Trading Iron Condor Options with Gavin McMaster


Bullshit-Free-Guide-to-Iron-Condors-book-coverGavin McMaster is an options trader from Melbourne, Australia who currently lives in the Cayman Islands. He trades a type of strategy that has a very high success rate, but also has the potential to blow up an account quickly. The following is an edited transcript of a podcast interview I conducted with him in 2013.

The type of option strategy that Gavin specializes in is called an iron condor. In the interview, he explains that he is basically putting on option spreads that profit from range bound markets. He has also written a book on iron condors and runs his own trading website.

When did you first develop an interest in trading?

I remember back in primary school when one of my teachers told us this fictional story about some guy who buys a stock for a dollar and watches the stock go all the way up to a hundred or whatever, then he refuses to sell, and then watches it come crashing back down to a dollar again.

That kind of story just always stuck with me, and I’ve really been interested in the markets ever since.

What did you do to develop that interest after you realized it so early?

I’ve always been interested in all things finance. My parents were really big influences as well, and a big help.

Back in ’94, there was a big government telecommunications company in Australia that went private, so my parents got all of us kids involved in the IPO and we bought a hundred shares or whatever it was. Not too much, but it gave us a bit of an interest in the market. I’d be there every day going home from school and checking the papers, seeing what the stock did for the day.

That was really my first taste of the stock market and investing, and I was absolutely hooked from then on. It was a really good experience, and I really enjoyed watching the ups and downs of the market.

Obviously, you continued that love and passion. Where did you go with it from there?

I guess just regular investing in some stocks and things like that when I was in my teens, and then I started working and having a bit of money and I put some money into some mutual funds and things like that.

That was around the mid to late ‘90s, and then I sort of took a few years off and went traveling and wasn’t involved in the market as much. I had a couple of investments, mutual funds and things like that that were just sitting there.

Then I began to be a bit more heavily involved and started reading up on options and other ways of trading in the market around 2000-01. Then I got a bit more heavily involved and started trading my first options in about 2004, and have just developed things from there.

I was initially attracted to options because there is a huge amount of flexibility that they offer in terms of the leverage and the income.

I always knew that you could make money with the market going down, and I knew you could short sell stocks, but I didn’t really know too much about it and I didn’t really know any other ways of making money when stocks went down.

Learning about options really opened my mind. I was blown away and just devoured every book that I could on the subject over these couple of years and started trading.

There are a hundred ways you could have gone when you decided to get back into the market. What was it about options?

I think initially the leverage. The fact that you can put in $100 and turn it into $1,000 pretty quickly. That’s actually not the way I trade now, but that was probably one of the initial attractions.

That, and buying put options where you could profit if the market crashes. When I started reading about options in 2000-01 the market was heading down, so that really piqued my interest towards how you can make money on the way down.

There are just so many different ways that you can trade options, not just buying puts if you think the market is going down or buying calls if you think the market is going up.  There are so many different things that you can do with options and the more I read, the more I wanted to learn, and I’m still learning today.

There’s so much about options trading in the markets that there is to learn and they’re constantly evolving. There are always new things to learn and new experiences to have in various market conditions.

Once you decided that options was the route for you, what were some of the books you studied?

A book from the Wall Street Journal was the first one that I read, and then there were a number of other ones. The Bible of Options Strategies by Guy Cohen is a good one.

Another one, it’s really technical but it literally covers everything, is a book by Lawrence McMillan called Options As A Strategic Investment. That basically covers everything.  It’s about 800 pages long, so it’s a pretty big read. It’s a bit daunting for some people, but that really covers everything.

If people are just sort of starting out, then they probably want to start with something fairly basic, and even just some of the pamphlets and things that are available on various investing websites. The CBOE has some good information, things that are 20-30 pages and are fairly easy to get through. That is a really good place for a beginner to start.

So were you successful right from the start or did you have some periods of struggling?

I definitely had some periods of struggling.

I studied finance as well. I went back to school, and in 2009 I finished my Masters in Applied Finance and Investment.

I was kind of a bit arrogant, I think. I started out thinking, “I know finance. I know what I’m doing. I know about stock market. I understand options. I’ve read a couple of books.”

