In last week's article, I discussed points options traders might consider when making decisions about the strategies they'll employ. That article prompts a second one.

One way in which we often compare different strategies is by looking at expiration breakevens. Some iron condors have wider expiration breakevens than do most butterflies, for example, resulting in a preference for iron condors by some traders. Those who don't like to adjust any trade, just taking it off when it hits a preset maximum loss, might prefer the wider expiration breakevens of the iron condor.

I had mentioned in my article, however, depending on whether and how one adjusts iron condors, an adverse move right after the trade is initiated will render those expiration breakevens useless. The trader's planned maximum loss could be reached well before those expiration breakevens are touched or sometimes, even closely approached. I've seen SPX iron condors show a theoretical unrealized loss of 11-15 percent just days after the trade is opened, when the SPX is still 70-90 points away from a sold strike. The combination of a quick move and quickly rising volatility widens the spread prices, making the unrealized loss bigger than it would be if the move had happened more gradually or later in the trade.

What if you never hold trades into expiration week, and you intend a butterfly or iron condor trade to last only two to three weeks? I've seen former market maker Dan Sheridan use such timeframes to compare the theoretical performances of butterflies with wings of different widths. When we're looking at a sharp adverse move soon after a trade is initiated, the width of a butterfly's wings may not make a lot of difference in the unrealized losses, even if the butterflies had quite different expiration breakevens, he sometimes notes. Will butterflies and the trade with the wider expiration breakevens, the iron condors, perform differently, or, like those butterflies with different size wings, will they look more similar than expected over a shorter time frame? Such questions are important to ask if you're not someone who risks holding these trades into expiration week. Those expiration-week graphs don't mean anything to you.

Let's look at some theoretical profit/loss charts, not at expiration but as of two weeks after a trade is initiated. Let's see what develops when we use such charts to compare theoretical profit/loss charts for iron condors and butterflies. I'm going to use the RUT for this exercise for several reasons. One is that fills have become tougher on the SPX the last few months, and I think the theoretical fills on the RUT would likely be closer to the actual ones than they would on the SPX, at least for now. Understand that if there's a true rout in the market, that might not necessarily be true. I don't think it was on the flash crash, for example. The presence of market makers can help maintain orderly market conditions.

Now that we know the vehicle we'll be using, the question we must ask ourselves is how we go about comparing apples to apples. Do we construct iron condors and butterflies with equal numbers of contracts, say three contracts of iron condors and three of butterflies, or do we construct them so that each has about the same margin requirement? For the purposes of this article, I'm going to go with approximately equal margin requirements rather than equal numbers of contracts. That way, we'll be able to look at the theoretical dollar losses or gains at certain price points and compare them.

I'm using freeware OptionsOracle for these calculations. Each such software uses slightly different formulae for these calculations. That means that if you're using some other software and load this same trade into that software, you might get somewhat different values. You'll find slightly different conclusions whether you use think-or-swim's analysis page, BX's more rudimentary charts or more expensive purchased and proprietary sites. That's why it's important to become familiar with your own preferred software and stick to it. I'll also be using end-of-day values, and those are sometimes skewed.

The first is a 3-contract RUT DEC call butterfly set at 720 on November 12, with 50-point wings. The strategy summary shows total expenditure and expiration breakevens (Lower and Upper Protection).

Strategy Summary for Theoretical RUT DEC Call Butterfly:

The total debit for this position--without commissions--was $5,175.00, the margin withheld or buying-power effect of this trade. The second position is a 6-contract RUT Iron condor, with the sold strikes and long strikes 10 points apart.

Strategy Summary for Theoretical RUT DEC Iron Condor:

I'm not including commissions in this comparison. Without them, the margin requirements for the two strategies are $5,175.00 and $5,277.00, respectively. The buying-power effects of the two trades were as close as I could get them, only a little over $100 apart. Commissions will be a little more intensive for the iron condor because more contracts are involved.

Without those commissions, expirations breakevens would be $687.25 and $752.75 for the butterfly, and a wider $618.79 and $792.21 for the iron condor. Even if the greater commissions were factored in, the expiration breakevens would remain much wider for the iron condor, at least at most brokerages.

