Stochastic Optimal Control of Iron Condor Portfolios for Profitability and Risk Management

TL;DR

This paper formulates Iron Condor portfolio optimization as a stochastic control problem, demonstrating that certain strike structures and stopping strategies optimize profitability and risk management in SPX markets.

Contribution

It introduces a stochastic optimal control framework for Iron Condor portfolios, proving the optimality of specific strike structures and stopping times, supported by simulations and real market case studies.

Findings

Asymmetric, left-biased Iron Condors with  = T are optimal in SPX markets.

Deep out-of-the-money strategies increase profitability but also risk of extreme losses.

Optimal stopping times generally occur between 50% and 75% of the total duration.

Abstract

Previous research on option strategies has primarily focused on their behavior near expiration, with limited attention to the transient value process of the portfolio. In this paper, we formulate Iron Condor portfolio optimization as a stochastic optimal control problem, examining the impact of the control process \( u(k_i, \tau) \) on the portfolio's potential profitability and risk. By assuming the underlying price process as a bounded martingale within $[K_1, K_2]$, we prove that the portfolio with a strike structure of $k_1 < k_2 = K_2 < S_t < k_3 = K_3 < k_4$ has a submartingale value process, which results in the optimal stopping time aligning with the expiration date $\tau = T$. Moreover, we construct a data generator based on the Rough Heston model to investigate general scenarios through simulation. The results show that asymmetric, left-biased Iron Condor portfolios with $\tau = T$ are optimal in SPX markets, balancing profitability and risk management. Deep out-of-the-money strategies improve profitability and success rates at the cost of introducing extreme losses, which can be alleviated by using an optimal stopping strategy. Except for the left-biased portfolios $\tau$ generally falls within the range of [50\%,75\%] of total duration. In addition, we validate these findings through case studies on the actual SPX market, covering bullish, sideways, and bearish market conditions.