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The Greeks. Are they Greek to you? Part II

This is an important, basic two-part post for rookies and anyone who wants to learn about using 'the Greeks' to manage the risk of an option position.  Part I.

Each Greek does its own thing

In your example, the position delta is -59, and that translates into an expected loss when the stock moves higher by one point.  I mentioned that the delta is not a constant number, but changes as the stock price changes.  It's gamma that measures the rate at which delta changes.

Your position has -3 gamma.  In terms you an apply to managing the position, that means:

  • If the stock moves lower by one point, you gain 3 delta.  Negative gamma works against you.  Thus, you get shorter on rallies and longer on dips.  Positive gamma works in your favor

  •  If the stock price moves one point lower, the position delta becomes -56.  If the stock moves one point higher the position delta becomes -62

  • Even that is an approximation because gamma is not constant.  It's rate of change is measured by a different Greek.  For the vast majority of trades made by individual investors, it not necessary to be concerned with such details.  Professional traders, who seek every possible penny in edge and take extraordinary caution to trade as 'Greek neutral' as possible, pay careful attention to these Greeks

  • More sophisticated traders also measure the rate at which change in volatility affects gamma.  To learn more about the less frequently used Greeks, this Wikipedia article is a good place to start.  But it's not necessary for us to delve that deeply into how options are valued

You begin the day short 59 delta.  When the stock rallies by one point, the -3 gamma tells you that the new delta should be -62.  Be careful with this next sentence; it's not tricky:  Thus, on average, you were short 60.5 delta over that one point move (59 at the beginning and 62 at the end).  A better estimate of the real world loss is $60.50, rather than $59.

Time decay

Your position theta is 14.  That should translate into a one-day profit of approximately $14 as a result of time decay.   As you probably already know, theta is not constant.  It accelerates as time to expiration decreases.

So, if you lose money ($60.50) on a one point rally, you can anticipate that the real lose may be $14 less, or $46.50 due to the effect of positive theta.


If the implied volatility changes, the vega component of your position results in a change in the daily profit and loss. 

Bottom line:  The Greeks provide a
reasonable estimate of risk – or how much to expect to make or lose when
the market moves.  Many Greeks interact, so the final result cannot be
exactly predicted. 

Even if you were able to be that accurate, the real world pricing of options (the option price (called the 'mark') that represents the value of the options in your account) can vary from day to day for random reasons.

Don't drive yourself crazy trying to get an exact handle on profit and loss possibilities.  Look at the bigger picture.  If a certain event (stock moves by 7%, for example) results in a predicted loss of $100, it does not matter if the loss is $105.  What must concern you is being aware when a loss that's too big to handle may occur (perhaps when stock is up 12%) – and taking action to reduce the effect of such an event.  That's referred to as adjusting a position.

Clarification:  If that 12% move is dangerous, you may decide not to do anything right this moment to reduce your exposure to loss.  But, if the stock creeps higher, at some point you cannot continue to close your eyes to a dangerous possibility.  Making a small change to your position can be a good way to reduce your potential loss.

There are no hard and fast rules.  The purpose of this two-part post is to be certain you are aware of how useful the Greeks can be in helping you manage portfolio risk.


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The Greeks. Are they Greek to you?

Hi Mark

Reading thru your blog, I feel I have a lot to learn. I noticed
the graph you use above.  Is there any software you recommend for us?

When I look at Greeks of the positions (I use OptionsXpress), there
are Delta, Pos.Delta, Pos.Gamma, Pos.Theta and Pos.Vega. What is the
difference between Delta and Pos.Delta?

I may know the definition of each
Greek, but I have no idea what the numbers represent.

For instance, -59
for Pos.Delta, -3.12 for Pos.Gamma, 14.66 for Pos.Theta and -7.49 for
Pos.Vega.(I have an IC with some kite) What message do those numbers
tell us?



Hi 5teve,

You do have a lot to learn.  It' not difficult to understand what an option is.  Options are not complex.  But putting everything together so you can understand what your position is supposed to do to make or lose money requires an education.   I understand that you are a rookie
option trader and I don't know where you are in your education process.
  Take your time.  You have the rest of your life to trade.   

It's important to be able to speak the language of options and to understand the terminology.  However, memorizing definitions without knowing how to translate those definitions into real world terms, does not help you learn what it is you want to know.  Let's see if I can clear up any
difficulties you may have with the Greeks.

