What's the best setup for an iron condor? A butterfly? Are long calls or puts, credit spreads or debit spreads preferable if you want a directional trade? Are weeklies preferable to 30-day trades?
No single best setup exists. Each decision offers pluses and minuses. Entering with more days to expiration may make adjustments less costly, but that extra time exposes the trade to more event risk. Structuring an options trade so that it offers more opportunity for profit often adds more risk. More protection from price movement usually requires more cost or more time in the trade, or offers less opportunity for profit.
Let's focus on the iron condor in the discussion.
SPX Iron Condor Entered 57 Days to Expiration, OptionNet Chart:
SPX Iron Condor, 8 DTE:
The two trades were established using the same number of contracts, two. They also both employed similar delta guidelines for the sold strikes: first call strike with a delta at or under 10.00, and first put strike with a delta at or above -10.00. The 57-DTE iron condor has expiration breakevens at 1534.18 and 1781.72, and the 8-DTE iron condor has expiration breakevens at 1633.30 and 1725.61. Maximum potential profit at expiration is $254.00 for the 57-DTE version, with a max loss of $1746 if the trader fails to or is unable to adjust or take off the trade when necessary. Maximum potential profit at expiration is $204 for the 8-DTE version with max loss of $1796 if the trader fails to or is unable to adjust or exit when necessary.
Clearly, then, the 57-DTE is preferable to the 8-DTE version, right? It has much wider expiration breakevens. It has the opportunity to make more money and might experience less loss if something goes wrong and the trader either fails to or cannot adjust or exit when appropriate.
That's not necessarily true.
Daily VIX Chart:
At the time those charts were snapped, the VIX was approaching an area from which it had often reversed, highlighted by the yellow oval. Such reversals higher in the VIX are sometimes accompanied by downturns in the market and almost always, by higher implied volatilities. This last year, those reversals had often proved short-lived and minor, not much danger to the iron condor trader in a 57-DTE trade. However, it's a time iron condor traders traditionally are getting less for their risk since iron condors offer less premium when IV's are low. While they're collecting less premium, they may be facing more risk of a rollover than is normal. Although at the time these charts were snapped, it was hard to believe there would ever again be a sharp downturn, we of course will see them again. The Thursday that this chart was snapped, the nervous iron condor trader might not have wanted to be stuck in a 57-day trade with this setup, afraid of sharply rising implied volatilities combined with sharp declines.
Markets might also have bounded higher again. This is what actually happened in the more than a week since these charts were snapped, although there's still plenty of time for a rollover. However, none of us had a crystal ball that Thursday morning. What we do know is that the trader who elected to enter the 57-DTE version was trading some pluses for some minuses. That trade choice offered wider breakevens, a smoother profit-and-loss line over the next few days and a wider price movement, along with more profit potential than the weekly trade. The minus was that the 57-DTE had more event risk. The trader who elected the 8-DTE version was trading less event risk for slightly lower profit potential and the absolutely critical need to stay on top of adjustments or exit plans.
Other choices exist. You might have noticed that the PnL line on the 57-DTE version sloped more sharply downward to the upside. In fact, long-time iron condor traders sometimes fear relentless climbs more than they do downturns. That's because of what happens with implied volatilities during climbs. They typically sink. When they do, that hedging long option, ten points away from the sold option in the iron condors shown here, decays more quickly than the closer-in sold option. It doesn't provide much hedging. Moreover, the decrease in implied volatilities means that it's difficult to roll in-trouble call credit spreads higher and get them out of the way and still collect any premium. For that reason, some active options traders have moved toward a different construction for their iron condors. They may sell fewer call credit spreads than put credit spreads. Below you'll find one example, but many variations exist. This example sells two put credit spreads but only one call credit spread.
Unbalanced Iron Condor with 57-DTE:
When compared to the original chart, it's easy to see that the PnL line now slopes more evenly on both sides of the current price. However, the real benefit doesn't show up now, but when time passes and implied volatility drops while prices climb. When it's time to adjust according to the trader's guidelines, that adjustment will be less painful. However, the trader has given up some profit potential, as maximum profit is now only $168.00, while maximum loss if the trader fails to or is unable to adjust has risen to $1,832.00. In addition, some and maybe most or many brokerages will margin this trade differently once the number of call and put credit spreads is unbalanced. They may hold margin separately for the call credit spreads and put debit spreads.
Some traders want downside protection when the VIX approaches support while indices are stretching toward new highs. Many opt for a cheap out-of-the-money put, made cheap by the low implied volatility. Because of the skew of options, out-of-the-money puts don't act the same as out-of-the-money calls when price moves toward them. They tend to hold their value better, and, in a sharp move down may even inflate enough to at least stem some of the losses while the trader adjusts. There's a cost for adding this put protection, of course, a cost that eats into the potential profit.
And so it goes. To handle the problem with relentlessly climbing prices, some traders add call debit spreads in front of their call credit spreads, since call debit spreads tend to work better in such moves than an out-of-the-money extra long call. However, there's a cost for that tactic, too.
Options are so flexible that trades can be structured to address each trader's most pressing concern. However, they can't be structured to meet all wish-list goals and also protect against all worse-fear dangers. Decide what works best for you and your needs. Woe to the knees-shaking conservative trader who elects for more profit potential and ends up pulling out of the trade unnecessarily because she just can't stand the tension. Woe to the adrenaline-junkie trader who elects a slowly unfolding trade and ends up over-adjusting the trade out of boredom. Don't follow anyone else's trades without making sure they're right for you, your personality, your risk tolerance, and your trading account's size.