There are many index iron condor & credit spread options advisory newsletters on the market today.  The index iron condor options strategy is popular because it’s relatively easy to understand, it doesn’t require options analysis software to visualize the trade, and it generates an excellent monthly income of 6% to 10% ROI per month.  Most iron condor newsletters fall into two camps, either recommending 70% probability trades or 90% probability trades.   A few of the more visible iron condor newsletters have simplified their argument of why one approach is superior to the other, for example by only focusing on the amount of risk capital per trade.   This article proposes a more thorough methodology to analyze the risk associated with 70% probability iron condors versus 90% probability iron condors, discusses the pros and cons of each approach, and attempts to dispel possible misinformation in the marketplace.

When defining “risk” for credit spreads and iron condors options, most experienced credit spread traders will agree that risk comprises many components.   Two of the more important components are the following:  1) Probability of the credit spread going in-the-money (ITM);  and  2)  The risk versus potential reward of the trade.   Additional risk related factors that should be included and that many times are omitted are the following:  3) The amount of time and effort required to monitor and manage the trades;   4) The amount of time available to react to a fast moving underlying security giving the trader sufficient time to make adjustments if needed;  5) The average number of times per year the trades get into moderate danger, that is they get close to going ITM, causing stress and uncertainty for the trader;  6) The average number of times per year that the spreads get into high danger requiring the trader to close out the spread or make adjustments, causing a losing month;  and 7) The average % loss for each of the losing months per year.

Using an example of a 10 point spread, and doing an apples-to-apples comparison by analyzing a single credit spread, let’s look at both a 70% probability trade and a 90% probability trade in more detail.  The 1.3 standard deviation, or 90% probability credit spread has a 9 to 1 ratio where the trade risks $9 to make $1, it shoots for an approximate 11% return, it has a 90% probability of expiring OTM and profitable, and has a 10% probability of getting into trouble and going ITM.   The 1.0 standard deviation, or approximate 70% probability credit spread has an 8 to 2 ratio where the trade risks $8 to make $2, it shoots for an approximate 25% return, it has a 70% probability of expiring OTM and profitable, and has a 30% probability of getting into trouble and going ITM.

In order to analyze these two scenarios in more detail, we need to take into account the additional risk related components that we discussed above.  From data that we’ve extracted from several iron condor services, and through our own experiences of trading both types of iron condors, we’ve observed the following:

90% probability iron condors tend to have on average 9 to 10 profitable months/year, and 2 to 3 losing months/year with typical losses of 10% or less.  Per the level of workload and stress involved, 90% probability trades tend to have 6 months of low stress where they make easy money, 3 to 4 months of moderate stress where no adjustments are required but some of the spreads get under pressure and have to be watched closely, and 2 to 3 months of higher stress and workload where they will have a loss and adjustments are required to keep the loss below 10%.

70% probability credit spreads tend to have on average 7 to 8 profitable months/year, and 4 to 5 losing months/year with losses usually 10% or less.  Per the level of workload and stress involved, 70% probability trades tend to have 3 months of low stress where they make easy money, 4 to 5 months of moderate stress where no adjustments are required but some of the spreads get under pressure and have to be watch closely, and 4 to 5 months of high stress and workload where they will have a loss, and adjustments are required to keep the loss below 10%.

Below is a grid that summarizes the characteristics of each approach, and one might come to the conclusion that both strategies can work.  In actuality, both strategies can work and each strategy returns about the same annual returns, over the long run, one with just more volatility than the other.

Some traders prefer the 70% probability iron condors, that comprise both a bear call spread and bull put spread, that shoot for a 25% to 40% return in 30 to 45 days and they accept the fact that:  1) There is about a 40% probability, or about 4 to 5 months/year that their iron condor will get under pressure causing a moderate level of stress and requiring additional time to watch the trade closely;  2) They accept the fact that there is a 30% probability, or about 4 to 5 months/year that their iron condor will get into high danger by a quick moving underlying index resulting in a high level of stress and a higher work load to make adjustments to minimize the loss for the month;  3) And investors that embrace 70% probability iron condors are ok with the fact that because of the higher probability of the iron condor going ITM causing a large loss, they should allocate no more than 5% of their portfolio to any single trade.  As a result, the trader will need to spend time researching and opening additional, non-related trades to put their available capital to work.

In contrast, some traders like the 90% probability iron condors that shoot for a 10 to 15% return in 30 to 45 days and they like the fact that:  1) There is a high, 90% probability that the iron condor will expire OTM and profitable, and as a result there is less work & time involved, it’s more hands-off, the trader sleeps better at night when the market gets volatile, and it’s a good fit for people with a day job;   2) There is low stress about 6 months per year when the 90% probability trades generate “easy money”;   3) Traders that embrace 90% probability iron condors accept the fact that there is about a 20% probability, or about 3 to 4 months/year that their iron condor will get under pressure causing a moderate level of stress and requiring additional time to watch the trade closely;  4) There is a 10% probability, or about 2 to 3 months/year that the iron condor will get into high danger by a quick moving underlying index resulting in a higher level of stress and workload to make adjustments to minimize the loss for the month;  and finally… 5) The experienced traders that have 2+ years of experience with index credit spreads & iron condors can leverage 90% probability trades to allocate up to 75% of their portfolio into this single strategy where they don’t have to trade any other strategies if they don’t desire or have the time.

In summary, both strategies can work since they both return, at least over the long run, about the same ROI.  As a result, the best strategy boils down to a trader’s risk profile, personality, ability to handle stress, and the amount of time and effort that they are willing or able to dedicate to the index credit spread & iron condor strategy.

Brad Reinard is Editor-in-Chief of Monthly Cash Thru Options, an index iron condor & credit spread options advisory and educational newsletter.  For more information about the service and track record please visit www.monthlycashthruoptions.com.