First: Choosing software is personal. I have not found anything I like – at least nothing that is available at no cost.  I don't require complex software, and look at the cost-free alternatives.  For my needs, my broker's offering is good enough.

Now on to the important discussion.


I'm sure you understand that each option has certain properties.  For example, you know that a call option has positive delta.  In the options world, each of those properties is represented by a Greek letter (ignore the fact that vega is not from the Greek alphabet). 

Collectively those characteristics of an option are knows as 'the Greeks.'

What purpose do those Greeks serve and why should you care?  The Greeks are used to quantify (in terms of dollars gained or lost) the estimated risk and reward that you will realize for a specific option, or group of options, if certain market events occur. Because you must understand how much you can make – and more importantly, how much you can lose – if the stock moves 5 points, or if three weeks pass, or if the implied volatility increases by 4 points, it's necessary to pay attention to the Greeks.  They allow you to make a very good estimate of just how much money is on the line at all times.

Position Delta

That 'group' of options may be a simple spread, such as a calendar spread or an iron condor.

However, the group of options can include more individual options, such as the entire collection of options in your portfolio.  Using different words, those are all the options that comprise your option POSITION.   Thus "Pos. Delta" represents your 'position delta' or the sum of the individual deltas associated with each of the options in your entire position.

Your position delta is calculated by adding the delta of each option you own and subtracting the delta of each option you are short (i.e., sold).  If you own 10 RGTO Dec 80/90 call spreads, your position delta = 10 x the delta of the 80 call, minus 10 x the delta of the 90 call.

**Remember that calls have positive delta and puts have negative delta.  Thus, when you sell puts, you subtract a negative number, and position delta increases.  When you buy puts, position delta decreases.

What's the point of knowing position delta, or any other Greek, such as position gamma or position vega?  As mentioned, the Greeks provide a good estimate of risk (and reward).  In your example, the message to be derived from: position delta = -59 is: 

If the underlying asset moves higher by one point you can anticipate earning that number of dollars.  In this case that is -$59. In other words, a loss.

Instead of getting confused by positive and negative numbers, look at it this way:  If you have positive delta, you are 'long' and should profit when the underlying rises.  When you have negative delta, you are 'short' and should profit when the underlying falls.

Keep in mind:  Each Greek is merely an estimate.  The market does not 'promise' to deliver a $59 profit if the stock declines by one point.  Other Greeks are in play, and sometimes the effects are additive and sometimes they offset each other (more on that in Part II).  

Repeated for clarification:  The Greeks don't do anything.  They don't make money.  They don't make positions risky.  Greeks allow you to measure risk.  the Greeks allow you to measure potential gains and losses.  They serve no other purpose.

When you measure risk, you have a choice.  You may live with the risk, or you may hedge that risk.  That's why the Greeks are essential for risk management.  When you measure a risk factor (delta, time decay, etc,) you can hedge, or reduce, that risk.  You can ignore the risk or offset all or part of that risk. 

When you trade stock, if you believe you are too long and uncomfortable with the risk, all you can do is sell some shares.

When you trade options, there are many reasonable alternatives to get 'less long.'  One choice is to sell positive deltas or by buy negative deltas.  And that does not mean you must buy or sell calls or puts.  You can hedge (adjust) the position (or portfolio) with any combination of options, including a kite spread.  Obviously some choices are more efficient to trade than others, but knowing how to hedge a position is one of those matters you learn from experience or by reading Options for Rookies.

When you understand how position Greeks translate into real money, you are well-placed to make important risk management decisions.  When the definitions of the various terms are merely a blur, you cannot function efficiently.

to be continued

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Position Size: When Is it Safe to Increase?


bring up an interesting point about increasing position size. You
mention increasing to two kites with a max of 20-lot of iron condors. But assume
that you don't use kites to protect against excessive moves, and
prefer covering part of the position to reduce risk.

By how much of an
increment would you recommend increasing your position size if you're
used to trading 10 lots? And once you've become comfortable with the new
size, how frequently would you consider increasing size again and by
how much? This assumes limited capital constraints — within reason of




Owning insurance allows a minor size adjustment.  But it's minor.  Insurance does not guarantee that you will not incur losses.  If you trade without insurance – as most do – size increase can only occur when it is justified.

