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Adjusting iron condors: Choosing among the alternatives

Mark,

Making the "right" adjustment, at the "right" time is, by far, the most difficult part of trading iron condors, as far as I am concerned. In my real trading, the only type of adjustment I dare try is to close part of (or all) the position or roll over. All other types of adjustments seem too difficult to manage for me.

Most probably I am asking too much but , if not, and if other visitors of your blog also find it helpful, may I suggest that for a period of one or two weeks, you set up a simulation game where every day you give us a specific position (IC) and the necessary data (price of underlying, volatility, the Greeks etc) and we are asked to make a decision whether we need to adjust or not and if yes what strategy we choose, and then, the next day you give us your own proposal. I fully understand that everybody has his own comfort zone but it would be a great opportunity to see in practice how all the different adjustment strategies are used and why.

If this is not realistic, is it possible to publish in "Expiring Monthly" a new "Follow that trade" like you did last March?

Thank You

Dimitris

***

It's not realistic because of the huge amount of time required.

However, what you ask is not nearly as beneficial as you may believe it is.  Asking for the greeks?  Isn't that easy enough to do yourself?  However, that's not the point.

As a rookie, you cannot always expect to read about something and immediately put it to use.  Sure, that happens part of the time, and one example is becoming aware of the risk associated with trading too much position size.

However, not everything is so easy.   Adjusting iron condors is complex.  There is much to understand.  You cannot expect to examine a few example and then know what to do.

 

Your job

You have two main tasks: understand the adjustment method and then practice.

Understand:  Think about the reason for making an adjustment of the type under consideration.  Decide if it makes sense to you.  Try to guage the amount of risk reduction to be gained vs. the cost.  Compare with alternatives.  Decide if the whole deal fits within your comfort zone.  When you find something suitable, it's time to go to work.

Practice:  Use a paper trading account.  There's more detail on this idea below.

When

You know that I have no idea whether you should adjust when the underlying is 5% OTM, 3%, 1% or any other number.  How can I know your tolerance for risk or your investment objectives?  Or just how much you understand and how much of a beginner you are.  Each of these items, and much more must be considered when adjusting an iron condor,  Remember that there is no right answer.  There is merely something that is good for you, and hopefully you choose something very good, or even 'best' for you.

Then if you decide to adjust, I don't know if you should exit, reduce by 10 to 30%, buy a debit spread, buy a kite spread, roll, etc.  I'll go further:  If I were to tell you what to do, and not teach you how do make that decision for yourself, then I would not be fulfilling my goals. No one knows what you should do. 

I have no idea what is right for anyone but myself.  Even then I may have a difficult time making a decision.

 

My job.

I cannot show you what to do.  What I can do is offer a list of suggested strategies and try to explain why each may be a good idea, depending on conditions.  I can be certain you recognize the risk involved.  That's all I can do.

If you cannot make a good choice from the information – and I understand that as a rookie it's far from easy – then you must practice.  You suggested that I undertake a specific task.  Instead, you do it.

Each day for a week, open a new iron condor in a paper-trading account.  Each new IC should be require an immediate adjustment. Because you don't know 'when' to adjust, try this.  Open the trade based on this assumption:  It was a good, netutral trade at one time,  but now the calls (or puts) are 2% OTM. It does  not matter how much premium you collected.  It does not matter how long ago you made the trade.  Today the position is uncomfortable for you to hold.  Thus, an adjustment is in order.

Pick one adjustment method.  If you don't know which to choose, buy some credit spreads.  Guess how many.  Guess which stirkes – based on what I have previously suggested.  Try to be comfortable with the cost.

Make an adjustment.  Follow the trade.  Determine how well you like the adjustment method being tested.  They try again with another straegy.
 

Follow the trades.  Record your thoughts and collect data.  Gain experience.  That will be far more useful to you than reading my opinion on specific trades.  My objective is to teach you to think for yourself.  I know that as a beginner, you want to learn everything NOW,  That is not going to happen.  You must have some patience and learn at your own speed.  Here, practice trades offers the best learning experience.

Over several months you will collect much data and have many entries in your trade journal.  Some trades will be comfortable for you, some will not.  Be certain to record which adjustment types fall into which category. 