That was a big mistake, so there were a few humbling experiences that the market taught me early on.

Anything that stands out in particular?

Absolutely. I remember my very first trade. It cost me about $200.

Again, I was attracted to the idea of making money as stocks went down, so I bought some put options on a retail company in Australia. Literally, my only criteria for buying these put options was that it was the only one I could afford because the stock was trading at about $2.50 or something, so the options were really cheap.

It was the only one I could afford and I ended up losing 100%. I lost all $200 on that one, so my first trade was a complete bust.

Then there was another one not long after where I had a portfolio of stocks still in the market. I was learning about selling covered calls and things like that, so I decided to sell some index calls over my portfolio of stocks.

I really didn’t understand anything at that stage about delta weightings and things like that, so I had a portfolio of really low risk stocks, and then I sold these index call options and had way too much exposure on the index call options that I didn’t realize. My stocks ended up going down, but the market index went up, so both trades went against me and I ended up getting a margin call.

I was living over here in the Cayman Islands and I literally didn’t have enough money in my Australian bank account to cover the margin call. I ended up having to wire money via Western Union to my brother, who had to go out on his lunch break, collect this money, and deposit in my bank for me so I could cover the margin call.

That was a very humbling experience, and something that I’ll never forget.

I can imagine.  So you’ve since developed some more risk control? 

Yeah, absolutely. You know, it’s just one of those things. I guess you don’t realize what you don’t know at the time.

I didn’t really have a plan back then, either. Now, I have a detailed trading plan for each strategy that I trade, and strict risk management and money management rules and things like that, and I really monitor option Greeks.

So yeah, I definitely learned some hard lessons. Thankfully, the dollar values at the time were still fairly small, so it wasn’t earth shattering or anything like that.

I’ve had some losses since then, but each time you have a loss you kind of pick yourself up, you learn from it, and you move on and you tighten up your trading plan and your risk management rules and things like that.

Do you want to give us a general overall overview of some of the strategies you use?   

My core strategy is trading iron condors, which is sort of a neutral trade where you’re expecting the stock or the index to be range bound over the life of the trade. I typically stick to US indexes like the Russell, SPX, NDX.

Occasionally, I’ll do some small positions in some of the high flying stocks like Apple, Google, Priceline, or Netflix, but mostly I stick to the indexes.

I really only have one or two main trades per month. The way I kind of look at it, it’s a little bit like the Warren Buffet theory where I’d rather have one trade that I watch like a hawk that has $50,000 exposure, rather than ten $5,000 trades where they’re all moving in different directions.

One trade on the index is going to move with the general market, whereas if you’ve got ten trades on various stocks, some of the stocks are going to be going up and some of them are going to be going down. In the event of a market panic, you’re going to be madly scrambling around trying to close these 10 trades or 20 trades or whatever, whereas I only have to worry about one.

As I said, Iron Condors form of the base of what I do, and then I will kind of trade around that position based on my view of where volatility is heading, because obviously volatility is a huge component when trading options. It’s the area where, as a trader, you can gain the most edge. I take a view on whether I want short or long volatility and then adjust my position based on that.

I generally try not to pick the direction of the market. I try to be pretty neutral. If I’m going to pick a direction, I’ll do it in a very inexpensive way by using something like directional butterflies.

Could you further explain what an iron condor is?

It’s a neutral strategy where you want the market, or the stock, to stay within a specific range over the 30 days or the 60 days, however long the trade is, and for putting on that trade, you receive a credit.

A typical iron condor trade might bring in $1,000 in credit, and you’d have $9,000 in capital at risk, so you’re looking at a return of around 11% or something like that. If the stock stays within that range over the course of the trade, then you get to keep the $1,000, the options just expire worthless, and you put $1000 more in your account at the end of the month.

That’s the very basic overview of how it works. Obviously, there’s a lot more intricacies to it than that. You’re kind of selling a call spread above the market and selling a put spread below the market, and then you just want the market or the stock to stay within those bounds that you’ve set.

You just wait for the time to expire?