My basic philosophy of trading is involved with this answer.  There's more of that philosophy in Lessons of a Lifetime.  I caution you to find a trading philosophy that suits you, and not blindly follow my suggestions.  The reply below is based on my comfort zone and experience.

1) Do not increase position size until you believe you understand how to manage risk for the strategy (or strategies) being traded.

2) Be certain that you get the nuances of the strategy and that you are comfortable with your positions and confident that you can earn money using these methods.

3) As a side issue:  Most people who trade have no idea that the average result for people who try to become short-term traders is to lose money.  That's the average result.  Most never become profitable.

I don't know how true that statistic is for us.  As option spreaders, we hold positions longer than the short-term trader.  Our success does not come from reading short-term trends.  It comes from managing risk efficiently and adopting methods that are appropriate for our psychological needs.   I suspect than earning any reasonable profit represents an above average result.

4) Before you even think about increasing size, you must be profitable.  Comfortably profitable.  Only you can determine what that means, but it does not mean earning $50 per month, after expenses. You must be able to see your account value increasing.  If you are withdrawing money for living expenses, then it's especially important not to increase size and jeopardize a significant portion of your account.

Although it may not be easy to determine, I'd want to know that profit did not result only from good luck, but instead was based on action taken or decisions made.

5) You must have faced several risk management decisions and handled them effectively.  If it all went smoothly and you had no pressure and no tough decisions, you have no method for measuring your skills.  I know that a string of profits is encouraging, but it is not enough to begin trading larger size.

What's a good decision?  It's not that the 'adjustment' made lots of money. It is knowing that the decision accomplished your risk management objectives:  it reduced risk, it resulted in your owning a position that met your needs and fit within your comfort zone.  It means you did not take defensive action just to do something.  It means that you wanted to own the newly adjusted positions and did not own it because it was 'the best' you could do. Furthermore, it means that additional handling of the position was done carefully and intelligently.

6) If you pass those tests, next comes your comfort zone.  Try a 20% increase and trade 12 iron condors, and remain at that level for several months.  When you believe you are ready to move to larger size again, repeat the entire process. 

Carefully examine what has been happening.  Do not rely on 'profits' as the sole factor that determines how well you are progressing.  Examine the same questions you tackled earlier.  If you do not find proof that you are handling the positions skillfully, do not increase size.

Yes, that advice is easy to ignore when you are making money.  But if you cannot prove to yourself that you have been skillful, rather than lucky, trading larger size will make things more difficult.

7)  Here's the problem:  If the market is kind to iron condor traders – as it is part of the time – you can get lulled into a false sense of confidence and when it hits the fan, you may have too much size to handle comfortably.   It's really easy to lose a year's worth of gains in a hurry – especially when trading too much size.

8) Don't ignore the size of your account.  I note that your question does take this into consideration.  But overconfidence can bring big trouble.

If your account value is not growing steadily, then it's too soon to increase size. No matter how much you decide to risk on a specific trade, it must never be large enough to jeopardize your being able to stay in business – if something terrible happens.  And it will happen – if you trade long enough.  You can own insurance to offset the major part of the problem, but that's not a cheap fix.



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Position Size: A Matter of Life and Death (for a Trader)


This is
what I've been considering (Conversation started earlier). I figure the kites provide great protection
if the Iron Condors don't behave, yet they reduce the premium of an IC
significantly.  The risk is minimal but so is the profit.

So if I exited both the kite and the 10-lot of Iron Condors at the same time – for say
only $300 profit, it wouldn't be enough for me. However, if I put on 10
times as many I would have approx $3000 profit ,which is more acceptable. Thoughts?



You may be too young to remember Lost in Space, a TV show from the mid-1960s, but one line from that show comes to mind:


1) It requires 10k margin to do a 10-lot (of 10-point iron condors).

It requires 100k of available margin to increase size by 10 times and trade a 100-lot.

If you earn $300 when risking $10,000 that is no different from earning $3,000 when risking $100,000.

2) The risk graph looks nicer.  And it is nicer.  Perhaps it's 'nicer' by enough for you to move from 10 to 12 iron condors.  But to move to 100?  No way.

It is not that safe.  It is just safer.  And the final safety is going to depend on skills as a risk manager.  Do you have enough confidence in those skills to up position size by an order of magnitude?

3) I  hope that you are suggesting, or at least asking about, increasing position size by a factor of 10 because you are new to the options world. 

I would tremble at the thought of an experienced trader asking this question.

