This article thoroughly analyzes the pros, cons and risk between 70% and 90% probability iron condors and credit spreads options.  It attempts to dispel possible misinformation in the marketplace about this options trading strategy, and it makes a case that 90% probability trades offer the best risk/reward tradeoff with the least amount of stress and work.

There are many options advisory newsletters on the market today that promote the iron condor & credit spread options trading strategy.  Iron Condor options are popular because they are relatively easy to understand, they don’t require options analysis software to visualize, and they generate an excellent monthly income of 6% to 10% ROI per month.   Most Index iron condor & credit spread newsletters that promote this options trading strategy fall into two camps, either recommending 70% probability trades or 90% probability trades.   Monthly Cash Thru Options primarily focuses on 90% probability trades because we believe this option trading system represents the best balance between risk and reward, and it provides an excellent 45% to 65% annual ROI.  Many competing iron condor newsletters that use the 70% probability option trading system will lead you to believe that their options trading system is superior and they usually simplify their argument by only focusing on the amount of risk capital per trade.  Our competitors also state that 90% probability iron condors represent a “high-risk, low-credit”  type of options trading strategy.  Reality is that both 70% trades and 90% trades will work, but one needs to dig deeper into the analysis of both approaches.  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 option trading system, attempts to dispel possible misinformation in the marketplace, and makes a case that 90% trades offer the best risk/reward tradeoff with the least amount of stress and work.

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…1) Probability of the credit spreads 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 iron condors 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 iron condors get into high danger requiring the trader to close out the trade 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 for this option trading system.  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 with this option trading system, 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 with this option trading system, 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 option trading system, 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, but the big difference is that the 70% trades come with higher volatility, stress, required work, and risk of getting hit with a big loss if the underlying security moves quickly.

From looking at the chart above, 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 prefer 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 option trading systems can work since they both return, at least over the long run, about the same ROI, but the 90% probability trades come with less volatility, stress, work, and less risk of taking a large loss if the underlying moves quickly.  Moreover, 90% probability trades are more hands-off, the trader will sleep better at night when the markets get volatile, and it’s a perfect strategy for people with a day job.  This is why Monthly Cash Thru Options primarily leverages 90% probability trades.

About The Author
Brad Reinard is Editor-in-Chief of Monthly Cash Thru Options LLC, a leading index credit spread & iron condor options advisory newsletter.   It’s track record is the following:  69% YTD 2009 (thru Aug); 33% 2008; 63% 2007; 42% 2006; 50% 2005.  For more information please visit www.monthlycashthruoptions.com or call Brad directly toll-free at 877-248-7455.  Monthly Cash Thru Options LLC is located in San Jose, California, the heart of Silicon Valley.

This case study analyzes and compares the credit spread option trading strategy of 1, 2, 3, 4, 5, 7 and 10 point credit spreads on the SPY.  The SPY is an ETF that tracks at 1/10th the value of the S&P 500 index.   We make the case that the 3 point credit spread is optimum and provides an excellent risk-adjusted return, minimizes the commission hit, it gives us flexibility to make adjustments when needed if the credit spread “get’s under pressure”, and it keeps the required maintenance level low enough to allow investors with different account sizes to participate in this option trading system.

Here are the assumptions used when making our calculations on this option trading system:
1) Commission = $1/options contract or $2/ credit spread. (we show additional commission rates in the spread sheet summary below)
2) $5000 of cash is available to open the spreads
3) The trade stays out-of-the-money (OTM) and profitable, and we let the spread expire worthless, which is 100% profitable for us, the seller.  Thus, we only pay commission to open the credit spreads and we call this “one-way” commissions. (in contrast to round-trip commissions where we pay to open and close the trades)
4) All spreads have 31 days until expiration
5) We simplify the number of spreads that we can open by dividing the available $5000 of cash by the required maintenance.

Below is the SPY Aug 89/90 option trading strategy bull put spread which has the following characteristics:

1) It’s a 1 point credit spread (i.e. 1 point between the sell leg and the buy leg)
2) Required maintenance by the broker is $100 per option spread (1 point spread * $100/point)
3) 50 credit spreads can be opened ($5000/$100 of required maintenance per spread)
4) Premium collected is $15 credit x 50 spreads = $750
5) Risk capital is $5000 in maintenance – $750 of premium collected = $4250
6) One-way commission at $1/contract is 50 spreads x $2/spread = $100.
7) Commission as a % of premium collected is 100/750 = 13.3%
8) ROI after one-way commission is (750-100)/4250 = 15.3% 

Below is the SPY Aug 88/90 option trading system bull put spread which has the following characteristics:

1) It’s a 2 point spread option (i.e. 2 points between the sell leg and the buy leg)
2) Required maintenance by the broker is $200 per spread (2 point spread * $100/point)
3) 25 credit spreads can be opened ($5000/$200 required maintenance per spread)
4) Premium collected is $25 credit x 25 spreads = $625
5) Risk capital is $5000 in maintenance – $625 of premium collected = $4375
6) One-way commission at $1/contract is 25 spreads x $2/spread = $50.
7) One-way Commission as a % of premium collected is 50/625 = 8%
8) Return for this option trading system after one-way commission is (625-50)/4375 = 13.1%

Below is the SPY Aug 87/90 option trading strategy bull put spread which has the following characteristics:

