Iron Condors vs Butterfly Spreads – A Detailed Options Breakdown compares the probability of an Iron Condor to the Butterfly Spread. See how the Condor has a higher probability at expiration, while the day to day probability is very similar to that of the Butterfly spread.

We also briefly discuss other popular option trades such as Calendar spreads and Credit spreads.

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Iron Condors vs Butterfly Spreads   Detailed Breakdown

Video Transcript

Hi there everybody! This is Morris from San Jose Options. Today, I want to talk about risk. I’m going to compare an iron condor to a low probability butterfly and it’s actually a rather interesting conversation. I’ll point out the way I look at probability and it’s interesting to see that even though the condor here has a much higher probability at expiration, well, as you’re actually trading through the trade in live, real time, you’ll see that the trade actually has a similar probability to the butterfly. It’s very interesting once you consider your day to day probability compared to your expiration. They could be quite different. Hopefully, this instructional video will open your eyes and help you see probability in a different light.

This is actually taken from our newsletter and just thought I would make a video and explain some of the things in here. This way I could clarify and also this is a good example of why you might want to join our newsletter. We send out a lot of interesting information and, hopefully, helpful to you guys out there.

Here we are looking at a high prob iron condor. You’ll see this one here has a probability of somewhere between 80 and 85%. Once you factor in the standard deviation, you’re going to see between the circles here, these are the breakevens that this trade typically will be from 80-85% if you start the trade selling near the 10 delta. That’s how this trade is constructed. It’s using, like I believe I did it with a 10 point spread on either side and I sold around the 10 delta. If you look at this trade, this is take from our software, but if you build this in whatever software you’re using, you’ll see that it’s somewhere around that range.

Next, we’re going to compare this butterfly which is considered to have a much lower probability. You’ll see that if you build this trade, I used the Russell in this case so I’m really comparing the same exact underlying asset and I sold this strike here at the money. Then I bought, I believe it was about 10% down and 10% up to build a butterfly spread. For this type of trade, you buy one here, sell two here and then buy one here. You could construct it a couple of ways. You could do it with all calls, you could do it with all puts or you could do it with puts and calls.

The main thing that you want to notice is this one at expiration. Notice the green circles here. These are your breakeven points at expiration. The red ones are actually your day to day breakeven points. This is more narrow than the condor. If I go back up to the condor, notice the shade of red, how narrow this is. This one’s typically somewhere about 35-45% probability at expiration where this one, again, you could see how the red shade here is much wider. Again, you have the green, the green is your expiration line. This one again is much higher probability trade at expiration. That’s the first thing we want to point out.

Now, we want to look at the trade as it progresses through time as you’re actually trading it because that’s obviously, extremely important; if not, the most important thing about it. Here we’ll see that the realistic probability of the condor is actually about 40%. Once you factor in a 10% loss. The red dashes indicate the loss area. If you look here, this red dashed line, this is your day to day, your live profit or loss line. The green line here is where the trade ends up in expiration if you don’t make any adjustments. In this image, the red here is actually measuring about 10% down. This up here measures about a 10% credit and you could see down here, it lines up at this point and this point. It’s about 10% down the zero line. This is your zero line, by the way, the white line, in case you don’t know.

Once we matched this up with the 10% loss to the downside or 10% loss to the upside, you’re looking about somewhere around a 40% probability once you consider that. That’s what so interesting about this trade. It has like 80-85, maybe even sometimes a 90% probability of profit at expiration, depending on what deltas you sell to start with. However, once you initiate the trade, your day to day probability is much more narrow once you start to factor in your actual losses and your actual risk.

Most people, once they’re about 10% down, they’re going to start to feel a bit uncomfortable, nervous, stressful on this trade because that’s the most that they’ll ever make up here without implying adjustments. Once we’re here, then again, if the underlying asset moves farther, then you start to lose more than you can make on this trade. What I’m looking at here is this probability zone where the user or trader is going to feel comfortable in the trade. It’s about 40% wide.

When we come down to the low probability trade of this butterfly, it’s interesting because your 10% downzone is actually a very similar width. You could see that, if not a little wider but it’s pretty similar. When you compare the two, you’ll see that this one is pretty wide here and then this one it’s a very similar width. They’re both, actually, even though this one has a more narrow probability expiration, they both have a very similar day to day probability range, about 40%, once you factor all this risk. That’s the interesting thing about this conversation and the thing that I just wanted to point out and have you understand because a lot of traders may think that the condor has a much higher probability. But in fact, your day to day is pretty similar. Then, when you build a calendar spread, you’re going to have, again, a very similar risk raft. You’ll have a trade here that at expiration has about, maybe, 40% similar to this butterfly, 40% wide probability expiration. But again, it’s your in the trade and you have your graph, kind of looks like this. It’s about the same. That’s about where your 10% really lines up about here and here, almost the same as the final probability of trade.