Increasing position size by anything except a small increment is fraught with danger.  First, you don't know how you will react if and when trouble looms.  Second, you may be risking almost your entire account on a single trade.  You just cannot do that and expect to survive. 

It's unlikely you would lose anything resembling the maximum 100k (yes, this is possible, depending on strikes chosen), but how can you afford to take that chance?  Would you be able to exit a trade to lock in a $20,000 loss if you judged the position too risky to hold?  If you cannot do that, you will become frozen and unable to take needed action.

4) Look at your risk graph the day prior to expiration.  Note how those kites have gone from a 'rescue plan' to a potential disaster.

I know you 'plan' to exit prior to expiration, but many times traders are just unwilling to pay the necessary cost to exit.

5) I agree that you may indeed do nicely with this concept.  But all it takes is one bad situation – guaranteed to occur (but who knows when?) and you may be permanently out of business.

Please do not do this.  If you get some practice with the 10-lots, and demonstrate a good ability to handle risk for a minimum of six months, then I would consider – and I mean consider (not automatically doing it), moving size up to where you buy two kites instead of one.  Under no circumstances can that be more than 20-lots of an IC, and I think that's too large of a jump in size.

One more point: When I said 'demonstrate ability to handle risk,' If you have six easy wins with no serious adjustment decisions, that does not count.  I am referring to situations in which you face serious decisions and make a good choice each time. I am referring to having the courage to do the right thing and not taking on too much risk just because you are frozen with indecision.  If you can do that a few times – then and only then can you consider yourself experienced enough to move up (gradually) in size.


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Perpetual Dilemma: Rebalancing an Iron Condor Position

Hey Mark,

Thanks for starting and maintaining this blog. The blog and your
books are valuable resources.

I have a question about the position described in this post. I had a
similar situation with 10 April SPX 1150/1160 call spreads; the put spread
portion of the IC already having been closed.

My question is: if I'm going to continue holding the call spread
(adjusted by buying back 3 short calls) should I start a new put spread?
This probably wouldn't be called a roll, but would this be a good idea?

It seems that
adjusting when a position goes well would be a good idea and considering
the fact that I will hold the call spread a bit longer (hopefully close
early April), adding another put spread position would allow me to
collect a bit more premium.

I know this specific situation leaves very little time to open a new
position and I'm unlikely to open a new put spread but please consider
this question in a more general sense. Adjusting a good position vs
moving on to a new position in a later month.



Thanks.  This is a perpetual problem with no answer that applies to everyone.  But I do have an idea of how to treat this situation.

Once you cover the put spread, your choices are:

a) Sell a new put spread.  It's closer to the money than the original and provides additional premium.  It also adds downside risk when you had none.

b) Do nothing.  Consider this situation to be a 'normal' a legging out of the initial iron condor position.

c) If you believe in market neutral trading, and if you don't have a market bias (on which you are willing to wager) that the market is about to decline, then selling another put spread to get to closer to market neutral is a sound policy. 

Selling those puts allows you to be somewhat less aggressive when adjusting the call spread, but is that a good idea?  It's the call spread that threatens.  Buying three calls is an expensive proposition.  Are you thinking about potential losses on a decline, or are you counting on the market to rise?


Having no predictive powers for the market, it makes sense to be invested in positions that are not far removed from neutrality. 

At least, that's the common mindset.  This is a topic
for another time.  Tomorrow.

Your market outlook, your comfort zone, your desire/need to keep delta somewhere near neutral at all times, all play a significant role in the decision under discussion.

Then there's the psychological consideration, which I consider to be so important, that for me, this is the deciding factor when I am faced with your problem:

Consider two scenarios:

a) You don't sell the new put spread.  It turns out that the market never retreats and not selling results in  a missed opportunity.  You did not earn that extra premium when you 'knew' you should have sold the spread.  That bothers you.

b) You do sell a new put spread, the market declines and you exit that put spread at a loss.  The fact that the call spread became profitable and you were able to exit at a good price is no consolation.  You lost money on that put spread, and find it bothersome.

Which of those outcomes, if either, results in a more unhappy feeling for you?  Does either of these outcomes anger you?  Does one 'poor' result feel worse than the other?  Or are you truly emotionless and shrug your shoulders, knowing you made a good decision at the time the decision was needed?

