Q and A. Trouble With Iron Condors

Mark,

I have been trading IC for some time now and have become accustomed to different types of adjustments, some with great success and others not so much. The point is, the timing on the adjustments are proving difficult to master. 

My IC tend to be opened approximately 3 months out – I like to give myself some time to let them work.  However as a few weeks pass and the underlying has moved within a few % of my short strikes I find myself deliberating whether to hold a little longer before adjusting. Ordinarily, my comfort level would be to wait longer, but no later than a month before expiry to adjust. That being said, I am now considering adjusting earlier. I would be interested to hear your thoughts on this situation? 

Thanks, 
S.

***

I believe very few people can successfully time the market.  That's true for new investments as well as for adjustments.  So don't beat yourself over the fact that timing is difficult to master.  It's difficult, period.  Forget about the 'master' part.

As to adjusting earlier – there's nothing either good or bad about that in itself.  It's simply a more conservative approach.  You will probably have fewer wins and more losses, but the losses will be smaller.  And if you adjust early enough, you may convert what would have been small losses into small wins instead.  [See the idea about adjusting in stages below.]  Does that work for your trading style?  It's a personal decision.


Trading philosophy

My philosophy (it may not suit you) is that you make the best decision you can at the time a decision must be made, and then you live with what you have done – until it becomes time to adjust once again.  Closing the position because you are happy with the profits does count as an 'adjustment.'

You may not be able to master the timing, but you can master knowing when risk has increased beyond your desire to carry that risk any longer.  Right now you are using "within a few percent of the short strike."  To me, that is a very reasonable adjustment point. 

Apparently you are not always pleased with the results.  Be fair when judging your performance.  Are you dissatisfied because the adjustment proved to be unnecessary (market reversed direction), or are you unhappy that a different type of trade would have worked out better?  If you made a good decision – a decision that was appropriate for your comfort zone at the time it was made – that's a good decision in my opinion.  It's not fair to call it a bad decision if result in a monetary loss and a good decision if it's a winner. 

 
Keeping score by 'the results of the adjustment' is fine for a very short-term trader whose goal is to time the markets.  But you hold iron condors for a month or two, and market timing is not your primary concern when adjusting.  Making sure you don't get blown away is your primary consideration. [My #1 rule for option traders:  Don't go broke.]

Stages      

 Stage Coach

Have you considered adjusting in stages?  You may decide to adopt different strategies, depending on the stage.  When you adjust a portion of the position at a time, you can encompass your idea of 'adjusting earlier' by making a Stage 1 adjustment earlier than your current methods.

The following is merely one idea for establishing stages. Please consider it as a possibility, not as a specific recommendation.  I assume you trade more than 2-3 lots of those iron condors.  Small positions are difficult to adjust in stages.  In fact, they are difficult to adjust.

Stage 1.  Adjusting 20% of the offending position.  How do you do that?  Several choices:

a) Close 20% of the position.  You have the option of rolling to a new spread, but you already have a risky position and there's no good reason to open another position when your portfolio is in a bit of jeopardy.

b) Buy extra options – enough to cover more than 20% of those deltas.  Also enough so that the risk graph is less scary than it was before you adjusted.  Again a choice:  Buy options that expire at the same time as your risky position, but spend the necessary cash to get options that are closer to the money.  For example, if you have a 750/760 put spread in trouble, buy the 770 put.  You may only be able to buy one or two because of the high price.  It's tempting to buy 740 or 730 puts, but thsoe only work when the market takes a big dive.  They make the risk graph look great, but there's a decent chance you could lose the maximum on your original position and also lose the cost of the OTM puts.

I prefer (but many traders cannot bring themselves to do this) to buy front-month options as temporary protection.  There are two excellent reasons [more details in Chapter 20 of The Rookies Guide to Options] for doing this:

i) They are less expensive (in dollars, not necessarily in implied volatility (IV).  But, we trade using dollars, not IV chips.)

ii) You can get an option with a more useful strike price at a decent dollar price.  In the example, you may be able to buy front-month 780, 790, or even 800 puts.  Those pack a powerful punch and provide excellent protection.  Even if it's a one-lot.

c) Roll part of the position to a same month, further  OTM strike.  This will cost you cash out of your pocket, but it's still a good idea if two conditions are met: 

i) You an get a decent premium for the spread you sell.  Don't pay $3.00 to close the dangerous spread and then sell a new spread for $0.50.  There is no point in opening the new trade with new risk for a mere 50 cents.

ii) If, and only if, your position is smaller than usual, you may choose to sell a small number of extra spreads – to pick up some of the cash you are paying to cover.  But, DO NOT believe that all you have to do is sell enough extras so that the adjustment trade is free (no out of pocket cost).  That would increase your size – and risk – by far too much.  That's a common trap.  Be careful not to fall into it.

Stage 2.  If the position continues to move against you and you are still not ready to exit the entire position, adjust an additional 30% of the original trade.  That cuts the position to half it's original size.

You can choose any of the adjustment ideas used in Stage 1, including the possibility of rolling (but please – roll only when you believe the new position is attractive to own.)


Stage 3. 
Comfort zone breached.  End of story.  Exit the remaining 50% and decide whether to open a new position at this time.

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