Recently, an active trader mentioned that he had run some iron condor back tests, testing six different time frames for entry. Those tests included everything from 24 days before expiration to 80 days before expiration.

Why might that trader be considering such different time frames?

Comparison of Time Decay versus Time before Expiration in At-the-Money, Out-of-the-Money and In-the-Money Calls, from Trading Options as a Professional, James Bittman, page 63:

If an option trader prefers iron condors, the main point of the trade's construction is to sell options, often far out-of-the-money (OTM) options hedged with further OTM long options. This is primarily, then, a trade in which options are being sold and premium collected. The long options are just hedges. The seller wants to see option decay happen as quickly as possible, then. The center chart shows how OTM options (or at least calls) decay. The shape of the chart shows that decay is actually quite sharp and steady from about 90 days to 30 days to expiration, depicted by an almost straight line with a steady slope. After that point, the line begins to flatten: the slant of the line is not as sharp, and the decay is not as fast.

I've quoted Bittman previously in reference to this phenomenon. This evidence and other evidence leads Bittman to suggest an alternative strategy to selling one-month OTM options in options trades that are primarily selling strategies. He believes that "under certain circumstances, selling a two-month option, covering it one month before expiration, and then selling the next two-month option can bring in more time premium than selling one-month options every month" (67). In other words, if you're selling options that are at least 5 to 10 percent out of the money when constructing your iron condors, it may be preferable to open that trade at least 60 days to expiration, closing it at around 30 days to expiration, rather than opening it at 30 days to expiration and letting it run into expiration. Of course, market conditions can change, and generalities don't always play out as expected. Always test these conclusions for yourself.

What if you prefer the iron butterfly, a scrunched-together iron condor, with both the sold put and the sold call at or near the money? The top chart shows that price decay behaves differently for at-the-money options (ATM). Decay is steady until about 25-30 days to expiration, and then it steepens. For those whose complex strategies involve selling at-the-money options, opening the trade closer to 30 days to expiration might make more sense than opening it around 60 days to expiration, although that would also depend on how the trade is managed.

What if implied volatilities are particularly low and the trader has to enter iron condors well before expiration in order to get enough premium to make the risk worthwhile? Selling the OTM options utilized by many iron condor traders would suggest that the decay would happen at about the same rate from 90 days-to-expiration as it does from 60 days-to-expiration, although the trade is exposed to more risk from economic or geopolitical developments, heightening the volatility risks, too. I personally didn't use to like quite that much time and event exposure when I was trading iron condors, but I did occasionally open trades in the 72-80 days-to-expiration time frame.

Why else would a trader be back testing different time frames? Let's take my likes and dislikes as an example. I personally dislike being in the market the week of ADP and non-farm payrolls announcements. Very little premium decay happens that entire week until after the Friday release of non-farm payrolls, at which time the hapless trader is exposed to price movement risk due to the reaction to those numbers. Is it possible to devise a DTE entry that would allow the trader to exit before the week of non-farm payrolls and make a profit over a year's time? I would have to back test that new entry time to have a good grasp of whether that is possible or not. If I didn't have the possibility of back testing, I could either simulate trades through various cycles, utilize smaller size RUT trades, switch my RUT trades to IWM ones for less risk while I tested a new entry time with live trades.

The iron condor trader who is used to entering a trade 70-80 DTE might find that watching profit accrue on her ATM butterfly entered that far before expiration is like the proverbial task of watching grass grow. That trader might not want to choose the same time of entry for all types of trades.

The take-away point is that different options decay differently. Your trade will behave differently with response to days before expiration, depending on how it's constructed and how it's managed. You don't have to be able to quote Augen's books or even Bittman's to be able to function as a trader, but you do need to be aware that differences exist, and the time frame you used for your iron condors in low-volatility times might not be right for your ATM butterflies in high-volatility environments. If you have the ability to back test, test your trade at different entry times. If you don't have the ability to back test, employ your trading platform's simulated trades or CBOE's free ones to test trades entered in several different time frames or scale your trade size back to test live trades, if that's your preference.

Linda Piazza