Q and A. Iron Condor Position Switch Near Expiration

Blue cat asked this question:

Hi Mark,

With respect to insurance — or other danger mitigation strategies — what do you think of splitting a spread in two?

Let's assume one were short the APR RUT 470/480 call spread. After today (RUT at 468.2) one would probably be
fairly uncomfortable. At current prices it would cost about 3.80 to get
out of the position.

One could pay for it by selling a 450/440 put spread for about 2.1 and a 480/490 call spread for 2.6.

These are all mid-point prices, and provide a
credit of 0.9.

After this trade, one would have at least the breathing room between
450 and 480. It's not much breathing room, but it's better than
being short at 470
. In addition, as premium sellers, time is on our side –
so any breathing room helps. And we did take in a bit more

One might even plan to get out of either or both positions Monday if
the market is fairly quiet between now and then. In this case, with  expiration coming next week, even the few days between now and Monday
should help quite a bit.

(I did the arithmetic for all this in my head. If I made a mistake,
look at the strategy rather than the numbers in this example.)

Hi Blue Cat,

I agree that the specific numbers are not important and that the strategy is the point of discussion.

As an aside: If you want to get out Monday, when are you planning to make this trade?  There are no days between 'now' and Monday. There are calendar days, but no trading days.

First a comment:  It is typical for investors and traders to want to collect a cash premium when making any adjustment.  The obvious thought pattern is that if you take in cash, the loss from the original trade is offset and you have a chance to earn a profit that's even larger than the previous potential profit.  Or, extra cash gives you room to pay up to exit the trade, and still have a profit.  And that makes sense to a point.

But, in my opinion, the cash is not important.  You cannot salvage every trade and inevitably there will be losses.  You want to manage your portfolio to give you the best chance to not get hurt (big loss).  You also manage a portfolio by balancing potential profits with your perceived risk for a given position.

Thus:  If you are not comfortable with the current position, the priority is to take care of that problem.  You can close all or part, you can buy calls for protection, etc.  Choose the risk reduction alternative of your choice.

Next, decide:  Do you want to get back into an April iron condor in an attempt to recoup losses NOW?  I'm not saying that's would be the wrong thing to do.  In fact, it's very tempting.  But for you and your comfort zone, do you want to make that trade?  If 'yes' – then do it.  You may even prefer to sell fewer contracts to compensate for the fact that you will be taking in extra cash.

Look at the new iron condor you proposed.  Do you truly like that position?  Is it one you want to own, or is it a desperation gamble to turn your current problem into a very profitable win?

My advice is:

Don't do it, if it's a panic move.

Do consider it if you feel it's a better position.

You are trading an immediate problem for a whipsaw risk.  If that's good with you, then sure, this is a very viable idea.

If I understand your question correctly, you are asking my opinion about this as a strategy.  I'm sure you understand that's not a question I can answer.  This is very much a comfort zone decision.  if you would be comfortable with the new trade, then it's a good strategy.  As for myself, I don't like holding near-term positions so close to expiration.  But, I must confess I do have a residual April position that I'd prefer not to have, and your proposed 'solution' is very tempting, but I would not want to do this myself.  My reason is that with two spreads, each close to the money, there's just too much chance of having one of them become a large loss.  Your current position has only upside risk.  But, that's my comfort zone speaking.

As a strategy it's okay.  You also have the choice of taking the loss, ignoring April, and moving on to May.  There is no right answer, unless you think it's fair to look back afterward and then decide what you 'should' have done.  There's nothing to be gained by doing that.

There are several very reasonable actions you can take here, and the one you suggest is among those.

BTW, if you do make this trade, I strongly suggest you cover your residual April put spread (if you have not already done so).  There's no reason to risk a gargantuan disaster.

Addendum, two hours later.

I appreciate the feeling that moving your ATM iron condor to new strike prices – a bit further out of the money, appears to give you some 'breathing room.'  But, when you look at the facts, you see problems.

Let's keep this simple and assume you will hold the position through expiration and that you want to choose between:

a) Short 470/480 call spread

b) Iron condor:  440/450 put spread; 480/490 call spread

The Apr 480 call has a delta of 34.  That means there is roughly a 34% chance than your current position will move to it's maximum loss.

The Apr 440 put delta is -11 and the Apr 490 call delta is 23.  Thus, the probability of incurring the maximum loss is basically identical (it's a fraction worse for the new IC) with either position – 34%.  It may appear to be less less risky, it may feel as if there is breathing room, but that's merely an illusion.

If your plan is to cover the position very soon on a market decline – thereby salvaging a small profit or accepting a much smaller loss, I don't see how the IC is any better – especially when you would have to make extra trades to open and close that new IC.  Those trades deal with slippage from those wide bid/ask differentials two additional times. And for some traders, those extra commissions become significant.

As long as you understand that the probability of success is not increased, it's okay to make this trade for your comfort zone.  But, it's not really any better.


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