Question about strike price distance between short put & call for a SPY or RUT iron condor option strategy

Question:   It seems that the inside short legs of the RUT iron condor that we opened for December span 20% (e.g. 790 short call and 660 short put). The % distance between the short legs for the SPY iron condor span only 12% (131 short call vs 117 short put), so theoretically one side of the SPY iron condor (i.e. one of the credit spreads)  is more likely to go ITM (in the money);  is this the case, for these alternative investments?

Response:  Here are a few things to think about as you trade options or learn how to trade options, and ponder the interrelations of the underlying index, implied volatility and strike price placement when you trade options on credit spreads and iron condors – for  these option trading strategies:

1)    Implied volatility of the underlying index is one of the values used to calculate the price and probability of an options leg expiring ITM (in the money) or OTM (out of the money)

2)    Implied volatility for the RUT (Russell 2000 index) is RVX, and as of this writing it’s around 36

3)    Implied volatility for the SPY (and ETF that tracks at 1/10th the value of the S&P 500 Index – SPX) is the VIX and it’s around 26

4)    Because the implied volatility for the RUT is higher, the RUT moves a larger % on a daily basis as compared to the avg % daily move of the SPY, so this is why we can get a larger % distance between our short calls and puts on the RUT when opening an iron condor – this option strategy

5)    The return on a RUT credit spread is calculated as follows, using the example of having $1000:  Let’s say we bring in 70 cents credit on the RUT Dec 640/650 bull put spread; this is a 10 point wide spread where each spread requires $1000 of maintenance; thus we are able to open qty 1 of this spread, and we bring in $70 of premium; our risk capital is $1000 – $70 = $930; our potential return on this trade is 70/930 = 7.5%;

6)    The return on a SPY credit spread is calculated as follows, using the example of having $1000:  Let’s say we bring in 13 cents credit on the SPY Dec 115/117 bull put spread; this is a 2 point wide spread, where each spread requires $200 of maintenance; thus we are able to open qty 5 of this spread, and we bring in $13 x 5 = $65 of premium; our risk capital is $1000 – $65 = $935; our potential return on this trade is 65/935 = 6.9%

7)    In general, the risk/reward nature of the majority of our credit spreads is the same, whether it’s a 10 point wide spread on the RUT (Russell 2000 Index), a 5 point wide spread on the MNX (NASDAQ 100 index) or a 2 point wide spread on the SPY (S&P 500 index) where each has an 87% to 91% probability of expiring OTM and profitable, the bottom bull put spreads bring in about 5% to 8% in 30 days or less, and the top bear call spreads bring in about 3.5% to 5.5% in 30 days or less.  As a result, when the bottom and top credit spreads are combined to create an iron condor, the overall potential ROI is about 8.5% to 13.5% in 30 days or less.

 

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