Adjustment Headaches II

To Mark,

Hi John (Addendum: MDW response in blue)

Here's what I do when trading iron condors (IC)

  1. I initiate positions
    without any market bias, which means I do not know whether the stock is
    going to rise or fall or remain in a narrow range.
  2. When the
    stock swings to one direction, not a lot, probably a few points, then I
    will rollover the spread on that side to further strikes.

    How far OTM are your current strikes when you 'rollover'?  Are you adjusting too late or too early?  Most important of all:  Are you rolling just because that's what you always do?  That is not a good idea.  Please be certain
    that the new position is a 'good' one.

    Another thought:  If trading stocks, perhaps the strike prices are simply not very far OTM.  You may be more comfortable with higher priced stocks or index options.  You find rollovers to be unprofitable, yet you do them when the stock moves 'a few points.'  If you are rolling when the stock moves only 5%, perhaps your options are too near the stock price.  Can you move more OTM and still get a reasonable premium?

  3. Doing so allows me to have a good position, but only for the
    I still do not know whether the stock will continue in that direction,
    stay there, or retrace.

    That's true for most traders.  If a trader had a market opinion when opening the trade, that opinion has been proven to be incorrect – when the adjustment was made.

  4. This adjustment gives me an unrealized
    loss. My observation is this happens in every adjustment, and the
    reason for this is fairly straightforward. Calling it deferred loss is
    only a matter of opinion. Regardless of how I call it, the unrealized
    loss is real. 

    Yes, it is real.  But it seems to be a 'realized' loss to me. What is your method for the
    'rollover'?  Farther OTM strikes in same month?  Next month? 'Rollover' is
    not the only type of adjustment available.  This is obviously not working for
    you.  Have you considered alternatives?  a) buy back 20% of the short
    spreads and hold the remainder until you feel it's time to repurchase
    more.  This is adjusting in stages, rather than all at once.  b) Buy one
    or two of your short calls.  c) etc.  There are other alternatives.

  5. Since I do not have market bias, I will never know whether my
    new positions will be profitable going forward.

    True.  But if you don't expect them to be profitable; if
    you don't 'feel' good about owning these positions, then don't own them.  Perhaps
    there is a different strategy that you can adopt?  

    The new position is
    just less risky compared to the old one, again, for the moment. Less risky is good, but it's not good enough.  The risk/reward potential must be acceptable. 

  6. On
    the other hand, if I exit the trade, then it will result in an
    immediate loss.

    To me that is not
    important.  If you don't want to own the current position and if the
    rollover doesn't appeal to you, then exiting is a good idea.  Holding onto a trade just to avoid taking a loss means you are going to own bad positions frequently.  When you do that, you are gambling.

    look like a good choice to me because of 3
    reasons: i) if I adjust immediately, theta decay can still come to my

    I don't like this rationale.  If
    you open a brand new position, theta is also on your side 

    gives no benefit because without market bias, I do not
    know when to initiate a new IC;

    I see
    your point, but without a market bias, isn't it safer to own a new,
    market-neutral, IC than the current position?  Don't forget that 'neutral' is a market bias.

    iii) if
    i exit and stay around hoping
    to roll with better strikes, then I am just guessing the stock will
    continue in the same direction, but I may be wrong.

    The basic decision remains:  Do you feel comfortable
    with the current trade, or would you prefer another?   Maybe you should consider an alternative strategy:  Less volatile stocks; selling options
    that are farther OTM and have a lower delta.  I don't have a specific suggestion, but I sense the
    frustration. I understand that you feel helpless doing what you believe is
    'right' and losing money.  Keep in mind that IC are not suitable for
    all markets.  They only work part of the time.

  7. My opinion is when I adjust, one side of the spread has
    already gone bad. Adjustment prevents it from getting worse. I don't
    see why I would adjust if the stock price stays at the middle of the
    range enclosed by IC.

    When you do that 'unnecessary' trade, it's the purchase of insurance. 