Among the comfortable trades, try to decide which seems to work best for you.  This is not to be determined by which makes (or save) the most money, but that is one consideration. 

Use that startegy as your primary adjustment method, but at the same time, continue the paper trading to gain more experience with other iron condor adjustment methods.  It's an ongoing proposition.

You may want to view my Oct 12, 2010 one hour webinar at TradeKing on this iron condor adjustments.

A lengthy example may be educational, but it's not a substitute for doing the work yourself.  I'm here to help or offer guidance.  But this request is more than I can handle

822

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Trader Education: Essay by Bill Luby

This blog is devoted to options education.  I recognize that other bloggers emphasize education and I'll occasionally share some thoughts from these bloggers.

A couple of days ago, Bill Luby (VIX and More) published a piece that had already appeared in Expiring Monthly magazine (May 2010), and I'm sharing it with Options for Rookies readers.


Do
you remember from your school days those students who, when confronted
with a complex issue, would acquire a look on their faces somewhere
between consternation and dread, immediately thrust a waving hand up
into the air and blurt out in a worried voice, “Do we have to know this
for the test?” I can be fairly sure that none of these people ended up
as successful traders.

One only has to look at the history of
hiring patterns at Wall Street firms to get a sense of the evolution of
thinking about how to develop a successful trader. For many years, the
model for aspiring traders was considered to be a genteel Ivy League
education. Over time, Wall Street firms began to favor graduates with a
more humble socioeconomic pedigree who were considered hungry, hard
working and highly motivated to prove something to the world. In more
recent years, we have seen Wall Street seek out physicists and those
with exceptional quantitative skills. Lately, a desire for poker skills
has also come into play.

As I see it, all traders are ultimately
self-taught. There are no required classes, readings, homework
assignments or even a syllabus with recommendations. Tests are
administered on a daily basis, frequently with multiple tests on the
same day. Worst of all, everyone is graded on an unfavorable curve in
which there are more Fs than As.

Against this backdrop,
education counts, but skill and experience count even more. An
insatiable curiosity helps, as does a willingness to explore unfamiliar
territory. Great trades, insights and strategies present themselves in
somewhat random fashion and, as Louis Pasteur observed, “Chance favors
the prepared mind.”

But what kind of preparation is ideal?
Malcolm Gladwell [in 'Outliers''] asserts that 10,000 hours of experience is a
prerequisite for greatness in almost any field. In a normal career, that
level of commitment usually translates to five years, but on Wall
Street, 10,000 hours of experience can be crammed into 3–4 years. Of
course, all hours are not created equal. A trader’s capacity to
distinguish between random events and meaningful patterns is important
to establish a solid trajectory of growth and development.

For
my personal education process, unlearning was more important than
learning. My formal schooling consisted of an undergraduate degree in
political science and a traditional MBA program. After two decades of
business strategy consulting experience deeply rooted in fundamental
analysis, I was ill-equipped to excel in a short-term trading time
frame. In order to embrace technical analysis, I first had to jettison
my fundamental perspective on investments and build a new foundation
based on technical analysis and market sentiment.

In my opinion,
the best way to approach trading is to consider the educational process
to be a lifelong endeavor, crossing as many multi-disciplinary
boundaries as can be digested. In a way, I like to think of the
foundation of trading success as building a large idea stew and
developing an eye for spotting high potential new ideas. The trick is to
have the right breadth and depth of knowledge so that when one stumbles
on the next great strategy, it can be easily identified, captured and
developed. Call it opportunistic research and development, if you will.

As
luck would have it, some of the most successful trading strategies I
employ are based on areas in which I had limited knowledge when I first
encountered them. No matter how well things are going, I take the
approach that I never have the luxury of being satisfied with the status
quo and need to embrace the idea of getting out of my comfort zone. In
trading and in life, it pays to constantly refresh the pipeline of new
ideas and continue to tinker with them, because you never know what will
be on tomorrow’s test.


As options traders, there are some differences in our approach (longer holding period is the most obvious). However, all traders have some traits in common and Bill's story applies to us as well.

795

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Trade like a market maker?

Visit the new home page for Options for Rookies


Mark,

The problem with my spread order is that it is sent to the
market maker who supposedly provided the best price.

On the retail
front end, I can't see the market makers' quotes. Do you know how to
connect directly to liquidity (in a way that I can see MM's quotes)?

