Quant Analysis: Iron Condor Back Testing Results – Part 1

Iron Condors are one of our favourite options strategies and popular amongst experienced options traders but we recently decided to look at ways of optimising results our LITT trading system.

Iron Condors are one of our favourite options strategies and popular amongst experienced options traders. So, recently we decided to backtest the numbers and look for ways to optimise the results of our LITT trading system.

About 6 months ago we created a number of hypotheses we wanted to test. Our quantitative analysts have been automating our rules and processes to brute force these tests.

To give you a sense of the scale of this number crunching, to test one idea over 50 stocks takes about 8 hours to run. That’s not including our hands-on analysis of those results. Our Quant analyst, Jahan, has been working with Ivan on this project for several months and below are some of our initial findings.

The Tests – Iron Condor strategies on every asset tradeable over 36 months with no active management.

Why Iron Condors?

A lot of traders spend a large amount of time looking for trades that profit if a stock is going up or going down, but by using Iron Condors you can trade when you believe the stock is doing nothing and moving sideways. They allow you to trade with a neutral view, which provides limited risk and a higher relative probability of success.

Iron Condors are a market-neutral strategy and the Australian market in comparison to the rest of the world is also considered fairly neutral, so it makes sense to put the two together.

Don’t know what an Iron Condor is? Click here for a quick video explaining the strategy

Test 1: Constant Iron Condors

This test simply involved putting on an Iron Condor one day after expiry and running them until the next expiry with no active management of the trade and no indicators involved.

This returned a 73% winning trade rate, which is basically the standard win rate of a 1 standard deviation Iron Condor, no surprises there.

And whilst on paper most would say they would be happy with that, due to brokerage – this strategy is barely profitable due to the sheer amount of trades and legs involved. This, of course, could be offset by trading with a much larger relative trading bank.

Key Finding: A start, but we need to refine our strategy, picking the best possible setups

Test 2: Underlying Price Test

In this test, we wanted to isolate just the most solid stocks – the real blue chips. What if we get rid of AMP, Myer, etc. to answer what stock prices yield the best results?

The answer was between the range of $15-25 and higherThis could just be a statistical abnormality, as there are simply so many stocks in this range, but when you take out the stocks at the lower end of the range, we found this is where you can get the best risk/reward and profitability on the trades.

Additionally, if you only trade on underlying stocks with a share price greater than $25, the annual profitability goes up from 14% to 18% (post brokerage).

Key Finding: The optimal underlying price is somewhere above $15

Test 3: Days to Expiry (DTE)

One of the most common questions we get is; if most of the time decay occurs in the last 15 days, why do we trade closer to 40 days out? The obvious answer to this is brokerage, you want to sell enough premium to simply cover the brokerage of the trade. But there’s a bit more to it.

If you look at the chart of volatility probabilities below, you’ll see that most of the movement occurs in the period of the first 45 days, from then on, you are not really rewarded by the difference in premium versus the added uncertainty risk. Between the first 15-45 days to expiry, however, there is a difference, and that’s what we are looking at with this test.

The above chart describes average returns (y-axis) of some top stocks based on entering an Iron Condor trade with x days to expiry (x-axis). This shows that most of the variability occurs in the first 10 days, where the returns have a significant negative skew. This points to a likely mis-pricing of volatility in the last 10 days of an option’s life. So, when you are trading iron condors, trade with at least 10-15 days left in the option’s life to give you the best chance of winning.

We also found that on average, the 45DTE Iron Condors returned a significantly higher percentage than their 15DTE counterparts. This goes to show it’s worth taking on that extra bit of uncertainty with the later expiry dates. Key Finding: When picking expiry, don’t typically trade less than 10 days, or longer than 45 days.

PART 2 is now available – click here to read.


*Please note: Past returns do not reflect future returns

Trading options is not suitable for everyone. There is a risk that you can lose more than the value of a trade or its underlying assets. You should only act on our recommendations if you are confident that you fully understand what you are doing. If you are thinking about acquiring a financial product, you should consult our Financial Services Guide (FSG) at www.reachmarkets.com.au and the relevant Product Disclosure Statement first.

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