In 2014, we traded our first XJO Iron Condor Model Portfolio using a very simple high probability iron condor strategy. There were many things to like about that strategy – it had a high winning percentage (11 out of 12 trades were winners),  it did not incur a lot of brokerage costs, and it was very low maintenance as it did not require any active trade management. However it had two major shortcomings which were that it:

  • Did not take Implied Volatility (IV) into consideration

Research has shown that IV at trade entry is very important for short premium strategies like strangles and iron condors (see November 2014 update for details). In my Summary post, we saw how we could have improved our returns last year if we had scaled our trades by IV or only traded when IV was favourable.

  • Did not include a plan to avoid big losses

We had a big losing trade in October 2014 which wiped out 10 months of profits. If we had taken action to reduce our maximum loss, our returns for the year would have been better.

In 2015, I would like to apply some of the lessons learned last year by running a second XJO iron condor model portfolio (we will call it the Mark II portfolio).  We will modify our trading plan to address the above shortcomings.

Firstly, we will take IV Rank into consideration when we open a trade. We will use XVI (the 30 day IV for XJO) to calculate the IV Rank for XJO using this formula:

IV Rank = (current XVI price – 52 week low) / (52 week high – 52 week low) x 100

We will scale our position size by IV Rank. When IV Rank is low, we will reduce our position size. The following is our capital allocation plan:

  • 15% if IV rank is 25% or lower
  • 30% if IV rank is between 26 to 50%
  • 45% if IV rank is above 50%

If IV increases after our first trade is opened, we will allocate more capital by opening a second and possibly a third trade for the month based on the above allocation rules.

Secondly, we will actively manage our trades to reduce our maximum loss. Tasty Trade research has shown that overall profitability can be improved by managing the untested side whenever the tested side reaches a 30% probability of expiring ITM (see August 2014 update for details).  We will apply this in our Mark II portfolio. We will look to roll our winning spreads to collect more credit when the delta on the tested side increases to 30. The extra credit will help to offset any losses on the tested side and reduce the maximum loss for the iron condor trade.  We will continue to roll our winning side if XJO keeps moving towards our tested side. If our tested side becomes deep ITM, we will look to convert our Iron Condor into an Iron Butterfly (see December 2014 update for details).

If we have collected sufficient additional credit from rolling our untested side to reduce the maximum loss of the iron condor to 70% or less, we will keep the trade on until expiry. If not, we will close our losing spread when the loss reaches 3 times the credit collected.

We will also use technical analysis as an engagement tool. For example, we will still target to sell at close to 10 delta but we will pick strike prices that are also above recent resistance or below recent support level. If a significant support/resistance level is breached, we may decide to close a trade early. For example, when XJO broke below the 200 day MA in October 2014, retested it and failed, it was pretty clear that there might be more downside to come. If something like this happens in 2015, we may decide to take our losses and close the trade early if our short strike is close to this support level.

Hopefully, the additional trading rules will address the shortcomings of our first model portfolio. My profit target for the Mark II portfolio is 15-20% of our total capital per year. We will trade this second model portfolio using a trading capital of $20,000.

The above is summarised in the Trading Plan for the Mark II portfolio. This trading plan is more complex compared to what we had for our first XJO Iron Condor model portfolio. More work will be required to manage the trades and the Mark II strategy is definitely not a “set and forget” strategy like before.

I opened the first trade for our Mark II portfolio, a Feb’15 iron condor, on 24 Dec 2014 which was about 56 DTE. As IV Rank was 36% that day, I allocated 30% of our capital (i.e. $6000) to this trade. I sold 6 contracts of the 4950/4850 put spread and 5675/5775 call spread and collected $760 for this trade.

IV increased after I opened this trade so I added a second trade for Feb’15 with an additional 15% of our capital (i.e. $3000) when IV Rank rose to 60%. On 7 Jan 2015 which is 43 DTE, I sold 3 contracts of the 4900/4800 put spread and 5625/5725 call spread and collected $385 for this trade.

I will provide a monthly update for this XJO Iron Condor (Mark II) model portfolio. Our next update will be after the February trades expire on 19 February 2015.

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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