Another method I can think of is to come out with a good algorithm for
legging in. This is much complicated and I hope I would not need to go
this route. My opinion is, in order to get into more liquidity, I may
need to learn how to trade like a MM.

John

***


Hello John,

It's difficult to know where your orders are sent without asking your broker.  However, they are never sent to 'a market maker.'  The orders are send to an exchange, and that should be the one displaying the highest bid (or lowest offer).  Sadly that is not always true because some brokers accept bribes payment for order flow.

If you trade enough size, your broker will (gladly?) get a quote for your order.  When I was trading 100-lots of iron condors, I found that the people who provided those quotes were, to put it simply, out to cheat me.  In other words, when I tried to find liquidity, my broker (IB) could not have done me any worse than sending the quote request to the people they chose.

I no longer have access to such quotes (I trade much smaller size), nor would I seek them.  I know they are useless to me.  I blame IB for that (they asked the wrong 'liquidity suppliers' for quotes).

I look at the bid/ask spread for each leg of the iron condor as well as the bid/ask for at the iron condor itself. I then decide if I want to play.  If yes, I enter my order at a price I will accept.  If I don't get filled, so be it.

A few years ago, whenever I entered an order, the IB software showed (for 2-3 seconds only) a counter offer.  In other words, I had the ability to see the true market.  That allowed me to enter a low-ball bid to see the true offer.  That service is no longer available, and we are flying blind when entering orders.

I complained to IB that in reality, I am the market maker.  I am posting a bid (or offer) with no ability to see the true market.  "That's not fair" I tell them.  "Too bad" say they. 

So, I play market maker and hate it.  To  make matters worse, IB charges a fee to cancel an order and replace it with a better order.  Imagine – they charge me, the true market maker in this scenario, to make a better market.  It costs me cash to raise my bid or lower my offer.  It's an obscene system, but I don't see how I can do anything about it.  The overall cost to trade at IB remains untouchable for me.

If readers have suggestions or a work-around, please share.

IMPORTANT: 

1) You will not find a good algorithm for legging in.  In my opinion, there is no such thing.  You would have to know which way the market is moving to leg the first side of the trade.  And if you can get that part right, why would you 'waste' a good trade just to complete the iron condor?  Use that (impossible to build) algorithm to day trade and make millions.

2) You cannot trade like a market maker.  You are never aware of large orders that are being quoted.  You don't know anything about large spreads that are being shopped or sitting with the specialist.  Many times just knowing an order is there allows you to make a trade and then go get a piece of that large order.

You never get to buy on the current bid – and if you do, you will discover that it is no longer the bid and may even be the ask price when you are filled.

There may be books that explain how a market maker trades, but the MM's advantage is not available to you.

792


Em_1009 

September 2010 issue now available

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Win a Subsription to Expiring Monthly

As a sincere thank you to subscribers, Expiring Monthly: The Option Traders Journal is running a contest and offering a valuable prize to  one lucky subscriber. 

Non-subscribers also are encouraged to enter.  Your entries will be separated from those of subscribers, and the winner receives a one-year paid subscription to Expiring Monthly.


It's easy to enter.  Details at expiringmonthy.com

Entry deadline: Midnight (CT) Saturday, Jul 3, 2010


Prizes awarded to the subscriber and non-subscriber whose entries are nearest to the closing price of VXX on July 16, 2010.  In case of ties, the earliest entry wins. 

The winner is determined by distance from the correct answer.  It does not matter whether your guess is over or under the actual closing price.


The Prize: IVolatility.com is generously offering a three-month subscription to the 'Volatility Essentials' Package.  Retail value $96.80 per month (although occasionally they
do make special offers, such as the one advertised in this month's
Expiring
Monthly
).

Six of their most popular analytical and management
tools are combined into a new convenient package called "Volatility Essentials."  

The subscription combines data and analysis tools in a single
package, increasing the probability
of making the best available trade.

