A Simplified Risk Management Method For Iron Condors

There are many ways to manage risk, and I'm always on the lookout for new ideas, and want to share something so simple, that I considered not blogging about it.  But, if it's new for me, it may also be new for others.

I believe that risk management is the most important aspect of being a successful trader or investor.  When the decision to adjust a position is made, market conditions and the attractiveness of available choices play a large role in determining which specific strategy is chosen.  That part of my overall game plan requires no change.

But what about taking profits?  I'm so busy managing my 'whole portfolio' of iron condors that I've been missing opportunities to exit trades and lock in good profits – and at the same time, eliminate risk.   The cost to exit: sacrifice decent profit potential.

The idea of meeting my monthly profit target and being able to watch from the sidelines (no risk) until expiration arrives - and it becomes time to open new positions - is attractive.  When you own positions with negative gamma, as I do as an iron condor trader, being out of the market translates into zero risk.

My goal:  To make good money with minimum risk. Thus, closing early has its advantages.

The Simple Plan for Exiting an Iron Condor Position

Assumption:  Iron Condor opened for a $3.00 credit

1) Exit the winning side of an iron condor when the price is relatively small.  To me, that means $0.15 to 0.$35, depending on how much time remains before the options expire.

2) Do not sell a new spread to replace the spread that was closed. 

3) Manage the remaining portion of the iron condor as usual, and if its too risky to hold, make an adjustment.

4) This is the new (to me) part.  Close the other side of the iron condor much sooner than my usual methods dictate.  It's unnecessary to hold long enough for the position to decline to my $0.15 to $0.35 target buy price, and it pays to 'pay up' to exit.  Why?  Because the entire iron condor position is closed, margin money is released (for those who want to use it), and there is no residual risk.

5) The monthly profit has been earned.  No risk remains.  That goes along with my general conservative philosophy.

Big Deal! That's It?

The driving force behind my desire to adopt this method for exiting positions is that I get whipsawed too frequently.  When I recently bought in all my Mar, Apr and Jun call spreads (plus a few May), that gave me no upside risk.  Imagine that.  I had a chance to make a substantial sum on any rally,  But, I decided to sell new call spreads to complete my iron condor positions – and RUT quickly soared by 20%.  Instead of a nice gain, I am facing trouble. 

I'm not second guessing my decision to sell.  That was a reasonable thing to do.  And the options I sold were about 25% out of the money.

The suggested approach is: "You've made good money on the calls, there's no need to try for more.  Let's see if we can close the put spread at a favorable price before it's necessary to adjust."   

I'm not playing results.  I'm just saying I've whipsawed myself too often to continue using my current methodology.  It's time to make a change – and one that's more conservative.  How can that be wrong?  

And if the market reverses quickly, as it did this time (I know it usually does not), I buy in the put spreads and gain an unmeasurable added benefit of sitting safely on the sidelines.  And if it does not reverse, all I've lost the opportunity for extra gains.  I like extra profits as well as anyone, but my primary risk management goal is to prevent large losses.  The more time I spend out of the market, the chance of such a loss is cut.

Conservative traders should like the idea of earning a good profit and then being able to wait, before getting back into the game.

How This Started

When privately replying to a question sent by S. (yesterday's blog post), I made a casual suggestion about adopting the idea discussed above.   I thought no more about it, until he wrote back to tell me that is exactly how he (sometimes) chooses to close his positions.

I now believe this is a reasonable alternative for managing overall portfolio risk, and is worth sharing.

I want to mention (again) that there is nothing earth-shattering about this idea.


4 Responses to A Simplified Risk Management Method For Iron Condors

  1. Sorry but I don´t understand (sure because my poor english and I don´t want to use a tanslator):
    “4) This is the new (to me) part. Close the other side of the iron condor much sooner than my usual methods dictate. It’s unnecessary to hold long enough for the position to decline to my $0.15 to $0.35 target buy price, and it pays to ‘pay up’ to exit. Why? Because the entire iron condor position is closed, margin money is released (for those who want to use it), and there is no residual risk”
    You mean you would close the position if you are earning even if it´s few amount?…
    Thanks, Antonio

  2. Mark Wolfinger 03/20/2009 at 8:08 AM #

    What I mean is: I may still have a chance to make more money, but it’s safer (less risk) to take the profit and settle for that profit. The choice is: take the risk to earn more, OR settle for what you already earned.
    Here’s an example:
    I collect $3.00 for a new iron condor position.
    I wait and the market drifts lower. Eventually I buy the call spread, paying $0.30. This represents a profit of $1.20 on the call portion.
    The put spread is still open, and is losing money. It is in no danger. I wait.
    What I usually do is wait and hope to buy the put spread, paying only $0.25 or $0.30. I am currently thinking about the idea of paying more – perhaps $1.00 – or even $1.50 (that would give me no additional profit from the put spread). The reason is:
    a) eliminate all risk
    b) lock in my profit: Collected $3.00; Paid $1.50 plus $0.30 or $1.80. Profit $1.20.
    That profit is less than I usually try to earn, but it’s a profit of $1.20 when my maximum loss was $7.00 (sold a 10-point iron condor for $3.00). That’s a 17% return.
    Yes, I may miss the chance to earn more, but 17% is an excellent return, regardless of whether it takes one or two months.
    It’s very conservative, giving up the chance to do better. But, because I can only lose money when I own a position, and because when running a business, my goal is to make money consistently, this is one way to give myself a better chance to earn that profit MORE OFTEN.
    BOTTOM LINE: I have not decided to do this. Right now it’s something I am working on – trying to make a good decision. I know I will hate closing a position when it appears that I can earn more money by waiting. I’m sure I’ll wait, trying for an extra $.10 or $.20 – but not always.

  3. Gil 03/20/2009 at 8:46 PM #

    Mark, the above “new approach” is defintely useful from some of your positions, which have got few months lifetime and risk period. My IC duration is usually just one month, and my experience tells me that most of the times it is still worthwile expire worthless, than contributing extra money back to the market, presumably this one month IC is wide enough (enough has to do with the trader comfort zone, of course).

  4. Mark Wolfinger 03/21/2009 at 9:58 AM #

    I don’t explain how I trade because I believe is ‘best’ and that everyone should follow what I do/suggest.
    I present food for thought and expect readers to consider my methods. ‘Consider.’ And all that means is to think about what you are doing and decide it that makes sense when compared with an alternative. Of course traders won’t switch to follow my suggestions, but some will.
    And for rookies – people first getting started, I offer sound advice that works. Once the rookie gains experience, I hope that person will adopt methods of his/her own.
    That said – all I can tell you is that if you constantly hold through expiration to earn an extra nickel or two, you will eventually be sorry. You wrote ‘most of the time.’ What does that mean? When ‘most of the time’ did not apply and you had to repurchase, how much did you pay? Were you stubborn? Did you lose one year’s worth of extra nickels, or 5 years? Or was it painless?
    I don’t have to see the answers, but you must decide which is a better way to play the game – and I mean better for you. If you survived the volatile markets of 2008 and 2009 and were able to allow your shorts to expire worthless, then that works for you. If you were successful – just how much premium do you collect for your one month iron condors?