While doing some research on how to sell Iron Condor in a low volatility environment, I came across to a video that talks about time decay made by Tastytrade.
The image below is taken from the video and it shows Theta (time decay) against Days to Expiration (DTE).
When it’s 75 DTE, 90% Out of the Money (OTM) trade has about 1.25 Theta, 70% OTM trade has 2.25 Theta, and At the Money (ATM) trade has 2.75 Theta.
Higher the Theta, faster the time value decay. So the reason TastyTrade is an advocate of trading 45 DTE options, is because Theta gets a little boost around that point.
However, what I noticed is the rate of decay for longer DTE trades. Why not trade 75 DTE options and get out around 30 days to expiration? The trade duration would be around the same of about 30 days. So I decided to conduct an experiment with SPX.
SPX Iron Condor Trade Setup
The key idea of this trade setup is to benefit from the time value. The focus will be options with 45 DTE and longer up to 140 DTE. We will sell delta 25-20 on the Call side and sell delta 20-15 on the Put side to create an Iron Condor.
Based on my initial observation, increase in volatility has a very little effect on the value of these long time horizon options. In other words we will not time the purchase based on Implied Volatility (IV). Even if the volatility is low, we will still go ahead and sell the options.
The table below summarizes the options traded.
The Initial Results
June options (less than 60 days to expiration)
In this experiment, I sold two Jun expiration SPX Iron Condor positions. One with 56 days to expiration and the other 29 days.
The result was terrible despite I got into the positions at 30% IV, which is considered pretty high these days as most of the time it is around 10% or less. Another potential reason for the lost was I set the exit point at 50%. What I realized was that even if I exit at only 35% of the maximum profit, I could still make almost 20% return of the money risked for the trade (shown in the “Lose” column, $960 and $990).
Overall, short duration trade is not worth the risk considering even when setting up the trade with high IV % and low delta, there just isn’t enough room for errors when the market is trending.
July options (less than 80 days to expiration)
When I increased the time to expiration by selling July expiration SPX Iron Condor, the result was much better. I actually adjusted the exit at 25% of the maximum profit because I did not want to repeat what I did with the June options.
The profit was only about 10% return of the money risked but considering the trade duration was about 50 days, when annualized it, 365 days /50 days =7 times.
In other words, I could potentially repeat this 7 times and make 10% return of the money risked each time, so 70% return annualized if no lost was encountered.
August options (less than 110 days to expiration)
This strategy seems promising as I managed to get out one position at 35% of maximum return after about 60 days of trade duration. This translates to about 20% return of the money risked. When looking at PNL / day, it has 6.17, which is much higher than what I got with July options.
When annualize it, 365 days / 60 days = 6 time. So if I manage to close the position every time at 20% return of the money risked, 6 x 20% = 120% annual return if no lost was encountered.
Considering the other position is still open, it could potentially take more than 60 days to close, but even if I manage to only trade 4 times in a year, 4 x 20% is still 80% return. Better than the July options trade.
September options (less than 140 days to expiration)
I was positively surprised at the results. I actually managed to close two positions at around 60 days or less at 35% maximum profit, despite that these options have much more time value left.
It clearly show the IV% is irrelevant when dealing with a longer duration options. What we are selling is almost solely time value. However, what I like about this strategy is the safety. By going out more with time duration, I managed to get options that are far out of money with the same delta number (see the summary table of the SPX options traded above).
Since I still have two options open, the trade duration may be longer than what I would like. Also the return is less than 20% of the money risked. Assuming I could only do such trade for only 4 times a year, 4 x 15% = 60%.
Based on the results, it seems trading options with about 100 days to expiration could be a good strategy. We essentially capture the fast rate of time decay up till around 40 days to expiration.
This would be an ideal strategy for IRA accounts due its limited margin requirements. If managed correctly, it should give a pretty good annualized return.