Exactly. Options are decaying assets. As time passes, the options start to lose value, which is what you want when you’re selling options, when you’re selling spreads. Over time, if the market stays relatively stable, if it doesn’t move too far, gradually that time ticks away and you accrue profits in your account.

What do you look for to identify good potential trades?

As I said, volatility is a big factor in how I would determine when I’m going to get into or out of a trade.

Iron condors are what’s called a short volatility trade, so you want them to be not too volatile. You want them to be fairly stable, so a good time to be trading them is after there’s been a period of big volatility, because generally it’s going to calm down after that, and a bad time to be trading them is when volatility is really low, because from that point, it’s likely the volatility will shoot up at some point.

I like to get into the trades when there is a big sell off in the market. That generally means that volatility is going to spike up. People know the VIX index, that’s kind of a fear index, so when that spikes up to a decent level, that’s a really good time to start getting in to some of these trades.

Then you can trade them a little bit directionally as well, if you want to. I generally don’t do that too much, but you can look at things like support and resistance and pivot points in terms of placing your strikes. You can look at things like standard deviation as to how likely the stock or the index is to move towards your short strikes over the course of the trade.

In terms of identifying trades and trade entry, a lot of it really is based off volatility.

What type of money management strategy do you use?

I have a couple of rules that if certain loss levels are hit on the trade, I’ll get out or I’ll adjust it. Then if I hit a certain level like 8% in a month, I’ll just close everything out and just walk away from it for a couple of weeks and sort of clear my.

There’s probably a few others that I’m not thinking of right now but those are kind of the main ones.

What about position sizing, how do you decide on a position size?  Based on volatility as well?

When volatility is high, I’m happy to go a little bit bigger in my position size.

Typically I’ll start with maybe 10-20% of total capital in a trade and then I’ll sort of scale into it as I go along. If I’ve got the one main trade that I’m doing for that month, I’ll go as high as 50% of my capital in to that trade. Then I’ll leave the rest of the smaller trades in the 5-10% range and leave a good chunk of 40% sitting in cash, just in case I need to make adjustments and things like that.

You also mentioned the option Greeks, how do you use those?

The main Greeks that you’re interested in are Delta, which is your exposure to price movement, Vega, which is your exposure to volatility, and Theta which is the time decay aspect.

The other one is Gamma, but that’s a little more complex. It’s definitely important, but the other ones are the main ones that you look at, at least when the trade is starting out and fairly far from expiring.

Because I want to stay fairly neutral, I never want to let my Delta get to be more than about 20% of my Theta. If it gets higher than that level, it just means that I’m taking on too much of a directional risk, relative to the amount of income I’m making each day from time decay.

The same in terms of Vega. I generally don’t want my Vega exposure to be greater than 2-3 times my Theta, so again, if it gets outside that level, it just means my exposure to volatility is getting a little bit too high and I need to sort of bring it back into line a little bit.

What kind of time frame do you usually work with in these trades?

Usually around 30 days, so sort of the monthly cycle.

Weekly options have become really popular in recent years, but I still tend to stay away from them. They’re a little bit riskier. They’re short term trades, so if the market has a big pop up or a big drop you can really lose a lot money very quickly, so the monthly trades are a little less risky from that perspective.

I like to start entering my trades around 30-40 days from expiry and then look to exit the trade around 5 days to a week before expiry, unless the trade is really safe and it’s a long way from my short strikes.

Occasionally, I’ll just leave it to expire if it’s something like two standard deviations away, but otherwise I tend to not want to be in the trade for that last week, just because it gets a bit risky and a bit hairy. That’s where gamma really comes in to play.

I really look at the monthly timeframe as a general rule and just trade around that position. Over the first two weeks of the trade, I tend to build up the position and play offense, as I like to say. Then, over the last two weeks of the trade, you’re playing defense and, just trying to manage the position. You’re not adding any more capital to it, you’re just managing it and when there’s about five days left to expiry, I look to get out.

How much time would you say you spend on these trades or just trading in general? 

I’m typically watching the markets and checking them a couple of times a day.

