What level of stop losses are effective for managing iron condors? Our baseline test effectively had a 100% stop loss on all scenarios. Will adding stop losses based on the at risk margin (See the test on Profit Limits to learn why I use this metric) improve the performance of Iron Condor trades?
My guess before looking at the data is that stop losses will be shown to drastically reduce the maximum risk, and should be able to improve the effective expected return. Because some tests will be stopped out quiet frequently (i.e. those with a 10% stop loss threshold), I expect many tests to have a higher number of trades compared to the baseline.
The test scenario use stop losses on the margin at risk for the following values:
10%, 20%, 30%, 40%, 50%, 60%, 70%, 80%, 90%, 100%
The following summarizes the performance of the test run:
|1 Month||2 Months||3 Months||All|
As expected the risk was substantially reduced in all cases. The vast majority of scenarios actually experienced lower expected returns and lower and lower profit factors. Meaning that the gains in risk were still outweighed by the loss in expected returns.
Profit Factor Improvement VS Delta
Looking at a histogram of the difference in profit factor compared to the baseline, we can see some patterns, but its not as clear cut. Very small stop losses perform poorly on average. And High Delta trades appear to perform poorly on average, although there is a cluster in the 3 month range and Delta 35 that does well. The clusters between the 30 to 60% stop losses and deltas under 22 seem to consistently outperform as well. But again, no very clearcut patterns emerge.
Looking at the expected returns, we can see that there appears to be a sweet spot between -30% and -60%, and Deltas less than 22. Similar to what was displayed in the profit factor tables.
We can also see that regardless of the stop loss, high delta trades perform poorly. This is not surprising given the construction of the test.
Traders may often hold the Front Month trades to expiration but also use stop losses. This test shows that many of those scenarios can be improved marginally, but using a 30% to 50% stop loss on 15 to 20 delta trades seem to gain the most benefit.
The second month, low delta trades with a 30% to 50% stop loss may also be marginally improved.
The tests with Stop Losses between 10% to 20% are significantly impacted across all deltas and all months. These trades are just stopped out to frequently.
Most other tests are only marginally impacted either positive or negatively.