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Different strategies benefit from different market conditions—some will be more profitable as the underlying experiences high volatility, while others gain value when that volatility is low. The other primary consideration includes trending conditions. It’s generally easy to identify the conditions that benefit a specific strategy; however, traders who master a specific strategy can also identify optimal values or trends for additional option analysis measures. These may include valuation measures (i.e. delta) or probability measures (i.e. Probability of Profit).

A trader’s current strategy uses delta as a filter to leg into each spread for an Iron Condor (=put credit spread + call current spread).  Last week the Probability of Profit (PoP) measure calculated using daily implied volatility [IV] values was compared to delta movement for a call condor (=call debit spread + call credit spread) to gain some initial insight on the relationship between the two. This week, delta, IV PoP and similar measures will be evaluated using an Iron Condor, along with each separate leg of the position. Once again the PHLX Gold & Silver Index (XAU) is used for analysis.

As a quick review, IV values for each position were used to calculate PoP in order to get the best apples-to-apples comparison against delta. The goal was to help isolate other factors that influence the two measures. In addition, Rate of Change [ROC] values were used in an attempt to normalize the data. ROC uses the daily percentage change in the value and provides good visuals when charting the data.

Trade Selection

Once again this analysis uses a single trade to serve as a launching point for the analysis. The Optionetics Platinum Condor Finder tool was used to scan XAU At-the-Money [ATM] Iron Condors with approximately 30 days to expiration. The Max Profit / Cost measure was used as the initial ranker to bring up 10 trades for further consideration. Using this short-list, the 3 trades with the highest PoP values (using the 20-day statistical volatility to calculate PoP) were evaluated.  The scan was completed over a three-month period (Dec-06 to Feb-07).

The trade selected was a February XAU Iron Condor entered on Jan-16-07 with a 20-dy SV PoP of 53. This PoP value was the highest among the 9 trades reviewed. In addition to evaluating different valuation and probability measures for the whole Iron Condor position, these measures were also evaluated for each leg.

Using daily data, each of the following values were evaluated:

1. XAU closes [XAU C],
2. Position values at the close [PV] (Iron Condor [ICV], Put Spread [PSV], Call Spread [CSV]),
3. Position Delta [D],
4. Position “1-Delta”,
5. Position Gamma [G],
6. Position Gamma Rent [GR]*,
7. Position 20-day SV PoP [SVP],
8. Position Odds using 20-day SV [SVO],
9. Trade IV [TIV], and
10. Position IV PoP [IVP].

* From ‘Valuing options with “gamma rent”’ by Gary Norden, in the August issue of Active Trader magazine. Also see Implied Volatility in my Discussion Boards or next week’s article for more detail.

Each ROC for these measures was also calculated. A single trade was evaluated again since there are so many different data values being used. This will hopefully help focus future analysis on 1 or 2 specific data measures since there are many that can be considered.

Trade details:

Figure 1: XAU Feb-07 Iron Condor Trade Set-Up

The bullish put spread credit is $385 and the bearish call spread credit is $170, for a net credit of $555. This credit represents the max reward for the position.

Figure 2: XAU Feb-07 Iron Condor Risk Graph

Note the trade was profitable due to gains in the put credit spread leg of the iron condor.

Selection of Added Filter Measure

The first step completed in this process was sorting through some of the data and getting a look at the trends and relationship for different measures. When adding a tool to analysis or trade signals, it makes sense to consider a measure that behaves differently than the existing tool. Otherwise it’s possible a confirming signal merely represents the same information displayed in another way. In order to identify a different measure that may provide additional insight to analysis or improve trade entry, correlation analysis was completed on the ROC data.

As always, keep in mind just one trade is being evaluated right now. In addition to the limited data set, market conditions are also limited because the term of the trade is only 31 days. One has to start somewhere, though.

Before looking at the relationship between delta and the other measures referenced, a quick comparison of PoP changes for the 20-day SV value and the position IV value was completed to see if it was necessary to plot and evaluate the two values separately. 20-day SV was selected as the default volatility measure used for PoP since the trade time horizon is approximately 30 days. The correlations between the two measures follow:

1. Iron Condor:  0.919
2. Put Spread:  0.983
3. Call Spread:  0.986

In addition, the Jan Call Condor reviewed last week had a positive correlation of 0.937. It’s reasonable to expect that PoP changes for each calculation will be positively correlated since SV contributes to volatility expected going forward. In the future 20-day SV will be used for analysis since it is much more accessible and represents a reasonable proxy. Consider testing this assumption for your own analysis or using the IV PoP if your strategy is based upon temporary spikes or declines in IV.

Using the ROC for each position delta, the following correlations were calculated to identify a measure that appeared to be uncorrelated to delta:

Table 1: ROC Correlation Values for Delta versus Other Trade Measures

First, it should be noted that the “1-Delta” calculation used for the last two weeks is wrong given the correlation results versus Delta. An inverse calculation should yield a consistent, negative correlation value between the two.

In Table 1, the blue highlights represent uncorrelated data sets (-0.20 < c < +0.20); the green, positive correlations (c > 0.70) and red, negative correlations (-0.70 > c). It appears changes in the position delta are uncorrelated to changes in position values which is probably due to the short-term nature of the trade. The week of expiration creates some extreme delta values.

The changes in odds calculated using the 20-day SV does not appear to be correlated to changes in delta for the Iron Condor or the Put Spread leg, but is negatively correlated to the Call Spread leg. Given the put credit spread was the profitable leg for this iron condor, it seems reasonable that the two positions have a similar result here. Since this is the one measure other than XAU or option position value that provides 2 uncorrelated results, analysis will focus on this measure. The strong negative correlation for the unprofitable call spread may also be of use going forward.

Charts

A variety of charts displaying position values, delta and SV odds follow.

Figure 3: XAU Closing Value (left scale) versus Iron Condor Delta

Net delta for the position is declining as time progressing towards expiration.

Figure 4: Iron Condor Value versus Delta ROC

Figure 5: Put Spread Value (left scale) versus Delta ROC

The sharp drop in delta ROC was caused by movement of the position delta from 0.43 to -2.49 immediately prior to expiration.

Figure 6: Call Spread Value (left scale) versus Delta ROC

Figure 7: Iron Condor Value (left scale) versus Delta-SVO Ratio

It appears the SV Odds / Delta relationship may be one worth evaluating further.

Figures: 8a-b Put Spread Value (left scale) versus Delta-SVO Ratio 1 & 2

SVO/Delta scale issues required a split of the Put Spread comparison chart.

Figure 9: Call Spread Value (left scale) versus Delta-SVO Ratio

The relationship between SV odds and the iron condor will be further reviewed next week, along with gamma. Recall odds were selected due to the low correlation for the ROC in this measure compared to delta ROC for the profitable leg (put spread) of the iron condor, as well as the iron condor itself. There also appears to be a relationship between the SVO/Delta ratio and position values for this isolated trade. The extent to which this might be extended to other trades remains to be seen.

To see the other articles by this author, please click here.


Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site

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