Do not minimize this factor.  Psychology plays a big role in trading.  Some traders find a loss resulting from a specific trade type to be far more emotionally upsetting than other losses.  The reason for feeling this way is not the issue, but generally results from a condition knows as 'I should have known better syndrome.'  If you know that you may get so upset that your ability to trade efficiently is hindered, then you must take that possibility into consideration when making the trade.  Is the reward worth seeking when there is a possible 'worse than normal' outcome?

I've learned to sacrifice that potential profit (and avoid the risk) when a poor result is too upsetting.  I believe I keep my emotions in check very well, but getting whipsawed, is the situation that I avoid. Thus, I seldom sell new put spreads in the scenario described.  I'd rather pay more attention to the riskier call position and pay cash to protect it (assuming that the adjustment is a better idea than closing), rather than collecting a 'bit of premium' by selling put spreads. That's me.  I am not suggesting that you trade that way.


Comments not addressed in the reply above:

a) I'd call it rolling the trade.  A delayed roll.  Terminology is not important here.

b) Opening a new iron condor trade in a
new month is a separate decision.  If you usually carry only one
iron condor then don't do it.  Wait until this position is
closed.  If you often own more than one position, then open the new
trade when you deem it appropriate.

c) Your current position will be well
protected, if you make the specified adjustment.  It is going to be very costly.  You would own three 1160 calls and remain short seven 1150/1160 call
spreads.  This is a true 10 x 7 back spread.  Time decay is now the
enemy.  You have good protection that disappears as time passes. Consider more than the risk graph as it appears today.  Be aware of how time affects that graph.

Your risk management skills, are going to be tested in a new way.

d) One big negative is represented by the idea that you are adding a 'bit' more premium.  Is that sufficient for the risk?  This is a question, not a condemnation.

Do you consider that the trade is going well because you closed the put spread?  Do you consider that the trade is going well because you are able to adjust the call spread and still hold it?  It seems to me that this trade is  not going well.

Keep in mind that if you choose this adjustment method (buy three Apr 1150 calls), the downside is going to be an unhappy occurrence or you.

If you usually sell spreads with (for example) at a $2 – $4 premium, don't sell a put spread to collect an extra $0.50.  Sell a 'cheap' spread only if that's your normal course of action.

Do not make the mistake of believing that this put premium is 'in the bag.'  Markets do move up and down, sometimes violently (yes, not recently).  It's okay to sell a new put spread.  It's not mandatory, and if you follow the main advice, you will avoid the situation that may cause heartache.


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Risk Management: Are Rules of Thumb Applicable?

Don asked:

I recently ran into trouble with some high probability iron condors on
RUT. I know this has been a difficult month but would like to know
“rules of thumb” to apply to these type of trades.



I don't believe there is a generic set of rules or generalizations that works for everyone. 

I know this rule of thumb is important:

Don't allow the position to move outside your comfort zone.

However, that's not a useful rule. To begin, there's no way for anyone to understand where your comfort zone lies.  It's even difficult for you to know. You'll know when the position upsets you or makes you nervous – but by that time you are already beyond your boundaries.  Thus, you must have a way to 'do something' before that happens.  Not so easy when you cannot recognize when the zone boundaries are about to be breached.

One way to make that 'stay withing the zone' rule easier to achieve is to adjust trades early, rather than late.  What will that do for you?  It makes the position less risky, making it less likely the position will reach the point of making you uncomfortable.  The problem with that idea is that many adjustments result in a loss – possible through a poor choice of which adjustment to make – but why spend money on insurance – unless that's your preferred approach?

But, there are side effects.  It makes you adjust more frequently.  Is that a good thing for your situation?  How can anyone know?  Why should you take a more conservative view just because it's not easy to determine when it's the proper time to make that adjustment?  

The point is that there is no suitable rule of thumb.  By definition, that's supposed to be a general rule, or one that applies to almost everyone.

How about this as a rule of thumb?

High probability iron condors are not your friends

That doesn't seem right, does it.  More than that, what is high probability?  Is it 95% or 90% or 80%?  The way you define the term is probably nothing similar to the way others define it. 

If you choose 98% probability iron condors (that means there's a 2% chance, if held to expiration, that one of the options will finish in the money), the low premium makes this methodology unsuitable for the majority .  The delta for each short option in the iron condor is 0.01 – and that means a low premium.

Why unsuitable for most?  Because undisciplined traders cannot bring themselves to adjust, or exit, a position to lock in a loss.  When you trade 98% iron condors, any adjustment is likely to lock in a loss.  That makes trading them a losing strategy for most investors.