Now that we've established two positions with similar margin requirements but with apparently much different expiration breakevens, let's see what would happen two weeks into the trade. Let's consider the case of a downside move that hikes up the implied volatilities by 2 percent.

Profit/loss Graph for RUT DEC Butterfly, Two Weeks into the Trade with Implied Volatilities Raised 2 Percent:

Under the conditions listed above, with the implied volatilities hiked up about 2 percent, the position is not profitable at any price point. To compare this graph and the one that follows for the iron condor position, let's establish a comparison price of $700 for the RUT. At that price, the butterfly's chart shows a theoretical loss of $471.10. It's not marked on the chart, but I did calibrate it on the chart and the software returned that loss value.

Profit/Loss Graph for RUT DEC Iron Condor:

The downside breakeven here is at about $681.76. If we use a downside move to $700 as our comparison, this chart calculates the position would theoretically be up about $306.80. Obviously, the iron condor has behaved better under these conditions over this short-term period.

This is just one calculation. Similar ones could be made for an upside move with lowered implied volatilities. What's the conclusion? At least under the conditions that we've outlined here, with a trade established 35 days before expiration, with roughly equal margin requirements and with implied volatilities rising 2 percent as the RUT drops, the butterfly still starts going underwater sooner than the iron condor. If the RUT's drop were deeper, say to $665, the difference is theoretically even more pronounced, at least according to this software. Without adjustment, the butterfly would theoretically have lost about $2,050.93, and the iron condor, only $333.91.

Across shorter time periods and relatively smaller price moves, without adjustment, the losses are going to accumulate more quickly on the butterfly than the iron condor. That's definitely something to consider, but does that tell the entire story? Not by a long shot.

That phrase "without adjustment" is the key. Imagine that a butterfly trader wants to bring home 20 percent of the margin withheld as a profit target. That potential gain is often preserved through the first few butterfly adjustments, at least. Few iron condor traders are going to capture 20 percent of the margin withheld, at least with the type of iron condors in which we're selling options when the absolute values of their deltas are in the 8-10 range (or 0.08 to 0.10 at some brokerages). Once an adjustment is needed, the profit potential is almost always cut down, too.

Many years ago--probably about a decade ago, in truth--one of our writers said that we pay for the ability to trade both directions in options by accepting time decay. I would also say that we pay for the ability to use options in many different strategies by having to educate ourselves as to what happens with our trades under several conditions. The freeware I've used here is a bit clunky, and it's not what I use now for my day-to-day trading, but I did use it for a time. If I can learn to throw up these positions and vary time and volatilities to estimate how the positions would behave under different conditions, you can do it, too. With this freeware, you'd have to follow the paper trades through time, adjusting as needed, rather than back test, but it's still a great way to think about how you'd like to trade and which kinds of positions best work for you.

I have to offer a caution, however. These trades don't always work out the way the theoretical charts show they will. Also, particularly if you're trading iron condors with far OTM options and in positions established well ahead of expiration, you're going to see some crazy numbers on these theoretical charts as the trade unfolds. All it takes is a wacky unfilled order somewhere out in cyberspace for one contract of one of the options comprising your positions to mess up all the calculations for your trade. This is particularly true of SPX trades with their wide bid/ask spreads. If someone puts in an order at the midprice for one of your long calls, for example, that's going to lower the new midprice calculation. For example, I typically trade 25 contracts of SPX iron condors a month these days, although I've taken off trading this month due to some lifestyle issues. If someone puts in a wacky order that doesn't get filled, I often see periods when it looks as if my 25 contracts of long calls are suddenly worth maybe $0.20 less each, which translates into an instantaneous $0.20 x 100 multiplier x 25 contracts = $500.00 drop in the value of my iron condors. If that person pulls that contract, then the value of the position will jump up again. It can drive you batty and complicate some decisions if you're close to an adjustment level or maximum loss. This is another reason why it's a good idea to follow a number of these positions on a theoretical chart day to day, watching how they react. That precludes some panic on your part when you move to live trading.

Calculations such as these aren't necessary to trading, but they certainly can be helpful when you're making decisions about the strategies you'll employ.