I want to share with you today is really some insight on a question somebody had.
It is about spreads.
Wouldn’t a spread be better like a vertical spread rather than an iron condor because an iron contrast risks in both directions?
You can get in little trouble on both sides. Whereas a vertical, you got risks in a single direction.
Here’s the question from Sam Allen:
when you look at an iron condor:
If you go over the X mark (from image), you’re in trouble. A spread loses money only if the stock moves in one direction.
My answer is — iron condor has a faster theta decay. Wouldn’t that make the iron condor better? Not really. Neither is better. It really comes down to the pros and cons you want.
So I think it’s important to understand that some people think which strategy is better.
Is that strategy better than that strategy?
Not one strategy is better than another strategy. It’s just that certain strategies have different types of risks involved or different kinds of pros and cons.
Here is a spread, let’s say we sell a vertical on Facebook.
We look to this vertical and I go from 160. Here I’ve got my vertical and I could bring it in a little bit, let’s say 210 and 180.
Wouldn’t this spread be better because I got no risk on the upside? But I’ve got downside risk.
Wouldn’t that make this better? Well, YES and NO.
Now you’ve got a further increased downside risk. Why?
You’ve got a 13 delta.
So as this pulls back, that means you’re losing 13 for every dollar move to the up to the downside.
Why wouldn’t I reduce this? Now I don’t have the pricing problem.
Now I’ve got a negative one delta. So I don’t mind if the stock stand still.
You’re thinking, what if it just goes up? Well that’s a risk there.
Why couldn’t I have more contracts on one side versus the other? You could do that.
What’s the advantage to doing an iron condor? Look at my theta my time decay I’ve got 9. Whereas, if I just do the vertical I’ve got 4.
I got twice almost twice the time decay if I do an iron condor.
So it’s a trade-off. You are limited.
You have risks in both direction But you’ve got a faster theta. You could get out of this trade faster so you could be in the trade a lot less and get out.
I could have put a little more capital in one area, let’s say the puts and less capital in the other.
If you still wanted more upside room or exposure or vice versa if you want a downside.
But in this case ,if I wanted some upside exposure and a less of a double area problem, meaning on the calls and the puts problem
I could just reduce my risk in one of the directions and have still increase my amount of contracts.
But again, you’re ramping up your delta.
So now If increase the verticals here on the call side, I could reduce my deltas.
It’s all really just about which one is better than the other. It’s not that a single vertical is better because it only has risks in one direction. That’s not the case. Yeah it’s true that it might be better from that standpoint,
But what’s the trade-off?
The trade-off is, you’re making less on a time basis.
Look at the margin requirements. So let’s say I just do one contract
You’re using more capital in a way to put on a vertical, why?
If I put on a single contract, I’m using 2619 dollars.
If I put on another vertical over here, I’m using 2664 dollars.
Now together, I want you to realize that I’m using this single vertical put spread.
Think about it.
Now I put the other one, I’m using less capital.
Less money to potentially make 717 dollars versus with just the vertical, you make 381 dollars. So you’re able to make more, using less money and you have a faster theta.
If you’re doing an iron condor you have a faster theta. The downside is, you have risks in both sides instead of one.
There is a little trade-off but it doesn’t mean that one is better than the other. I can make the counter argument there that this is better.
Well, yeah, use more capital but you don’t have the risk in this direction.
So it really just depends on the pros and cons. It’s not that one trade is better than the other.
It depends on what you’re trying to do and where does that trade fit. This one has a faster delta to the upside.
So if this pops and heads higher, you could take this trade off very quickly. On the other hand, if this pops you can’t take the trade off very quickly
So there is a trade-off.
It’s not that one is better, it’s just which advantage and disadvantage do you want to deal with.