The problem is, can that rule of thumb be used?  I don't think so.  Especially for anyone who considers a 75% to 80% chance of success to be a high probability.

You can use this rule of thumb.  I know it will help with the problem.

Trade smaller size

The easiest method for managing money (and thus, managing risk) is to be certain the size of the position is not too large.  Imagine a gap opening that makes one side of the iron condor completely ITM.  If the amount lost would hurt, then the position is too large.  Trade smaller.

Don, if you manage money properly, the position will not be too risky.  That already helps when the markets don't behave.  Outside of that rule, I'd suggest that you look into becoming a bit less aggressive and consider making small adjustments earlier than you do now.  Even an early one-lot can make a difference.


Unsolicited comment from Don: "the author is an experienced floor trader who replied to all questions asked. If you are inclined to purchase $2000+ in software and another
$2000-5000+ in so called "training" or "education", please save your
money and seed your options trading account with it instead. But before
making ANY trades, nail down what this book teaches. It is all you need."


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Trader or Gambler. Which are you?

Trading options is not easy.  As is obvious, there is  no one handing out prizes just for playing the game.  You must work to make money.

Some traders are more successful than others. It's most likely that these winners put in their hours of study and preparation, but it's also possible that a few of them have been lucky.  The bottom line is that if you are hoping to be one of the lucky ones, then you are a gambler, not a trader. 

If you make an effort to truly understand what you are doing, if you devote time and energy to learning your craft, then that improves your chances of success.

The above is prelude to an email I received just two days ago.  It upsets me on so many levels, but mostly because I feel sorry for this trader.  He wants to be successful.  He studies charts and thinks about his trades.  But something is missing.

Here are a few excerpts from his message, along with my comments.  I am not going to identify that reader.


I realize that I am your student. I'm inexperienced and foolish.   I seek advice from the more experienced trader.

You are not foolish.  You are only inexperienced. I'm trying to help you learn, but I would not go so far as to call you my student.

I opened an iron condor position when RUT was lower.  This position has wiped out my profit from the previous three months. 

Looking at my charts, I decided that 650 was the resistance point, so I chose to sell the 660/670 call spread.  With RUT at 666 as I write on Sunday 3/6/10, resistance has been broken.

My reading of stochastics tells me the market is overbought and will soon trade lower. 

If 650 was resistance, why are you holing the position now, with RUT above 666?

If you rely on support and resistance to help you make decisions, why did you ignore the breakout above resistance?  If you don't rely on resistance, why did you bother to see where resistance lies?

You ignored resistance, but now you mention stochastics as an indicator that is telling you the market will decline.  Do you have more confidence in this as an indicator than you have in your charts?

Why?  Has this method of determining market direction served you well in the past? Do you have a proven track record of making money by using stochastics?

Or is this just another excuse to allow you to hold this position?

It appears to me that you are seeking any excuse to hold, rather than fold, and take the loss.

I always thought I could find the right place to roll the position to one that is safer, but I read that you believe 'rolling is not good.'

I never said that rolling is not good. 

It's so disappointing to find that you not only ignored all the rules of managing risk, but you also claim to be my student, yet do not understand what I said. 

Here's how I feel about rolling a position:

Roll only when both of these conditions are met:

i) You like the new position and want to own it

ii) You want to exit the current position

That's pretty simple, isn't it?  Nowhere do I say it's 'not good.'

When you hate the new position and would rather not own it, it's beyond foolish to roll so that you now hold that hated position.


Here's what I see, and it truly makes me sad.  The writer used technical analysis to choose his strike prices.  When that analysis told him that his premise was wrong (650 is resistance), he ignored that fact.  Note that he used TA to support his trade idea, but when TA sent a different message, he chose to ignore that message. Why?  So he could maintain his trade.

He considered rolling the position, but chose not to do so because I told him that was 'not good.'  Again, an excuse to hold the position.

The truth is that he owns this position, wants to own this position, and is afraid to act.  He is unwilling to do what he knows is best and is now looking to stochastics to prove that the position is good and will become a winner, if given enough time.

He is hoping that the market will reverse.  To tell the truth, so am I,  However I am not ignoring risk and relying on that hope.  As I have mentioned many times, hope is not a strategy.