With these trades, particularly at the start of the trade, they’re actually fairly boring, not too much happens unless there’s a big move in the market or stocks. You can get away with checking it once a day, so it really doesn’t take too much time to trade this type of strategy.

I’m constantly looking at the markets anyway and looking at different ideas and doing research and things like that. In terms of the actual trading, it’s just my one main trade every month and then each week I make probably one or two adjustments to it.

You’re really not looking at too many actual trades that I’m making each month. It’s one of those things where you can just monitor it, and if the market is pretty stable, you don’t even need to log into your brokerage account. You know that your trade is doing fine. It’s really a very low-stress way to trade.

I get the impression that you did an enormous amount of work on the front end to gain all of the knowledge of what kind of trade you’re looking for, but I don’t get the impression that you stress about it very much now. 

It does get stressful occasionally if a position starts to move against you, as with any strategy, but on a day-to-day basis, it’s pretty low-stress.

Where do you trade from?  Do you trade from a home office? 

I still work full time, so I’m a retail trader. As I said, I can make a couple of trades a week, and that’s it.

So you’re not a multi-screen, stare at the screens all day kind of guy?

I do have three screens, but no, I don’t sit and stare at them all day.

I have found that multiple screens work better for fantasy football than they do for trading. 


If someone is interested in your strategy, what do you believe is the most important ingredient to becoming successful?

I think you’ve got to build up that knowledge base and be patient. A lot of people want to rush into these sort of things and that’s where you’re going to get burned.

You have to really start small and build up your knowledge base and learn as you go. There’s only so much you can learn in a book, you have to really get in there and start placing some trades. Just start with one contract with a low amount of risk and go from there.

Patience is really important. Not trying to rush things, and also patience in terms of waiting for the right trading opportunity.

The other key ingredient would be discipline to stick to your trading rules, because it’s a strategy where, in a typical trade, you’re risking $9,000 to make $1,000. You can potentially lose more than you can make, so you do have to be pretty disciplined with your risk management and cutting your losses when the trade starts to go against you.

If you’re risking $9,000 to make $1,000, you’re obviously batting a pretty high success rate on these trades, right?

Yes, exactly. You’re looking at a 75-80% success rate.

That’s pretty impressive.

The key with these strategies is when you do have those losing trades, not letting them blow out. That’s the real key.

I think that goes hand-in-hand with what you said earlier about getting your losses out of the way early and with getting in the market and getting some experience. 

Just building up that experience and starting small, then scaling into it and scaling up once you get that experience, build up that confidence, and build up your knowledge base.

How much capital would someone need to start trading this kind of strategy?

You probably would need about $10,000 to start. You could do it with maybe with as little as $5,000, but I think $10,000 would be a much more reasonable number.

You mentioned a couple of books already, but what is the first book someone should grab if they’re looking to learn more about this kind of strategy?

I’ve actually written a book, so a little bit of self promotion here, it’s called the Bullshit-Free Guide to Iron Condors.

A lot of books cover every single option strategy, whereas this one just solely focuses on Iron Condors. You can check that out on Amazon, or there’s a link to it on my site at Options Trading IQ.

Are there any lesser-known, or non-traditional trading books that have helped you along the way? 

There’s a really enjoyable read called Traders, Guns and Money. That one is quite entertaining.

Another really good book, I don’t know if it’s a lesson learned, but it’s called High Probability Trading by Marcel Link. That’s a very good, general trading book that’s not really regarding options, but there is some really good advice in that book.

You also run a website, is that right? 

I’ve been running my website since 2010. I have a blog on there where I put up some trade ideas and lots of educational articles, and offer some coaching services and things like that for anyone who’s interested. I’ve been doing that for a few years now and it’s going quite well.

It’s called Options Trading IQ.

I think it’s a very interesting approach, and it’s quite different than a lot of the other people I’ve interviewed. 

I’m not sure how many of your readers and listeners will know much about what I was talking about in terms of the options, but hopefully it would have at least piqued their interest to find out more about them. There’s lots of great, free resources out there on the CBOE and things like that.

What’s the best way to contact you?

Just head over to the website and you can email me from there, or you can email me direct at