Tag Archives | iron condors

Adjustment Woes

Hi Mark have been trading iron condors for awhile but always get burnt when time comes to adjust

Hello Kaye,

Adjustments prevent getting burned. So let me make a few observations:

    –If you wait too long and have already lost too much money by the time that you decide to adjust the position, then all the adjustment can do is help you not lose too much additional money. It is unlikely to produce a happy overall outcome. I understand that we don’t like the idea of adjusting too early because the market may reverse direction. However, there is a good compromise that depends on your comfort zone. I hope that you can discover that compromise. Consider adjusting in stages.

    –If it is the adjustment trade itself that produces the poor results, then there are alternate adjustment strategies. Rolling is not the only choice. And if you do roll, I urge you not to increase position size by more than a modest amount. It is okay to roll from 10 spreads to 12, but increasing size to 20-lots is just asking for trouble because some trades get rolled multiple times and positions can become var too large.

    –It is easy to get burned when you sell extra put spreads (on a market rally) or sell extra call spreads (on a decline). It the scheme of things, it is very important to prevent risk from escalating. Translation: If you must sell new put spreads on a rally, please cover the already existing put spreads — just in case we see a market just like the past week. The rising market reversed direction suddenly and made a bit move lower. There is not enough residual profit potential in that original put spread to risk leaving it uncovered. That is the reason it pays to cover when selling a newer spread.

    –If you are trading with a market-neutral bias, then the adjustment should return your position nearer to delta neutral than it was before the adjustment. In other words, when you do not have a market bias, try to avoid using the adjustment to recover lost money. Don’t suddenly decide to trade an iron condor that tries to take advantage of the current market trend. In general, iron condors are not suitable for traders with a market bias (unless it is a small bias).

    –If none of those situations apply, if you provide an example or two that describes what went wrong, I will try to provide some insight on your trade. Remember that every losing trade does not mean that the trader made any mistakes.

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Managing Iron Condors: The Worst Adjustment

My oft-stated belief is that it is almost impossible to become a successful options trader without becoming a skilled risk manager.

When it comes time to decide how to reduce the risk of holding a position, there are many choices. The alternatives are too numerous to describe, however, the basic choices are

  • Do nothing. This is not risk management. This is wishful thinking
  • Adjust the trade to reduce risk
  • Cut position size by exiting all or part of the position

The best decision

making a decision

I believe that adjusting the trade represents the best choice, with the following stipulation: Once the position has been adjusted, the trader likes what he/she owns; believes it is likely to earn profits going forward; is no longer too risky to own, and satisfies the psychological needs of the trader. That last phrase simply means that it is comfortable to own the position and is not being held for the sole purpose of recovering a loss.

When it comes to adjusting, there are always going to be alternative trades from which to choose. Today I want to discuss one specific type of trade. I know that many traders like to adopt the example that I’ve chosen to highlight Despite that fact, I believe it is the worst possible choice.

The worst choice

    Assumptions: We opened an iron condor position and the market has declined to a point where the put spread has become worrisome. For this discussion, it doesn’t matter whether the put spread is 5% OTM (far too early to be concerned in my opinion); 3% OTM or ATM. The point is that the underlying asset has moved to a point at which the specific trader who made the trade is uncomfortable holding the position as is, and wants to make an adjustment.

    Let’s assume that the position is long 300 delta.

There is one adjustment method that I avoid discussing – just to minimize the possibility that it would occur to any reader to experiment with this trade idea. Keep in mind that the ONLY reason for making an adjustment is to reduce risk – as long as the new position is worth holding. We do not reduce risk to crate a position that we do not WANT to own.

So what is this adjustment that I think is so terrible?

It’s the sale of call spreads to add some negative delta to the portfolio. (Or put spreads when the market has been rising and the portfolio is delta short.) Selling call spreads accomplishes some noble goals: It move the position nearer to delta neutral. When trading with no market bias, that’s a good thing. It also adds more cash to the trader’s account, increasing the potential profit, and we all like to earn more money.

