Note to new readers: This is a regular update on the status of our XJO Iron Condor Model Portfolio. Please read the setup post first in order to understand the objectives and the rules for trading this model portfolio.

With the XJO index settlement price (also known as the Opening Price Index Calculation or OPIC) at 5441.3 upon options expiry on April 17, all the options in our April iron condor expired worthless. We got to keep the entire premium received which was $2040 after brokerage costs as shown below.

So far we have had 4 winning months and collected $8100 in gross premiums as shown in the table below. We will track our performance is a similar manner as 10percentpermonth.com, who do not include commissions as this will vary from broker to broker.

 

For our May trade, I put on our full position (20 contracts) on April 4 which is about 6 weeks to expiry, in order to collect sufficient premium to meet our target of 10 percent per month. I was able to collect premium of $2000 as shown below.

For May, $2000 is our maximum profit which we will get if XJO is trading between 5150 and 5600 when these options expire on 15 May 2014. The margin required for this trade is $18,000 ($20,000 – $2000). This is also our maximum loss which we will incur if XJO is trading below 5050 or above 5700 upon option expiry. Hence the potential return for this trade is around 11.1% ($2000 / $18,000) before commissions. XJO was trading at around 5410 when the trade was opened on April 4.

There are a few lessons that we can learn from the April and May trade. Firstly, you might have noticed that the April Iron Condor (5675 – 5125 = 550 points) is about 100 points wider than the May Iron Condor (5600 – 5150 = 450 points), even though both trades were placed with similar time to expiry (i.e. 6 weeks) and at strike prices with similar probabilities (i.e. at delta of 0.1). This is because volatility was higher in early March (when the April trade was opened) compared to early April (when the May trade was opened). Experienced option sellers like higher volatility as this normally means higher premium and wider (and hence safer) condors. April was a perfect month for iron condors as we collected a good amount of premium and had a nice wide profit range. With XJO trading in a narrow 200 point range (see chart below), April was also a stress free month as the XJO price was comfortably in the middle of the profit zone of our iron condor for the duration of the trade.

 

However, May might turn out to be a difficult month for our iron condor. Because of the low volatility, we could not get a much premium for our May iron condor and the width of our May iron condor is narrower (and hence riskier). May is also historically a bad month for the market – you may have heard the saying “Sell in May and go away”. Last year, XJO fell over 500 points in May as shown in the chart above. If this happens again in the next few weeks, we could incur a big loss in May which could wipe out all the gains we have made in the past four months.

One reader also wrote to me about trading system expectancies which I thought was very interesting (thanks Jim!). He pointed out that our iron condor trading system has an expectancy of zero, which means we will make no money over the long term. I will try to explain this in a simple way without too much technical jargon. As we are selling options with 90% chance of expiring worthless, we would expect 9 out of 10 trades to be winning trades where we make a profit of roughly 10 percent for each winning trade. We would also expect 1 out of 10 trades to be losing trades. If our losing trade hits maximum loss, this would result in a loss of 90% which is the total of what we make in the 9 winning trades. Hence, we would effectively make nothing, and in fact would have a net loss if we include brokerage costs!

The key realization for me is that we must improve our risk management strategy so that our maximum loss is less than 90%. If we can reduce our maximum loss to 60-70%, we will have a great trading system with positive expectancy of 0.2 – 0.3 or in other words we can expect a return of 20-30% over the long term! I have some ideas for this which I will apply to our June trade and discuss this in future updates, so stay tuned!

I will provide another update after the May trade expires on May 15. If there are any readers out there who are trading XJO iron condors, I would like to hear from you. Please share your experience by leaving a comment or sending me an email. Thank you to all who have done so already.

Disclaimer: This post is for educational purposes only and should not be treated as investment advice. This strategy would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek investment advice if required.

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