Markets are tumbling - time to sell premium

Important note: The strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.

• Implied volatility is at 23.29, while historical volatility (HV) is at 19.03. This means that the market is pricing in more future movement than has actually occurred.
• IV Rank (implied volatility rank) is at 76.06, meaning that the current implied volatility is in the 76th percentile of the last year, indicating that options are significantly more expensive than usual.

When implied volatility is higher than realized (historical) volatility, it suggests that options are overpriced relative to actual market movement. This is often seen as a reason to sell volatility, as implied levels tend to mean-revert back toward realized volatility over time. If IV drops, option prices decline, benefiting premium sellers.

This is the kind of environment where selling premium-based strategies makes sense. That’s where the iron condor comes in.

An iron condor – selling volatility in a high-premium market

Since IV is high and above historical volatility, we want to sell options rather than buy them. One strategy that works well in this scenario is the iron condor—a neutral, range-bound strategy that benefits from time decay and declining volatility.

Iron condor setup (XSP)

Here’s an example trade showing a possible iron condor setup:

• Sell 580 call
• Buy 585 call
• Sell 550 put
• Buy 545 put
• Expiration: March 21, 2025

Premium received: $272
Max loss: $228
Break-even points: 547.28 and 582.72

Why this trade?

This trade is based on a range-bound outlook, meaning that we expect the S&P 500 to remain within a certain price range rather than make a significant move up or down.

• Volatility is high, so premiums are rich – we collect a high premium, increasing our probability of profit.
• XSP is still range-bound, despite the drop – the market has sold off, but unless we expect a continued breakdown or rapid recovery, a consolidation is likely.
• We profit if XSP stays between 550 and 580 by expiration – the goal is for time decay (theta) to work in our favor while volatility cools off.
• IV is higher than HV, meaning we are selling options at inflated prices that could revert lower.

However, if you expect the S&P 500 to continue declining in the next 10 days or to strongly rebound, this strategy would not be ideal. In that case, you should look at other strategies that are better suited for trending markets.

This article is purely educational and does not reflect a market outlook or a recommendation. Markets are extremely volatile, and anything is possible. Always do your own due diligence before placing any trades.

Defined risk vs. undefined risk—why choose an iron condor?

An iron condor is a defined risk strategy, meaning you know upfront the maximum possible profit and loss before entering the trade. This makes it a safer choice compared to an undefined risk strategy like selling a strangle, which has a higher potential reward but also unlimited downside risk.

A strangle involves selling an out-of-the-money call and put, without buying protective options. While this can generate larger premiums than an iron condor, the risk is significantly higher. If the market moves aggressively in either direction, losses can be catastrophic, potentially far exceeding your account size if not properly managed.

In contrast, an iron condor has a built-in hedge because it consists of two credit spreads:

• A bear call spread (selling a call and buying a higher strike call)
• A bull put spread (selling a put and buying a lower strike put)

This structure caps both potential profits and losses, making risk management far easier.

How to calculate the max risk?

The maximum risk on an iron condor is calculated as:

Max risk = width of the wings – premium received

In the example trade:

• The width of the wings is 5 points (difference between short and long strikes)
• The premium received is $2.72 (or $272 per contract)

So the max possible loss per contract is:

$5.00 – $2.72 = $2.28 (or $228 per contract)

Taking profits early to increase consistency

A common approach when trading iron condors is to take profits before expiration rather than waiting for the full premium. Many traders use a profit target, such as closing the position when 50-60% of the maximum profit is reached.

For example, if the premium collected is $272, a trader might place a closing order to buy back the spread once they can keep around $160 of profit. This approach increases consistency by avoiding unpredictable late-stage market moves that could turn a winning trade into a loss.

Final thoughts: sell volatility while it’s high, but stay flexible

The market selloff has spiked implied volatility, making this an excellent time for selling premium-based strategies like iron condors. But as always, you must align the trade with your market outlook and manage risk accordingly.

Do your own due diligence before placing any trades.