condor’s expiring profitable, but there are a few adjustments that need to be
made.
First, because with an iron condor the idea is to profit from net short
option premium, it usually makes more sense to sell shorter-term options to
profit from higher rates of time decay. This entails trading condors
composed of one- or two-month options. The IV needs to be deannualized
and converted to represent the standard deviation of the underlying at
expiration.
The first step is to compute the one-day standard deviation. This is found
by dividing the implied volatility by the square root of the number of
trading days in a year, then multiplying by the square root of the number of
trading days until expiration. The result is the standard deviation (σ) at the
time of expiration stated as a percent. Next, multiply that percentage by the
price of the underlying to get the standard deviation in absolute terms.
The formula 2 for calculating the shorter-term standard deviation is as
follows:
This value will be added to or subtracted from the price of the underlying
to get the price points at which the approximate standard deviations fall.
Consider an example using options on the Standard & Poor’s 500 Index
(SPX). With 50 days until expiration, the SPX is at 1241 and the implied
volatility is 23.2 percent. To find strike prices that are one standard
deviation away from the current index price, we need to enter the values
into the equation. We first need to know how many actual trading days are
in the 50-day period. There are 35 business days during this particular 50-
day period (there is one holiday and seven weekend days). We now have all
the data we need to calculate which strikes to sell.
The lower standard deviation is 1134.55 (1241 − 106.45) and the upper is
1347.45 (1241 + 106.45). This means there would be about a 68 percent
chance of SPX ending up between 1134.55 and 1347.45 at expiration. In
this example, to have about a two-thirds chance of success, one would sell
the 1135 puts and the 1350 calls as part of the iron condor.