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Consistent income trading options: Comparing widths of SPX ICs

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In our quest to understand trading options for income, we often consider further OTM (out of the money) ICs (iron condors) in the SPX. Would moving the short strikes further OTM to improve POP (probability of profit), while increasing the width of the spreads, improve our P&L? This article attempts to answer that question.

A vertical spread is comprised of two options within the same option chain (Weekly or Monthly) which are bought and sold concurrently. To form a credit spread (which brings money into your account), you sell one option with a strike that is closer to ATM while buying an option with a strike that is further OTM. A short IC (iron condor) is comprised of two OTM (out of the money) credit spreads.

To determine if a further OTM short IC is a viable strategy when the width of each spread is increased, Tasty Trade recently ran a test on the SPX over a 5-year period. The criteria was as follows: at the first trading day of each month (approximately 45 DTE, or days till expiration), purchase two SPX ICs; the first IC with a POP of 60% (short strikes located at 80% OTM) and a spread of $10, and the second IC with a POP of 80% (short strikes located at 90% OTM) and a spread of $20; the exit strategy of both ICs is 50% of premium earned, and held to expiration.

The results: when comparing the short strikes at 80% vs. 90%, the P&L for the 80% dramatically underperformed the 90% (-$5,131 vs. $3,129), even when managed at 50% of premium (-$25 vs. $2,152). The reduction in average premium of moving the short strike from 80% to 90% (and increasing the width from $10 to $20) was approximately 21.8% ($3.48 vs. $2.72).

In conclusion, moving the short strikes further OTM (from 80% to 90%) increased the IC POP (60% vs. 80%) and had a dramatic effect on the P&L and percent winners (54% vs. 87% when held till expiration; 74% vs. 92% when held till 50% of premium). Increasing the width of the spreads ($10 to $20) also increased the biggest loss (-$705 vs. -$1,843 when held till expiration; -$680 vs. -$1,843 when held till 50% of premium).

To put this in terms of SD (standard deviation), a 60% POP is approximately 0.77 SD; a 80% POP is 1.15 SD. We at Options Annex prefer IC POPs of 90% or better (1.5+ SDs) on the SPX.

When viewing the charts, it is clear that the greatest number of challenges occurred with the Call credit spread. This seems to indicated that the short strikes were determined by option chain skew and not by expected move (the SPX has an unusually large skew that favors the Put side).

It would be interesting to determine the impact on P&L if the ICs were pushed further OTM to 1.5 SD and 2 SD while increasing the spread to $25 and $30 respectively.

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.