A Quiz: The Secret Directional Bias of Condors
Wed, Oct 17, 2007 | Jared
Is the following argument sound?
- Volatility is not price-agnostic: it tends to decrease when prices go up, and increases when prices go down, generally speaking.
- So being long (short) volatility has a slightly bearish (bullish) bias.
- Iron condors are always short vega, which means they are short volatility.
- // Therefore, iron condors are always implicitly bullish.
Discuss. Comments are turned on for this one, and we’ll reward any analytic brilliance with a free month’s membership!
[tags] iron condor, options trading, volatility, bearish, bullish, quiz[/tags]
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October 17th, 2007 at 12:24 am
this is just a guess.
1. Volatility increases when prices go up and down, and decreases when prices do not go up and down.
2. Iron Condors are not implicity bullish. Rather, they are implicitly neutral.
4. Vega is decay in the underlying through the passage of time. But you certainly want to sell (be short) volatility becaue higher volatility means higher premiums and thats the whole point of Iron Condors, which is to sell as much premium as you possibly can.
October 17th, 2007 at 1:02 am
I agree with Kevin on 1 through 3. However, Vega does not measure time decay. That is Theta. Vega measures the option’s premium in relation to the underlying’s changes in volatility. Vega is always positive, so a condor can’t be short Vega.
October 17th, 2007 at 1:20 am
I don’t agree with the statement that iron condors are implicitly bullish.
In your statement, you have discussed the impact of volatility (vega) but other greeks (delta, gamma, theta) have been ignored. Just as an example, an iron condor has a positive theta which offsets the effect of volatility to a certain degree.
Before deciding whether a strategy is implicitly bullish or bearish, we need to consider the effect of all the greeks and their impact on each other.
- Vikas
October 17th, 2007 at 1:30 am
The argument is as sound as a swiss made hang durm. Volatility is directly linked upon price action (of the underlying) and therefore cannot afford to be an athiest towards price. In options trading there is a godhead: 1. The Father (the stock) 2. The Son (the option) and 3. Holy Volatility.
One would think that buying calls at a seeming market bottom to grind higher would be wise…but they are loaded with volatility and thus are high in premiums. Meaning that as market sentiment turns as prices climb up…all the volatility evaporates and the options you bought barely move up! The fact is that the up move was already factored in! So, per argument number 2. long volatility means a bearish bias.
Then, we add another member to the godhead…the blessed mother….VEGA (or the cage fighter from Street Fighter 2)
Vega is the move on the options price due to a change in volatility…meaning vega is proportional to volatility and not price as much because the expected volatility can change while price remains constant. However, vega falls as the option gets closer to maturity…and iron condors want that because we try to hold till the end and thus we want to be short that vega.
So, Short Iron Condors ARE Bullish on implied volatility because we are hopefully buying when volatility is LOW and the market has topped…so we pray the market rosary that prices don’t fly…
I am I right? If not then I am Freakin’ confused and will definately need this account to be “autotraded.”
October 17th, 2007 at 2:52 am
The argument is sound. Prices go down more violently than they go up therefore volatility increases. I guess iron condors would favor a bullish market, so your statement that iron condors are bullish would have to be right.
October 17th, 2007 at 3:31 am
I would say it depends. My thinking is that delta is more powerfull than vega, so a large up move will certainly override vol decrease and produce loss.
October 17th, 2007 at 5:07 am
iron condors are directionally neutral not bullish as stated in your line 4 because your line 2 is backwards…long options have positive vega (short=negative) therefore more volatility helps buyers and hurts sellers however since I.C. are both buyers & sellers, technically they cancel, hence market neutral, not bullish…
October 17th, 2007 at 6:26 am
1 is sound but the heck with vega! The condor is DELTA neutral and therefore a neutral strategy…neither bullish nor bearish best used in sideways markets.
October 17th, 2007 at 7:36 am
I tend to buy this argument, but there are several caveats that seem to make it a moot point:
1) If you plan to hold your position until expiration (or close to it, as we do), the bias in implied volatility doesn’t really matter. If the stock price is between your short strikes at expiration, VIX could have moved up from 20 to 50 and you still earn your full premium. Of course, it would not be a fun ride!
2) You can tweak your initial position to counter the implied bias in any direction you want. If SPY is at 154, and you’re worried about the implied bias with short strikes at 150 & 158, you could use 149 & 157, for example.
3) If the price quickly drops toward your short put and implied volatility has spiked to a level that you believe to be unreasonably high…well then it’s time to sell more iron condors. While you’re probably losing money on your initial position, the opportunity to make an unusually high premium on the second position can help make up the difference (as long as IV doesn’t continue to spike up). Basically, you’re switching to a position with higher downside potential, but a higher P(win). So here, you don’t really mind so much if the underlying drops quickly; in other words, you’re not necessarily in an implied bullish position, praying for the market to move up so IV will go down. (The argument doesn’t work as well if the price spikes toward the short call, because implied volatility has probably dropped, but it worked pretty well for us this past month.)
October 17th, 2007 at 8:32 am
1. An Iron Condor is not bullish, but has a greater chance of realizing pre-expiration profitability in a bull market if the spread is initially established with each leg equidistant from the underlying asset’s market price at that time.
2. An Iron Condor writer who seeks a more “price-agnosticism” would adjust for the Vega skew by selling the Put spread must be farther out of the money than the Call spread.