One other benefit of adopting this strategy is that it seems to work so often. Much of the time the market continues to drift lower, making this adjustment profitable. Of course the put situation has gotten worse. That’s not a real problem when the trader is on top of the situation and is taking steps to manage risk. However, all too often the steps taken include the sale of even more call spreads. Once again, taking in cash and reducing the immediate delta risk.

I must admit that this strategy works very nicely when it works. Sometimes the cash from the call sales is sufficient to cover all losses from the put side of the iron condor and the trader may eventually earn a profit. Sometimes the market stops moving lower and the trader not only earns the original cash collected when initiating the iron condor trade, but is rewarded with extra profits derived from the call sale.

That’s the good news.

However, the primary (if not the only) purpose of making the adjustment is to reduce risk. This method does reduce delta risk (temporarily), but it adds negative gamma and a significant downside risk. when selling those additional call spreads, too often the trader sells a cheap spread (so it is reasonably far OTM). That does notr add very much cash to the kitty, and adds major risk of loss – if the market turns – for very little cash. If the trader makes the better (but still terrible) choice of selling calls spreads that generate a ‘decent’ amount of cash, then there is at last a reward worth earning for taking the risk.

But that’s the point. Adjustments are risk-reducing trades (or should be). The idea that lessening delta risk makes for a good adjustment is not the way a successful or experienced executes adjustments. I understand how powerfully profitable this plan looks. But it only takes one large and sudden market reversal to blow up an account with far too much loss exposure.

But there are two potential disasters that await. I believe that the sole purpose of adjusting a position is to reduce risk – not to seek extra profits. [I am not against earning extra profits, but the primary purpose is to make the current position safer and worthwhile to hold.]
When extra call spreads are sold,nothing is done to reduce the risk presented by those put spreads.

Problem number One: If the market continues lower, the loss form the puts is going to increase rapidly. The sale of call spreads is not going to generate enough cash to offset these losses. Thus, the primary purpose of making an adjustment – to keep risk of loss at a reasonable level. Once those puts move into the money, it becomes far more difficult to manage the entire position. Not only are the put spreads problematic, but the continuing sale of call spreads can result in blowing up the trading account if there is a sudden market reversal.

Problem number Two: When keeping risk in line is not the MAJOR (it should be the only) consideration when making an adjustment, far too often risk builds and goes unnoticed. The type of trader who employes this ‘sell more calls’ method of risk management seldom bothers to buy back those now, far OTM call spreads. It’s bad enough to create downside risk – where none existed before – but to not buy back the cheap options creates a scenario in which a traders account can disappear overnight.

This is unacceptable risk (Obviously an pinion and not a statement of fact). But it is a tempting methodology. It works most of the time. It can lead to extra profits. It’s easy to fall in love with this strategy. But good luck does not hood forever. Markets do get volatile again, and despite promises that the trader makes to him/herself to act in plenty of time – f necessary – the personality that sells those extra spreads to bring in more cash – is not the right personality type to be able to rush in to cover those call spreads when the market turns. In fact he sale of additional put spread would probably be the trade of choice.

This is a disaster waiting to happen. I feel it is the worst possible adjustment chocei and would go as far as to say that if you are considering this play – selling more calls without buying back the original call position – it’s better to exit and take the loss, rather than to build risk to unacceptable levels.

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Trading Iron Condors in 2011

It’s 4½ months into the year and I’ve found this to be one of the easy periods for iron condor traders. Of course, that’s a personal opinion, based on my results. Here’s someone who seems to disagree, yet has made decent money with this strategy.

Christopher Smith at TheOptionClub.com

This year I committed to an experiment that has me trading an iron condor on the SPX every month – regardless of market conditions. The purpose of this exercise is to demonstrate techniques for managing risk and prove that with diligent risk management it is quite possible to limit losses while still creating profitable opportunities.

This year has not been particularly favorable for iron condors, but we have managed to avoid any significant loss and currently we have what amounts to a 20% yield on capital of $5,000 while risking approximately $4,000 or 80% of the capital – holding $1,000 or 20% in reserve.

