Condor Options

You might say that the three key components of any options trade are time, price and volatility. That is to say: the time left until those options expire, the price of the underlying, and the volatility implied in the options prices. It’s easy to forget that last component, and sometimes people don’t take implied volatility into consideration when opening trades. But it’s an absolutely essential factor to consider. Here’s an example.

We have an open position in IWM in our newsletter. We opened it for a credit of $0.57, but now if you wanted to enter that same position, you’d only get a credit of about $0.38. In other words, we’ve already realized a paper gain of about 13% on this trade. So, how did the price change so quickly, and which of those three components is responsible?

It’s not time, that’s for sure: we opened the trade back on February 5, so only 10 days have passed, and there are still 36 days until March expiration. Theta doesn’t really start kicking in for a few weeks yet.

It’s not price, that’s for sure, too: when we opened the position, IWM was trading around 70.50 – 71.00. Right now (intraday), IWM is at 71.26, so it’s not like the underlying has moved significantly enough to affect the price. The delta of this position is still pretty neutral.

What has changed is the volatility environment since the trade began. Since we opened our trade, RVX (the VIX equivalent for the Russell 2000) has fallen about 3 points, and the implied volatility in the ATM March IWM options has fallen over 4%. While that may not sound like a lot, what happens when the volatility turns down – especially when it was sitting at recent highs (see chart) – is that the premium in those near month options can get hit fairly hard. That’s why it’s often a good idea to enter trades when IV is higher than normal; conversely, it makes you more hesitant on days like yesterday, when all the volatility indexes (VIX, VXN, RVX, etc.) are at or below their 50 day moving averages.

Volatility matters!

[tags] options, trading, iron condor, volatility, implied volatility, vega, theta, IWM, RVX, VXN, VIX [/tags]