The first Friday of the month brings with it one of the most highly anticipated economic reports for the month: the U.S. Department of Labor’s Non-Farm Payrolls report. This report has the potential to move markets, and can drive significant movement in stocks, bonds, currencies and even precious metals.
Implied volatility levels (IV) in bond options tends to rise the closer the report is to being published. To take advantage of higher IV levels, use an iron condor strategy. It can help you profit from a decline in IV and a muted reaction in the bond market.
What Is an Iron Condor Strategy?
An iron condor strategy usually involves four contracts.
Here is one way to utilize such a strategy for implied volatility levels:
- Look at the recent trading range for the 30 year bond futures contract
- Look to sell a call spread and a put spread that are at least three basis points away from the current price
- Execute your trade and wait for the non-farm payrolls data to be released
- Manage the position
How Can I use This Strategy?
Take a look at the following example to see how you can use an iron condor strategy:
- With 30 year bond futures trading at 163-00, sell the 166-00/170-00 call spread and the 160-00/156-00 put spread for a combined premium of 78 ticks or $1218.75 (not including any transaction costs).
- If IV declines in the immediate aftermath of the announcement, the position may be closed at a profit. The position can also benefit from the passage of time because the position is net short premium. If the bond market is between the short strikes of 160-00 and 166-00 at expiration, all options will expire worthless and the total premium collected is profit (minus any transaction costs).
- The break-even points of the position are calculated as the short strikes of 160-00 and 166-00, plus and minus the 78 ticks collected. Therefore, the upside break-even would be calculated as 167-07 and the downside break-even would be calculated as 158-25. (This is because the bond futures are quoted in 1/32nds and the bond options are quoted in 1/64ths).
If the price of bond futures climbs above or declines below the respective break-even levels, the position will begin to lose money. The maximum loss potential of such a position is expressed as the difference between short strikes and long strikes. This would equal our basis points, or $4000 minus 78 ticks. It could also mean $1218.75 premium collected equals $2781.25 maximum risk, if bonds are above or below long strikes at expiration.
As you can see, the position is risking more than the potential profit, so risk management is key.
The strike prices and width of the spreads can be adjusted for individual risk tolerance and account size.
This iron condor strategy or similar strategies can provide a way to take advantage of rising IV levels surrounding the non-farm payrolls report. Positions may be closed at a profit or loss any time before expiration depending on market movement and changes in IV levels. Risk should be monitored, and because the risk is greater than the profit potential, you should try to avoid taking a full loss on such a spread.