To recap on that condor there, even though expiration is wider, once you factor in your 10% draw down, then you end up with almost the same probability. You’re day to day on this type of trade, even though it looks like this square, rectangle shape and this one’s a triangle, it’s actually a pretty similar trade. The grades could be a little bit different but similar. The butterfly has your negative vega, this one has your negative vega. The butterfly actually, having these, both of these strikes closer to the money, they may have a higher theta but they actually have a slower decay rate. In the butterfly, your outside strikes are going to have a higher decay rate because they’re farther out of the money, they’re going to decay faster on you. This is going to have more theta but actually it’s decaying slower. Your condor would actually have a higher overall decay rate because your short contracts are farther out of the money. That’s something to consider there.

Your calendar, this one here, you’re selling a front month, buying farther out in time. This one, ideally seems like it would have a flatter vega position because you’re splitting two months and the two months are a little bit unpredictable. We do have tools in our software to ensure they can help you enter and exit trades, to identify some opportunities with your volatility skews and things like that. But overall, this one is not necessarily positive vega like you may think, like this calendar trade here. I do a lot of studies on these and we just find that it’s not exactly positive vega like you might think. Actually, when volatility drops, oftentimes it hits the front month much harder and that particular trade actually makes money oftentimes the volatility drops it. Even though your software may say it’s positive vega, it may actually react like a negative vega trade. Just be aware of that.

All these trades have very similar probability. Your credit spread may look like this and then you have a similar effect on one side. You have that zone here where you’re about 10% down. To the left side on this trade, you would have that pretty normal probability but this one, all the way at one side has a higher probability. Once could argue that the credit may have a higher probability overall because of that but others may argue that brings them half the credit and it’s also more directional because this one starts off with a very directional delta, where the others have a flatter delta. Again, once you factor in some of those numbers, it’s hard to say it’s the credit spread that’s reeling higher probability or not but you can argue with this ones, more like 50% once you factor in. To the left side, again, it’s going to actually be worst because this ones start off at a flatter delta, so they have more room to the left. This one actually has less logarithm to the left and then more to the right. It’s hard to say. The thing is, all of these trades actually have a pretty low day to day probability.

It’s very important when you’re trading because you can’t just look at your expiration here and here. If you just do that, then, I mean obviously, we’re not made of steel here. We have emotions; we have real money on the line. It’s hard to just base everything on your expiration. Mostly, I’m talking about this situation here. Again, if you’re working with your condor, just be aware, if you come into this trade, believing in this, the 85% probability, sure, that’s mathematical but this zone here is very stressful, to say the least, and same with this zone. This is your safe zone up here and it’s very narrow. Again, 35-40%, something like that; the safe zone. It’s not as low stress and safest trade as you might think.

Come down to the bottom part. As you can see, the high probability condor and the low probability butterfly have a very similar short-term risk profile and, again, the same holds to for the credit spread and the calendar. The fact is, we trade in real time, not in the future which makes the realistic probability, this day to day risk of those who trade as opposed to other ones that I demonstrated to you, they’re all very similar. I already kind of did this for you but, I mean, for homework, you can certainly look at calendars, diagonals, and credits and determine, for yourself because everybody has their own risk appetite, what your safe zone is and what that probability is once you factor in the area that you’re willing to be in on the trade. For me, there are about 35-40% probability.

In our course, we teach other way to trade with a much higher probability where we can pretty much double your comfort zone, dump all your day to day probability and, well, obviously that’s going to translate to a longer term probability and it’s a different way to trade where your mathematical probability is matching your day to day. It’s really nice. If you’re interested in learning more, you can click on this link. Again, this is on our newsletter but it goes right to the website and schedule your personal demonstration.
I guess that’s about it. The San Jose Options, again, double your probability. We also have our software’s crew working on this every day and if you’re serious about option trading, you really need to see what it can do. I’m not going to say anything. Just get yourself a demo and I’ll show you what it could do. You’ll love the tools if you’re a serious trader. Phone number’s down here at the bottom, 1-800-868-2503. Give us a call for your live demonstration and that’s about it. Alright! You guys have a good night, good day, whatever country you’re in and we’ll talk to you soon.