Iron Condor – Set it and Forget it?

Continuing our discussion of iron condors, I want to calculate the expected return from mechanically trading it. No adjustment.

The Russell 2000, RUT, closed yesterday at 604.28. So we could sell the Nov 650 call and buy the Nov 660 call; and sell the Nov 550 put and buy the Nov 540 put.

Call Spread

Conservatively, we would sell at the bid and buy at the offer. We might do better, but in that case, we would have (7.7 – 5.9) * $100 = $180 deposited in our account for each spread. What is our expected return?

If the probability to close above 650 is 18.4%, then the probability to close below 650 is 100 – 18.4 = 81.6%.

The Monte Carlo calculation says that RUT will close above our higher strike, 660, 14.4% of the time.

So our expected return, not even worrying about closing between 650 and 660 is $180 * 81.6% – $1,000 * 14.4% – loss inside (650, 660) – transaction costs = $146.88 – $144 – other costs. So this is not a good strategy. It has a negative expected return.

Put Spread

Doing the same thing for the 550 / 540 put spread. The premium is 10 – 8.9 = 1.1 or $110 per spread.

The probability for the put spread to expire worthless is 100 – 13 = 87% and the probability for maximum loss is 8.9%. So the expected return is less than $110 * 87% – $1,000 * 8.9% = $87 – $89 = -$2.

Iron Condor

Now to combine the two spreads. The probability for RUT to end up between the inner strikes so that all the options expire worthless is 100% – 18.4 %- 13% = 68.6%. Reading off the probabilities from the table above.

So the expected value of the condor is less than ($180 + $110) * 68.6% – $1,000 * 14.4% – $1,000 * 8.9% =  $198.94 – $144 – $89 =  -$34
Next we’ll look at adjusting and see how that might help.