One of us is living on a different planet. If not, then this comment illustrates that trade selection and risk management techniques vary tremendously among traders. I always knew that traders are different, but cannot see how Chris sees early 2011 as not favorable for iron condors and from my perspective, I could not disagree more.

It’s not a good year for the strategy, but he has already earned 20%?

I think it’s been a very easy year and have earned more during this period than I have ever as a retail investor (over a comparable period of time). I mention this for one reason: I didn’t have to do anything. No skills required. Just trade the iron condors and then exit. Perhaps a minor adjustment or two, but nothing special. I know these returns are not going to continue. And to be honest, I don’t expect to ever see a five month run that is this profitable again. Nor one as easy to manage.

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Iron Condors: Introduction to Risk Management

One of my oft-repeated messages to option traders is that it is easy to make money when trading options and the difficult part is keeping those earnings. Many of the income-producing strategies win a majority of the time. They are designed to produce more wins than losses.

The problem arises when the stubborn trader, doing whatever he/she can to avoid taking a loss turns a position into a giant loss. That’s the path towards blowing up a trading account. We all say that it will never happen to us because we are too smart, or too disciplined, or too anything else that you want to include.

The fact is that you must be able to apply that discipline when the pressure is on. That means when losses are mounting, the market is not moving your way, and you are pleased with neither what you own nor the chances of salvaging the position. If you cannot pull the trigger when that’s what must be done, then you are in trouble. Warning: pulling that trigger far too early – just to prove you can do it – is also ineffective.

With that as background, a discussion of risk management is necessary for option traders.

Introduction to risk management

Today’s video is a basic introduction to the concept of risk management. It’s 8 minutes of background and general advice, with no specific trade suggestions.


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Less Costly Method: Hedging with put options

I’ve joined the impressive group of writers who publish their thoughts at the new CBOE blog

The following excerpts comes from a recent post by the (Surly Trader)

Put Spreads as an Attractive Hedge

Hedging equity positions [with puts] can be fairly expensive, but there are very attractive ways to mitigate that cost.

Bearish Diagonal Put Spread

I like the (bearish/reverse?) diagonal put spread strategy for a number of reasons: [MDW: I would call it ‘reverse’]

I am purchasing implied volatility at much lower levels by buying the short dated put, making the short dated downside protection fairly inexpensive.

I am selling implied volatility that not only takes advantage of the steep skew, but also takes advantage of the fact that longer dated options are trading at higher implied volatilities than short dated options.

I hope this brings some new ideas to your option trading strategies.

My all-time favorite hedge is one step removed from here – a bearish ratio diagonal put spread in which I buy short dated put options and sell a larger number of far out of the money longer dated put options….

He (ST) is advocating buying a front-month, less expensive, put option and selling extra longer-term, farther OTM puts. Two points:

  • Less expensive because it is front month an d has much less time value (obviously), but also
  • Less expensive because it has a higher strike price and thus a lower (becasue of skew) implied volatility

    I like part of this plan, but prefer not to sell naked options.

      Example, Surly Trader’s play may be:

        XYX is trading ~520 to 540

        Buy 10 XYZ Jun 500 P
        Sell 30 XYX Nov 420 P

    I’ve previously written about a similar plan. It’s the coward’s version. He sells naked options and I sell option spreads. But we both suggest owning the short-dated options. I encouraged that idea as a risk management method for adjusting iron condor positions in The Rookie’s Guide to Options.

    In the coward’s version, I sell 30 or 40 put spreads (vs.10 puts bought): It’s not easy to know which strikes because so much depends on IV. Yet a reasonable guess is the 420/430 P spread or the 430/440s.

    If the market makes a steep decline, My long put will prove to be very profitable – perhaps explosively so due to a much larger IV increase (as measured by IV points, not in $) in the front month options . This represents a situation in which positive gamma becomes our ally – and there is no worry about fighting negative gamma.