    In other words, I adjust to prevent the bad side
    from getting worse

    Yes, that's one reason.

    As a
    consequence, there will also be deferred

  8. Here lies the problem of deferred losses. If the stock
    heads in
    direction suddenly and quickly, the deferred losses are quite big. If
    that stock do this for few days in a row…well you get the idea.
    Although still unrealized, that unrealized loss gives you the shivers.

    I look at risk.  If it's too risky, I get out of the
    trade – either by adjusting or exiting.  Perhaps you don't look at
    adjusting the way I do.  It is not just a risk-reducing trade.  It is
    not just a 'reduce the position size' trade.  It is a trade that gives
    you a good position – a position you want to own.  It does not give you
    a position you are forced to own.  Adjusting is voluntary.  If you don't
    like the trade, don't make the trade.  As mentioned in yesterday's response, adjusting affords profit opportunities.  If you don't find that to be true, then you are not making the best adjustments.

  9. I believe this is the nightmare of IC, apart from a big gap
    that put the trader ITM without a chance for adjustment.

    Yes.  That is one argument for owning insurance in the
    form of extra options.  It doesn't always help enough, but it helps. 
    The problem is that the extra options must be closer to the money than
    your short options, and that makes them expensive.

  10. I
    do not have any solution for this, and market making seems like the
    only valid strategy to me. Everything else has a market bias built in.

    There is nothing wrong with a market bias – if your
    track record shows you have good judgment.  You and I trade with a neutral bias.

The points you mentioned seem to suggest that you know the
will stay range-bound after adjustment.

know nothing about the future market.  What I do with an adjustment is
reduce risk, and maintain a position I like.  I suspect your options are
very near to being ITM when you adjust, and that means it's probably
too late to salvage the position.  

Judging from this
'believe the position will be profitable going forward'. That is having
a market bias in my opinion.

understand how you feel.  When I open an IC position, I feel the
position will be profitable going forward.  If I didn't, I would not
make the trade.  Sure, that assumes a market bias.   IC assumes a
range-bound market.  Every trade has some bias – bullish, bearish, or
neutral.  Not knowing which to choose, I choose neutral.  But that's not
'better' than bullish, it just more comfortable for me  – and 'neutral' has been drummed into my head by risk managers for more than 25 years.  Now I'm the risk manager.

from a technical analysis
background, I find that market bias is only guessing and consistency
can never be measured.

Well, thanks for reading my rather long details. If you have
something to add, correct, or alternative theory… please

I sense your frustration.  I'm  offering advice based on my opinion as to what I believe is
sound.  In the final analysis, it's up to you.


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8 Responses to Adjustment Headaches II

  1. rluser 04/13/2010 at 9:52 AM #

    That’s confusing. Did the Mark and John colors get swapped?

  2. Mark Wolfinger 04/13/2010 at 9:59 AM #

    I apologize for the confusion.
    I hope it’s understandable now.

  3. Frank 04/13/2010 at 12:27 PM #

    Speaking of the impossibility of predicting which direction the market will go, does this approach make sense? Put on a series of IC’s, one third with the sold options 1 standard deviation away from the money, one third that are 2 SD’s away from the money and another third that are even farther (further?) away from the money, or maybe at 1.5 SD away from the money. That way, one might not feel compelled to adjust more than a third of the positions at any one time as the market pendulum swings back and forth. Yes, the closest to the money will almost surely have to be adjusted, and I’ll only be playing for nickels and dimes with the farthest OTM (and with higher possible maximum loss at that), but it might have two benefits:
    a. Less psychological pressure to “fix” a failing position all at once. This being an alternative to scaling in and out as you suggest.
    b. Less slippage since fewer contracts are likely to be adjusted. In paper trading at the CBOE Virtual Trader, I’m seeing a lot of slippage simply because I need to submit market orders in order to get the position put on in a timely way (ie, the same day). Putting in limit orders, even ones that give up a significant portion of the bid/ask spread, never seem to get filled.
    While your risk management ideas are much better developed than what I’ve outlined here, I wonder if you think my idea about risk management by making a mix of CTM and FOTM IC’s has any validity.