October 17th, 2007 at 8:36 am
The first statement will be dependent on where the market views the most risk. This view of volatility increasing as prices go down dates back to Black Monday, the 1987 stock mnarket crash. Since tnen in the Stock Market there tends to be a tendency for volatility to increase if there is a dowmward bias.
Recently there have been instances where the OIH has seen an increase in volatility when risk was perceived on the upside. This type of behaviour can also be seen in commodity markets.
Iron Condors are implicitly short vega, i.e taking a view that volatility within the time period specified will decrease.
Volatility does tend to deacrease with time to expiry, however, gamma can still rear its ugly head to give you a good kicking, which is why is generally advisable to get out of your condor positions by the friday before expiry week.
Volatility is price agnostic, it is more dependent on where the risk is perceived, which could be either up or down.
Iron condors are therefore neither bullish nor bearish as regards price, but more a view on the expected level of volatility within a specified time period.
October 17th, 2007 at 8:44 am
Mostly correct except for the key point. A condor perfectly centered around the market will have a slight bearish bias. I don’t think it has to do with volatility, although condors absolutely have negative vega and negative theta (decay accrues to the condor holder).
If you have a not too far from the money condor, you will profit if the market falls, even if the market takes you past your short put strike. Interesting to me is that you still have positive theta past the short strikes. But I’m not giving away any more secrets today!
October 17th, 2007 at 9:59 am
Wow, you guys are full of interesting opinions!
I’m working on our first November trade at the moment, but will try to come back and answer some of these comments later today.
October 17th, 2007 at 11:13 am
can close out the short & just be long.
October 17th, 2007 at 12:45 pm
First, about volatility:
-Real vol doesn’t matter as much as implied vol
-IV is driven by market sentiment, which is why “volatility” goes up when traders perceive high risk (generally when the market is going down).
-However, I’ve observed that the IV on calls may climb (as put volatility drops) if the market is driving higher, because of the higher demand for bullish positions.
Therefore, with an Iron Condor, being short vega can hurt you on the up side as well as the down side. Moreover, I’ve found that, especially near expiration, IV is skewed toward the lower-strike (short) call when the underlying is near or slightly in the money. I’m sure the corresponding conditions apply on the put side too, but the fear level during a correction outweighs bull-market greed, so I have the impression that volatility *skew* on puts isn’t as large (i.e., the lower-strike, long put trades at almost as high IV as the short put) when the market is correcting.
Another point, which I believe others have made, is that you get *some* benefit from the higher vol, because it pushes up your long positions (just not as much as the short ones).
Now for delta:
Even though, on paper, an Iron Condor is delta-neutral, the strategy is, in delta terms, bearish, because of the bullish bias of the market. The market tends, in the long run, to climb 0.6% to 0.7% per month, so if you position your condor “neutral”, you are actually net bearish.
On the other side, when the market does correct, the drops, especially serious ones, often happen very suddenly. So even though your average risk on the put spread is less, because of the market’s bullish bias, you can get burned suddenly, with little or no chance to get out, if there is a crash.
So, especially in a bull market, an Iron Condor, if centered around current price, is inherently bearish (trust me, I know–I’ve been burned on the call side far, far more often than on the puts); however, the downside risk in a strong correction or crash is substantial as well.
So, considering everything above, I’d say that, regardless of theoretical vega, the Iron Condor is slightly bearish–unless you adjust by skewing your strikes higher than center, but then you increase your downside risk if a correction happens, so I generally don’t do this. Which leads me to an entirely new thought:
Maybe the word “bearish” is misleading in this case, because if we set our short strikes at the outer edge of the market’s likely course, up or down, then we’re only slightly more bearish than the most fanatical bulls–and, slightly more bullish than the most fearful bears. So is that “neutral”?
October 18th, 2007 at 10:16 pm
1. Volatility increase if there is a spike on price.other words go up and down dramatically.
2. Yes if the market trend was bullish.
3. Agree. In Bullish trend when the price go down quite big, time to make bull put spead
4. Neutral is the most profitable.Bullish may harm the position.
4.
October 19th, 2007 at 1:44 am
One simple rule. Vega is the highest near the current stock price. So volatility has the greatest effect in ATM options. As to why iron condors had negative vegas, thats bcos the sold calls/puts are always closer to ATM than the bought calls/puts.
I agree that vega had a slight effect but in my opinion, delta is still the killer here. Reason being, for 1 point rise in volatility, the sold option became pricer by vega but the delta will have already caused even much more damage to the sold position.
October 19th, 2007 at 10:29 pm
I am going to add to my previous answer by saying that while I agree that all of these Greeks, volatility (both real and implied) and all of these other fancy measurements are very interesting, they don’t take the place of the thing I care about the most, and that is the price action of the underlying. If you want to call it delta, or theta, or vega, or green cheese, thats fine with me. All I really care about is that the price of that underlying ends up between my two short position strike prices in the Iron Condor. You can define it all you want, analyze is all you want, talk about it until your blue in the face. I just want the price to settle between the two short strikes and I am happy!!!!!
April 4th, 2008 at 1:23 am
The argument that iron condor’s have a slight bullish bias is sound. Effective portfolio risk management often calls for placing a calendar below or near the short put strikes on the condor in the event that there is a sudden spike in volatility. Because markets generally don’t crash to the upside, a calendar on the short call strikes is not necessary — a move to the upside could be offset by a decline in IV. In my practice, I generally look to place one calendar spread for a 5 lot condor and that suffices, but a discretionary decision can be made based on the greeks to place the calendar further OTM or further ATM depending on time to expiration and other situations.