1) It’s a 3 point spread option
2) Required maintenance by the broker is $300 per spread option
3) 16  credit spreads can be opened ($5000/$300)
4) Premium collected is $35 credit x 16 spreads = $560
5) Risk capital is $5000 in maintenance – $560 of premium collected = $4440
6) One-way commission is 16 spreads x $2/spread = $32.
7) One-way commission as a % of premium collected is 32/560 = 5.7%
8) Return for this option trading strategy after one-way commission is (560 – 32)/4440 = 11.8%

Below is the SPY Aug 86/90 option trading system bull put spread which has the following characteristics:

1) It’s a 4 point spread
2) Required maintenance by the broker is $400 per credit spread
3) 12 credit spreads can be opened ($5000/$400)
4) Premium collected is $44 credit x 12 spreads = $528
5) Risk capital is $5000 in maintenance – $528 of premium collected = $4472
6) One-way commission is 12 spreads x $2/spread = $24.
7) One-way commission as a % of premium collected is 24/528 = 4.5%
8) Return for this option trading sytem after one-way commission is (528 – 24)/4472 = 11.2%

 Below is the SPY Aug 85/90 option trading strategy bull put spread with the following characteristics:
1) It’s a 5 point spread
2) Required maintenance by the broker is $500 per spread
3) 10 credit spreads can be opened
4) Premium collected is $50 credit x 10 spreads = $500
5) Risk capital is $5000 in maintenance – $500 of premium collected = $4500
6) One-way commission is 10 spreads x $2/spread = $20
7) One-way commission as a % of premium collected is 20/500 = 4%
8) Return for this option trading strategy after one-way commission is (500 – 20)/4500 = 10.6%

Below is the SPY Aug 83/90 option trading system bull put spread with the following characteristics:
1) It’s a 7 point spread
2) Required maintenance by the broker is $700 per spread
3) 7 credit spreads can be opened ($5000/$700 required maintenance per spread)
4) Premium collected is $58 credit x 7 spreads = $406
5) Risk capital is $5000 in maintenance – $406 of premium collected = $4594
6) One-way commission is 7 spreads x $2/spread = $14
7) One-way commission as a % of premium collected is 14/406 = 3.4%
8) Return for this option trading system after commission is (406 – 14)/4594 = 8.5%

Below is the SPY Aug 80/90 option trading strategy bull put spread with the following characteristics:
1) It’s a 10 point spread
2) Required maintenance by the broker is $1000 per spread
3) 5 credit spreads can be opened
4) Premium collected is $65 credit x 5 spreads = $325
5) Risk capital is $5000 in maintenance – $325 of premium collected = $4675
6) One-way commission is 5 spreads x $2/spread = $10
7) One-way commission as a % of premium collected is 10/325 = 3%
8) Return for this option trading strategy after one-way commission is (325 – 10)/4675 = 6.7%

Below is a grid that summarizes our analysis of this credit spreads option trading strategy.   For a larger view of this grid please visit the Monthly Cash Thru Options Learning Center at http://www.monthlycashthruoptions.com/LearningCenter.htm and read the entry “Why we usually open 3 point credit spreads on the SPY”.    If you would like access to this spreadsheet, please contact us at support@monthlycashthruoptions and we’ll forward it to you.

Conclusion:   From the analysis above, we like the 3 point option trading strategy spread where it gives us an excellent return, minimizes the commission hit, gives us flexibility to make adjustments when needed if it “gets under pressure”, and the required maintenance is low enough to allow investors with different account sizes to participate in the trade.  When we say that we need “flexibility” to make adjustments with this option trading system, when the spread gets under pressure from a fast moving underlying index (the SPY in this case) we implement the “stay ahead of the wave” strategy by “clicking-down” our strike price to move further away from the underlying index and we open more spreads to bring in more premium. If we use the 3 point spread we have the flexibility to “click-down” 3 times if needed. (in this case we are talking about the bottom, bull put spread) For example, let’s say we have a SPY 90/93 bull put spread and 10 days after we open this spread the SPY sells-off putting our 90/93 bull put spread “under pressure”. In this situation, we would not yet close-out the SPY 90/93 spread but we would watch it closely, and in parallel we would “stay ahead of the wave” and click-down a strike to the SPY 89/92 bull put spread (in the same month) and open some to continue to bring in premium. And if we need to click-down again, we have the flexibility to click-down one more time to the SPY 88/91 bull put spread to allow us to keep bringing in premium. If we need to click down even further, we won’t be able to open the SPY 87/90 bull put spread until we close-out the original SPY 90/93 bull put spread because the 90 strike overlaps and will cancel each other out; however, this is ok because if the underlying SPY is dropping this fast, and just by the fact that we’ve already clicked down 3 times, we probably will need to close out the original SPY 90/93 anyway to cut our losses and to minimize any further downside. With this said, and especially for bull put spreads, we would not engage in the “stay ahead of the wave” strategy unless the “market timing” indicators were giving us the green light that the economy and the market are “healthy” and therefore it’s ok to keep clicking down and bringing in premium.   For more on how we Market Time, please go to http://www.monthlycashthruoptions.com/WhyMarketTiming.htm.   For more on the “staying ahead of the wave strategy”, please read the entries “what if the market surges, how do we protect ourselves”? and “what if the market crashes, how do we protect ourselves?” in the MCTO Learning Center.

About The Author
Brad Reinard is Editor-in-Chief of Monthly Cash Thru Options LLC, a leading index credit spread & iron condor options advisory newsletter.   For more information please visit www.monthlycashthruoptions.com or call Brad directly toll-free at 877-248-7455.  Monthly Cash Thru Options LLC is located in San Jose, California, the heart of Silicon Valley.