Article rating: 5/5

Algorithmic trading has been on the rise over the past decade with around 70 percent of the trading volume on the US markets coming from algorithms. This raises the question of whether we should look to automate or continue to manage trades in the old fashion way?

What is Algorithmic trading? Wikipedia – Algorithmic trading is a method of executing a large order (too large to fill all at once) using automated pre-programmed trading instructions accounting for variables such as time, price, and volume to send small slices of the order (child orders) out to the market over time. They were developed so that traders do not need to constantly watch a stock and repeatedly send those slices out manually.

This idea of Algorithmic trading has also expanded to form many different strategies to make money out of markets. Some Algo traders go as far as setting up lines closer to exchanges so that they get a millisecond or two advantage in placing orders. Others are designed in a way to enter and exit trades based on a set of technical rules.

This is a more advanced version of the old black box idea from back in the ’90s that would give you entry signals to get in and out of the market.

This is all well and good for traders picking the direction of shares, forex, or commodities. But how does this concept line up with options strategy’s like the popular Short Iron Condor?

What is a Short Iron Condor?

With the increase of enquires in this strategy and with its wide popularity, I felt it would be a good time to talk about the strategies in managing an Options strategy like this.

This strategy profits from Time Decay in the options. Setting up a Bear Call at a level of resistance and Bull Put at a support with all options out of the money. Both the Support and Resistance are believed to hold until the expiry of the options. So, this is a view the market will go sideways, and Implied volatility will fall.

There are various things you need to consider in entering and managing this strategy.

  1. Your technical view of the stock or market
  2. A view on Implied Volatility vs Historical Volatility
  3. What stock is giving you good value?
  4. Which expiry is giving you best value?
  5. Your fundamental view of the market. (Are there any events coming in the duration of the trade that will make the market volatile?
  6. Liquidity of the options and getting filled for a fair price.
  7. What will you do if the market breaks the support or resistance?

The majority of the above could be solved by mathematical parameters or a set of theoretical rules. The simplest entry signal could be to measure the Implied volatility vs the Historical to create a scoring system.

But in our experience, traders that do well out of this style of trading are ones that remain adaptive to the market. Watching, reading and keeping up with both Fundamentals and Technical analysis. Adjusting their strikes on the daily to weekly basis if needed with a plan on how to manage risk on each trade.

I have personally been trading Options for 8 years and have mentored thousands of clients in this strategy. Over that time, I have come to realise that a strict set of rules does not work for this type of strategy. Using your experience of market behavior and adjusting a trade when either sold leg is tested is a must.

Looking at the market since the election is a perfect example. Liberals won a majority government when Labor was expected to win hands down. The market jumped and has stayed strong with the RBA expected to cut rates tomorrow. The XJO has completely disconnected from overseas markets that have been falling strongly on Trade war fears as Trump aka “Tariff Man” has had a busy few weeks.

In this situation, I have reduced risk by adjusting the current condor trade expiring Thursday to a more directional trade and out in time. We also received an additional credit so we can profit more if we get our view correct. The view now, is the market will likely follow the offshore markets lower in the coming week despite a rate cut tomorrow. Also, the technical signals on both our market and the US markets are bearish.

Programming this kind of market behavior into an Automated trading system that is trying to predict a sideways market would not be an easy task. In addition, a judgment call needs to be made if your trade is being tested. Often a few moves whilst in the trade to keep the options out-of-the-money (OTM) will do the trick. The tactics are to know when and where to move the strikes.

So, by not using an Automated system I have a lot more flexibility in how and when I adjust my trade. I can move to a more directional trade or push out in time and pick a new range if I think the market will go sideways.

This is where the true edge is with options trading. Experience will trump Automation in the long term. If you plan to trade this style of trade it pays to have an experienced options advisor that can help you price trades that suit your view. A good advisor can look at various expiries and strikes to help refine your trade and ensure you are getting good value.

With the rise of AI, maybe one day the technology will get to a point where we could automate trading decisions, but for now, we will stick to what works for us.

If you want to know more about a Short Iron Condor and how I manage this strategy, jump on to this Thursday’s webinar at 7:00 pm. Register your spot here