    The shorts are spreads, with limited losses. Profitability for the whole trade depends more on how far the market moves and how much time remains in our long options (time value can be significant, even during the last few days prior to expiration) than on the price of the short spreads.

    This reverse ratio diagonal spread produces favorable results when:

    • Rally occurs with volatility decline. Longs expire, Cover shorts cheaply
    • Large, rapid decline
    • Time passes, longs expire, but shorts decline by enough to turn the whole position profitable. This is the result of owning cheap Jun options (and not costly Nov options) as protection against the Nov shorts

    This trade is uncomfortable for many traders because they know must buy new protection, or exit the trade.

    Despite the apparent ‘backwardness’ of this trade, at times it can be the best choice – if not as a stand alone trade, then as an adjustment for a credit spread gone awry. I would not make this my strategy of choice. But it has enough going for it that it is always a consideration. And it is ST’s favorite.

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Advice for the new options trader

I ‘borrowed’ (and modified) the following question from the EliteTrader Forum.

I have been studying, paper trading, and real trading – using mixed options strategies with mixed results. I mainly sold call & put spreads and did ok – until I got hammered on one trade. I’ve tried weekly & monthly expiration because I was attracted to these trades and their high probability of profit.

I have a $5k account and pay $1.50/contract flat rate commissions. At the moment, I am being lured into iron condors.

I am not dependent on my account but I want to grow it. I prefer strategies that require low monitoring/maintenance, but I am open to suggestions. What strategies should I try to incorporate and why?

Good news for this trader

This rookie trader is seeking advice, has experimented with several trade ideas, has a good attitude (does not expect instant riches), and incurred a loss from which he has learned a lesson. He appears to be patient and is seeking new ideas to consider.

This person has a nice edge: He has a flat rate commission per contract. That allows him to trade small size (yes, even one-lots) without having to be concerned that the ‘per ticket’ charge will consume too much of any profit. This was an intelligent item to negotiate and I strongly recommend this idea for all traders who trade small size. The savings can be significant – if you can get them.

The not so good part of the story

He is being ‘lured’ into a new strategy, but he should only adopt this play if he feels comfortable using it. In truth, it’s merely a combination of the strategies he has already been using – and in my opinion, anyone who understands the risks associated with selling vertical spreads is ready to consider trading iron condors.

The other problem is the size of the trading account. I understand that brokers allow customers to trade with even less capital, but it is a difficult task. It is simply too easy to lose the entire account when it is small.


As a young person with a job, he is in position to make a deposit into this account every time he receives a paycheck. That’s an outstanding method for increasing wealth over time. However, with this advantage comes the responsibility of carefully managing risk.

Learning to do this well takes time. The best recommendation I have is to be very careful with trade size because that is the simplest and most efficient method for managing risk for any trader. Smaller is better. Less risk and less profit potential is better – especially when the trader is first getting started. There is plenty of time to increase size as experience and confidence grow.

Patience is necessary because some strategies (such as selling credit spreads) may take some time to perform as hoped. [It’s true that selling a put spread can become very profitable quickly when the stock rises, but in a neutral market, iron condors require patience and good risk management.] Experience does not come quickly.

I also offer this advice for our rookie trader:

  • Rapid time decay may look great on paper, but (as you already learned) it comes with explosive negative gamma, making these trades riskier than they appear
  • Longer-term options come with higher premium and more protection against unwanted market moves. They also lose time value more slowly
    • Trading involves trade-offs. Less risk requires accepting a smaller profit target.
    • Your problem is to find the trade-off that feels ‘just’ right.’ Not a simple task – but it gets easier with experience
  • Choosing a good strategy is important. You want to feel that you understand how to use it effectively
  • However, risk management is more important and will have the greatest effect on your overall performance
  • Which strategies?

    The list is long. Options are very versatile and provide many alternatives. If you are comfortable with credit spreads, they make an excellent choice because losses are limited, margin requirement is small – allowing you to diversify, and they are easy to understand.

