Saturday, March 23, 2013

Selecting single wing strike price distances for iron condors

When selling option premium with iron condor spreads, it's usually true that the wider the distance of strike prices of either wing (one side of the spread), the lower the return on margin, if the sold option strike is fixed. It's understandable since wider strike distance of a single wind means wider break-even points, or high probability of success.

If we want to use a similar amount of margin for IC spreads, we face a selection of  wider single wing strikes like $20 apart or narrower strikes like $5 for $SPX/$RUT iron condors. With narrower single wing strikes, we need to sell more contracts to reach the same level of margin.

I guess the answer depends, mainly, on whether we need wider break-even points or not. The commission costs and transaction costs are less important in making the decision here usually. If we sell far OTM iron condors with 80% or better probability of success, and our adjustment strategy involves closing (or rolling) the IC once the position has certain degree of damage, we could probably choose narrower single wing strikes ($5) for higher ROM.

On the other hand, if the short strike of the IC is sold less OTM as in the above case, the success probability will be lower. So, we may create a little bit more wiggle room with a wider single wing strike distance ($20). Additionally, if we'd like to hedge against damaging IC positions without closing (some times called rolling) the wings, it would worth having larger BE points with less ROM. This is what I usually do. One of my current SPX April IC has a short $1555 call with a upper BE around $1561. It's damaged modestly as $SPX is at $1557 and hedged by some calendars right now. The damage would be bigger if I used narrower single wing strikes with higher ROM.

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