To me there is a single word that describes my correspondent: Gambler.  He has placed his wager and the race has begun.  He looks at this as if it were a horse race.  He bought his ticket and there are no refunds.  Hedging his bet is apparently not allowed.  He feels he must hold on to the trade and accept the results, whatever they are.

He had every opportunity to buy plenty of protection when RUT broke through 650.  Now any protection is very expensive.  A prudent investor or trader would do something to reduce risk.  A gambler does nothing.

Dear correspondent:  I know how bad you feel about this loss.  You could have acted prudently.  I know that you would hate to exit now and see the market reverse.  But, if you had acted sooner, you would not be facing this dilemma. 

I wish you the best of luck because it seems to me that you are depending on good luck rather than on learning how to develop good risk management skills. 

If you prefer to be a gambler, then accept that is who you are.  If you want to learn to be a trader, then there is much for you to learn. The first step is to reduce your position size and place much less money at risk.


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Q & A. Avoid Increasing Risk When Rolling a Position

I received a very interesting e-mail from someone with whom I had corresponded on the EliteTrader forum. He was short a call spread, and the short option had moved into the money.  His concern was how to repair the position.

I thought portions of our conversation would be of value to option rookies and am repeating them here.  From my vantage point I see an intelligent trader, adopting new ideas as he gains experience.  But I see misconceptions and too-hastily drawn conclusions.  And I see myself many years ago – making the same decisions as my correspondent is making now.  Today I have a different vantage point.


"What would be the most common repair for OEX / XEO credit spreads with the short going ITM?

… is a decent money management strategy to buy back the credit spread when the premium doubles? and roll over to next month at slightly further OTM

A decent money management program has nothing to do with the premium doubling. It has everything to do with not placing too much cash at risk in this (or any) single trade.

My opinion is that premium 'doubling' is not an efficient method for deciding when to close a position – unless you have no confidence in your judgment and need a firm rule to tell you when to exit.



I note that you are speaking about when the option is still OTM. But think about what you are saying. You sold the spread, collecting fifteen cents. How are the 'option pricing gods' going to know at what price you sold the spread? Yes, it's value can increase to more than 30 cents, or double the premium you collected.

If you sell a 10-point spread and collect 10 cents, the spread can easily move to 40x the original price ($4.00) and still be OTM.

Consider the spread you sold: Maybe someone else sold the same spread for $5. In that case, the spread value (price) cannot move beyond double – because double is the maximum value for the spread. None of that should matter.  There are better methods for deciding whether to exit or roll a position.


The most common 'repair' – but in my opinion a poor choice – is to roll the losing position to another month, with further OTM options, and increase the size to trade dollar neutral (collect as much in premium as it costs to close).


I have no doubt that this has worked for you. That's what makes it so tempting to continue. Consider someone who has been rolling – and (at least) doubling the quantity of call spreads.  Recently the market has moved through a bunch of strike prices on its bullish march.  If you had such a position, it's possible your 50-lot Aug spread position could have become 200 Sep spreads and then 400 Oct spreads.  Reasonable risk management never allows that to happen. Your possible $5,000 loss has become a potential $40,000 loss.  If you expect to survive, this must be avoided.  All that has to happen is for you to end your winning streak with a single devastating loss, and
you will be out of the game

Here's the problem, and you can solve it as you see fit. When you decide to roll the position you have obviously decided to close the original and try to move it 'down and out' for a cash credit.  That gives you the hope of earning a profit when the next expiration arrives.

By believing you are required to make this trade (roll), you may do it blindly – without making a crucial decision: Is the new spread a position you truly want to own (do you want it to be a part of your portfolio), at this price, at this time?  It's a very poor idea to have positions that you do not anticipate will make a profit. When you believe you are forced to roll, you often find yourself with positions you would prefer to avoid. Why do that?

You are not required to do anything. You are allowed to take a loss. It's often the very best possible choice. Trying to salvage every trade – despite how successful you say it has been in the past – will lead to grief when the market continues to move in the same direction – as it sometimes does.


One more point: 

OEX is the WORST POSSIBLE index option in which to sell call/and or put spreads. Why? Early exercise risk. If you are not familiar with that risk for OEX options, then you are making a big mistake trading them. European style, cash settled options are far less risky. If you don't want to trade SPX, NDX or RUT, then consider ETFs such as SPY or IWM (they don't settle in cash), rather than OEX . Anything but OEX.

XEO is okay.


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