s being unveiled, a product recall, a management change, or some other shake-up that leads to greater uncertainty about the company’s future—good or bad. The goal is to profit from a rise in IV, so the trade needs to be put on before the announcement occurs. The motto in optionvolatility trading is “Buy the rumor; sell the news.” Usually, by the time the news is out, the increase in IV is already priced into option premiums. As uncertainty decreases, IV decreases as well.