  4. Mark Wolfinger 04/13/2010 at 2:00 PM #

    Yes, it has validity
    1)Most paper-trading accounts do NOT reflect reality when it comes to getting fills. If you must essentially enter market orders, then you would never use such a broker.
    Find another place to do simulated trading.
    With all the things that a trader must worry about to earn a profit, dealing with unreasonable slippage is foolhardy, at best.
    2) Your idea is wonderful for anyone who is willing to make those trades.
    I appreciate owning a variety of iron condors, rather than just one or two.
    3) Speaking for myself, I only make small concessions in my requirements for a trade. FOTM is just not for me – but I do like the high probability of success.
    Bottom line: Your idea is practical, buy ONLY when each of the iron condors is acceptable to the trader. I would not force a trade just to own a position with different adjustment points.

  5. John 04/13/2010 at 8:32 PM #

    Thanks for the reply. I think our difference is how we look at adjustment. I usually do front month further strike roll, unless expiration is near where I will establish a less sensitive position. I have tried kite spread before, and only found it useful when the stock makes a huge move during the early holding period. I think it should be exited during the last 3 weeks for a fairly obvious reason. Not sure how you view potential risk/reward for adjustment, but this sometimes can be confusing, especially to new traders. I believe the initial RR doesn’t change. When I rolled out one side with a profit/loss, the P/L will be accounted into the risk graph. For example, when I close with a profit, the max loss will increase in the risk graph; and vice versa. I believe the RR profile doesn’t change. Again, another realised and unrealised P/L problem. Kind of reminds you of the deferred loss view point.
    Mark, when you trade IC, what is your preferred distance between the current price and the side of the wing? I think one SD gives out barely enough premium, and anything more than one SD gives out low premium.

  6. Mark Wolfinger 04/13/2010 at 9:47 PM #

    1) Obviously rolling down to farther OTM strikes locks in a loss. There’s nothing you can do if that is the adjustment method of choice.
    2) Right on. Kites do suffer from time decay, and when held to the end, involve far too much uncertainly.
    3) I look at my risk graph as: What does the P/L picture look like from today forward. I ignore whether it has been a profit or loss up to this point.
    I acknowledge that the majority of traders are always aware of P/L of any position. I’ll remain with my minority view that P/L is completely irrelevant and the only thing that should concern any trader is the position as it is right now: Do you want that position in your portfolio? If yes, then hold it.
    If ‘no’ then there are two choices: Exit or modify it so that you do want to hold it.
    P/L in the past is out of my control. All I care about is P/L in the future, and owning a position that I believe will be profitable.
    4) Honestly – I prefer not to consider ‘how far.’ In Nov 2008, I had no trouble finding good (at the time I opened them) IC spreads that were more than 100 RUT point OTM. And RUT was much lower, so the % OTM was very large. Today I had to settle for 60 points (10-week spread).
    I prefer to look at cash credit, delta, and probability of touching a strike – prior to my planned (hold for 6 weeks for today’s trade) exit.
    It’s basically the same idea, but I don’t use SD.
    Remember that ‘high’ and ‘low’ premium are relative terms. Some traders want to collect less than $1 for a 10-pt iron condor, and others want >$5.
    Thanks for the update

  7. John 04/15/2010 at 12:14 AM #

    Thanks for the reply. I take a quick look at the RR profile of 60 points 10-week spread of RUT. The Risk:Reward is about 2.6:1. Does that seem acceptable to you?

  8. Mark Wolfinger 04/15/2010 at 7:35 AM #

    Yes. That’s a premium of more than $380.
    My comfort zone would settle for less cash and a bit farther OTM. I’d rather settle for $300 – but that’s my CZ. You should carry positions that are comfortable for you.