    Then there is something you may not yet recognize: Selling the put spread is equivalent to the very conservative collar strategy. More than that, selling put spreads is the same as buying call spreads (same stock, strike, and expiration date), and selling call spreads is the same as buying put spreads (same stock, strike, and expiration date).

    That means you are already using a much wider variety of strategies than you realize.

    I believe you are on the right track. Don’t get greedy. Increase position size one contract at a time, and don’t do that too frequently. Keep asking questions and don’t accept all replies as ‘correct.’ Use your own judgment.

    Excellent reviews for first live discussion session at Options for Rookies Premium. Become a Gold Member and get invited to future sessions
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    Condors vs. Iron Variety

    Mark: If you will, address an options trading question (maybe a rookie question) to which I’ve never found an answer.

    What is the benefit of selling iron condors (bull put spread/bear call spread) over buying condors (bear spread/bull spread – puts or calls, but not both)? The profit/loss graphs of the IC and the condor are identical. Clearly, with the IC the cash remains in your account and is increased by the premium collected rather than paying for the condor and collecting a profit (hopefully) later on, but the interest earned on the funds is, at least presently, negligible. Also, it appears that there might be a slightly greater premium for an IC over a condor, but I don’t have enough of a statistical sample to draw that conclusion.

    So, why are iron condors so popular while non-iron condors are rarely mentioned? Thanks, as always, for your wisdom.


    That’s a very interesting question and the truth is I don’t know.

    I believe it’s a trader mindset. I believe that most traders prefer to have the cash in their account (iron condor), rather than pay cash for a position (condor). In this situation, the positions are equivalent and there is no theoretical advantage to trade one over the other.

    However, there is a practical consideration. Because the trader anticipates that all options will expire worthless (obviously only when the trade is held though expiration), there is an extra reward for winning: There are no exercise/assignment fees to pay.

    When the condor buyer wins, one of the spreads is completely ITM while the other is worthless. That requires payment of one exercise fee and one assignment fee. We know that some brokers do the right thing and provide exercise and assignment at no cost to the customer. However, that is not a common situation. Thus, all things being equal, the iron condor is better by the amount of fees saved.

    More on mindset

    Covered call writing is very popular among rookie traders. It’s easy to learn and nearly all brokers allow their novice traders to adopt that strategy. Selling cash-secured puts is the equivalent strategy, and adds cash in the trader’s account, but most brokers don’t allow their beginners to make that play. That’s true despite the fact that the trades are 100% equivalent.

    Where does trader mindset come into the picture? I can’t be certain, but I feel that most traders who get used to writing covered calls never make the effort to switch to selling puts – even when their broker would give them permission. There is a certain comfort in trading a familiar strategy.

    I believe it’s the same with condors. More books are written on iron condors, more bloggers use iron condors as topics, and thus, people who adopt this strategy begin with the iron condor and never make the change.

    In the condor case, it’s correct not to make the change, but writing covered calls is not a good idea when the trader understands the equivalence of selling cash-secured puts. What’s the edge? Fewer commission dollars per trade. To me, the other, and more important point is that it’s far easier to exit prior to expiration. when the stock rises above the strike, OTM puts become cheap (eventually) whereas it’s not easy to trade ITM, higher priced call options as a combination with stock.

    Exiting not only locks in the profit, but it frees cash for another trade.

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    Managing Iron Condors with Imagination

    This post is based on the very thoughtful comment/questions posed by Chris O.

    Dear Mark,

    I have been thinking lately, If one always exits an IC early, say one month before expiry on an IC that was opened three months before expiry, is it useful to do the following:

    As the short legs of the IC ought to be closed one month early and I want to discipline my self to do so, why don’t I select my protection, the long legs of the IC, at one month earlier expiration.

    Such wings of the Condor are cheaper to buy. The wings of an IC chosen the normal way, extending to the same expiration, are mostly worthless when I sell them one month before expiration, together with buying back the short legs of the IC.

    So using shorter duration long legs on the IC takes away any hapless covering of the entire IC, and allows me to make more money?
    Looks like Free lunch = I must be overlooking something.

