Hat tip to jcvictory for suggesting this discussion.
If you are not familiar with these option strategies, use the above links for an introduction to each.
When trading IC the trader usually has a good method in place for deciding when to exit a profitable position. He/she may have a specific price that is willingly paid, and that price may vary with the number of days remaining before the options expire.
The plan may be to hold through expiration.
Some traders buy in the position when a specific percentage of the maximum profit has been earned (roughly 80+%). That's similar to the first method, but the price paid is a function of the original premium collected, and not time remaining.
I've discussed adjusting an iron condor trades gone awry many times and offered several risk-reducing (this link is to one idea) approaches for you to consider. Today I'll discuss happier times – profitable times.
When trading diagonal spreads (or double diagonals), the 'close for a profit' decision is much more complex. Why? When the iron condor has reached a price of $0.15, there's only that $0.15 left to be made. There's not too much to be earned from holding and each trader can decide whether holding or closing is best. It's not a big deal, although I am a big fan of closing early because there is so little to gain and so much to lose.
When trading the diagonal, the major difference is that you are short the front-month option and own an option with a more distant expiration date – most often one month later. Thus, as your short option moves towards zero, you don't want to hold 'too long' because the value of your long option must be protected. The cash you collect when selling your long options plays a huge role in determining the overall profitability of the diagonal spread (single or double).
Time decay is generally positive (profitable) for the diagonal spread owner, but there is some compromise point at which it's no longer a good idea to own the position because the time decay collected by remaining short the front month option is readily offset by several factors:
Time decay of the long option: At some point your long begins to decay as rapidly as your short.
Vega risk: If IV is declining, as it has been in recent times, then the longer you own the position, the less you can collect when selling your longs. Holding longer is a wager that IV will soon increase.
Delta risk: If the underlying stock or index moves so that your options are farther out of the money (we are only discussing one half of the double diagonal spreads; not both sides simultaneously), as soon as the delta of your long exceeds the delta of your short, your spread declines in value – and a portion (all?) of your profits can disappear. When looking at a call spread, it's bad enough to lose money when the stock surges through the strike price of your short options, but you don't want to see your profits disappear when the stock declines. At some point, it a good idea to close the trade and keep what you have earned. Remember, profits that are in your account today represent your money.
The objective is to exit the trade when you can still collect enough from your long option to provide a decent profit. This is not a consideration when trading iron condors (because your long is always worth less than your short). I can suggest no cast-in-stone rules to guide you. As with many decisions that must be made when trading options, your comfort zone limitations and profit requirements can best be determined by the individual investor.
Next time I'll take a closer look at some items to think about when it's time to take the money.