No matter what products you choose to trade, each and every one of us is constantly running various scenario analyses. These type of "what if?" questions help us filter for the best possible opportunities, not to mention the risk management dimension of such mental exercises.
At tastytrade, much of the research we conduct is intended to help traders with scenario analysis - case in point, a new episode of Market Measures, which focuses on whether it's smarter to scale with more contracts or wider wings.
While the episode uses Iron Condors as the basis of this hypothetical question, learnings from research presented on the show can also be applied to other position structures, and trading opportunities/products.
The premise of the show is what traders can do if they are looking to scale up their portfolios.
While some traders may decide to get involved in new products (i.e. futures), others may decide to simply trade additional symbols in their existing pool of opportunities - like adding single stock options alongside the options of ETFs.
But another way that traders can scale up is by adding more contracts to potential positions, or by adding additional risk exposure through other means - like adjusting the width of wings in defined-risk positions.
On this installment of the series, the Market Measures team looks at the hard data when evaluating the potential impact of adding more contracts to an Iron Condor, as compared to simply widening the wings. No matter what you trade, this type of scenario analysis may help if you consider scaling-up at some point in the future.
As a reminder, an iron condor is essentially the combination of two types of different options positions. It involves trading contracts on four different strikes in the same expiration month, and the same underlying. The easiest way I find to view an iron condor is to think about it like marrying a short straddle with a long strangle.
In that sense, the long strangle acts as a protective "wing" on each side of the short straddle; to protect against theoretically "unlimited losses." The big question when setting up an iron condor (aside from choosing the underlying symbol and expiration month), is how wide to set your long strangle wings.
As the wings get closer to the short straddle, the potential for losses is reduced. However, the risk-reward sword always cuts both ways. Wings that are closer to the straddle strike prices are also more expensive, meaning potential profits are also reduced.
The same risk-reward analysis can be conducted when considering the number of contracts for an iron condor. The greater the contracts, the greater the potential profit or loss.
On Market Measures, the team constructs a study that is intended allow for a side-by-side comparison of the risk vs. reward of scaling-up through wider wings or a larger number of contracts. The full parameters of the study are presented in detail on the show.
Due to the complexity of this material, we do recommend reviewing the entire episode of Market Measures when your schedule allows. As a teaser, the findings indicated that widening wings in iron condors may be preferred when compared to simply trading more contracts on narrow iron condors.
However, the reason for this difference involves both risk AND reward considerations, and is somewhat nuanced. In that regard, we refer you to the complete episode for a full breakdown of the results from this analysis.
If you have any questions about scaling up, or any other trading topic, we hope you'll reach out by leaving a message in the space below, or contacting us via Twitter (@tastytrade) or email (firstname.lastname@example.org).
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.