    Not so free lunch

    This is not a free lunch, and there is likely to be significant margin problems. However, the strategy has a great deal to recommend it.

    You envision an iron condor similar to the following:

    Buy X INDX Jul 1050 calls
    Sell X INDX Aug 1040 calls

    Buy X INDX Jul 880 puts
    Sell X INDX Aug 890 puts

    Your long options expire before the short options. This has a lot going for it, per your description above. However, the margin gods don’t like such positions. When the long option expires after the short, they are considered to be naked short. That uses up a ton of margin for the average investor.

    Portfolio margin

    However, if your account uses portfolio margin, you are granted many special advantages regarding margin. Such accounts are margined by looking at the overall risk associated with the portfolio – and not by looking at each individual position. The bad news for many is that the account must be at least $100,000 to qualify. But readers should ask their broker about portfolio margin, just in case they do something different. [IB follows the rules mentioned here]

    Forced exit

    If you want to ‘discipline yourself’ to exit one month early, this is certainly a good way to do it. However, do keep in mind that when INDX is near 880 or 1050 (the strikes of your long options), the longs are going to expire worthless and it is going to cost a lot of money to buy back your shorts.

    Nevertheless, that specific result will not occur very often and over the longer-term this may well be a winning play. This trade allows the position to be opened for a large cash credit, and there are obvious benefits in doing that.

    1) one spread, put or call, might be too close to the money and have to be bought back at a loss or a additional wing must be bought for that side to cover a short position during this last month. Does not make sense as an argument, I want to stick to the rule of closing the short legs on month before expiration, so closing at a loss is “biting the bullet”. I definitely don’t want to stick around in a high gamma last month environment with a short option close to the money, even when it has a long option covering to the final month.

    Yes, it makes sense to me. However, I urge you to take the worst case scenario, estimate an implied volatility for the August calls, and get yourself a good estimate of how much can be lost. If you size this trade properly (that loss is acceptable, not devastating), then you will be in good shape when using strategy.

    It’s easy to back-test, if you have the data. Or you can accumulate data in a paper trading account. To gain data quickly, do three different indexes simultaneously.

    2) IV might have jumped on the underlying, and both short options may have higher value than I collected – even with one month to go. Does not matter? If IV is so high I don’t want to remain in the last month when gamma is also high. Wild swings can happen. So again, why bother buying wings on an IC when the plan is to carry the IC to the final expiration?

    Are long legs of an IC carrying to to the last expiration date worth anything, one month before expiration at a high IV?

    Yes, it matters. Yes, IV may become a problem. And yes, those one-month options would have a very high value in your high IV scenario.

    However, a low IV offers an occasional extra profit. The key to survival here is being very careful about position size.

    There is a point you are missing. If you own the traditional iron condor in a high IV environment, one month prior to expiration, your remaining long call would significantly cut the loss when exiting. But, as you say, your plan is to earn extra profit all those times when IV is not extra costly and your long option is not near the stock price. Probability is important for a good analysis of this play, and having he ability to back-test this method for a bunch of years would be helpful.

    3) I am trying with a small position, now running until final expiration in May, at Interactive Brokers and see little effect on margin requirements. No argument either.

    Can you shed some light?

    Thanks a lot for your efforts

    I don’t understand why there is no problem with margin. Please let me know if you are using portfolio margin.

    Do keep in mind that there is little to be learned from a single example. You can develop some novel adjustment ideas, but this study requires a good deal of data.


    P.S. On Options for Rookies Premium, is the planned content difficult to organize for people in a very different time-zone than yours?

    [Visit the link above for a short video that describes live meetings (and the problem of time zones), one of the important features for Gold Members. You must become a free member (Bronze) to gain access to the video]

    Yes, different time zones present a problem when planning live meetings. We already have members from Hong Kong, Singapore, and the Netherlands. Therefore, I am requesting that members suggest times that are best for them and I’ll do what I can to make it convenient for as many as possible. If necessary, I’ll add extra sessions. For now, I’m promising four live sessions per month, but I suspect it will have to be more than that.

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