"Everything needed to run an option portfolio like a professional"

Included are:

  • Vol ranker: quickly find equities with cheap/expensive options
  • All important pricing data plus the
    "Greeks", skew and volatility surface data
  • Live P/L calculator. Automatically updates data for multi- variable risk profiles
    and simulation analysis
  • Maintain updated portfolio with prices,
    volatility and correlation data
  • Historical volatility data, put call ratios,
    volume, open interest, and volatility charts going back as far as 10 years

     
  • Live calculator automatically updates prices and "Greeks"

A little information about VXX

The iPath S&P 500
VIX Short-Term Futures ETN
, VXX began trading Jan 9, 2009. As Bill Luby reports at VIX and More, this product was a hit from its first day, and trading volume has been expanding steadily. The unfortunate news is that most who bought this vehicle (as a long-term investment) were far too early.  VXX declined steadily from the beginning.  Until one day, it reversed direction


Vxx
Weekly chart of VXX, since inception (StockCharts.com)

VXX
is not designed for investors.  It's a short-term trading vehicle because
it is re-balanced  daily to keep the portfolio invested in futures with an average expiration 30 days in the future.  That involves daily trading expenses and slippage.

iPath, the company that manages VXX, tries to explain the important details.  The sad fact is that too many individual traders buy and sell this item without understanding what they are trading. That's nothing new, as it has been a way of life for VIX option traders. (VIX options DO NOT track the daily VIX  -  they are options on VIX futures contracts.


Join the fun.

Enter the contest.

Thank you for subscribing.

727


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Contest Winner: Options Tagline

Thanks for participating in my search for a new options tagline.  Not just for my use, but perhaps for the industry.  The purpose of the contest is to find a good phrase that will generate interest in understanding options among individual investors. 

The need is real because almost any time that options (or derivatives) are mentioned in the media, the news is always negative.

There were several clever entries.  However, I set up this contest to select a practical tagline – one than may be effective if used.  On that basis, I've chosen the winning entry (and discovered why advertising execs are so highly paid – this is more difficult that it appears):

"Uncertain times require options."


Sample usage:

"Tried and true portfolio protection is no longer valid.  The Prudent Man rule no longer works.  It takes far more than asset allocation to protect your holdings. Today's investor, striving to succeed during uncertain times requires more options, and the ideal investment tool is the stock option.

Options represent the modern and perhaps final frontier in investing. Options allow you to enhance your portfolio performance and protect it at the same time.  You will no longer lay awake worrying about your investments because options work while you sleep.

Options represent a sane investing approach when you work with an advisor who shuns hype and understands the beauty of options as a risk-reducing investment alternative.

That's the options advantage.  Learn to use options today. Order your copy of The Rookie's Guide to Options."

 

The winning entry was submitted by Josh, and his prize is a one year's subscription to Expiring Monthly: The Option Traders Journal.

There is only one official winner, but I
found a number of useful ideas – ideas that I used above and may be able to incorporate
into future writing. Other top entries (in random order) include:

  • Options: The final frontier  (Alec) 
  • Has your portfolio lost its nice figure? Get it back in shape with options; no exercising needed (same Josh) 
  • Options: They keep working while the market sleeps (Josh again) 
  • Sane options: Derivative discussion without the hype (rl)
  • Enhance and protect (David)
  • The Options Advantage (Penny, who is not eligible to win contest)

***

Additional subscription is awarded to Jeff', whose suggestion to compare option educators to a doctor who provides many benefits to the patient is very clever, but lengthy.  Perhaps I can use it in an appropriate place.

"The Options Doctor"

The way we should use options as risk management tools for our
investments is analogous to the role of our doctors, who:


  • evaluate our current condition

  • determine risks and benefits of alternative actions

  • provide a recommended approach
  • identify the risks of not following a particular course of action.


Generally speaking, doctors are highly respected as advisors on our
health matters. Likewise, options should be respected as viable risk
management tools for our investments.


Thanks to everyone who entered.

721


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Not Satisfied with your broker? Change and get a free Expiring Monthly Subscripion

As most of you know, I am one of the founders and owners of Expiring Monthly: The Option Traders Journal.  We sell annual subscriptions @ $99/year. 

As a special promotion, I've made arrangements with two brokers.  In exchange for opening and funding a new account, you not only receive the broker's current promotion, but you also get a free one-year subscription to Expiring Monthly. 


To receive the free subscription, you must link to the broker directly from one of the banner links below (no exceptions)


***


The brokers are TradeKing and tradeMONSTER.  Both are option trading specialists.

 

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716

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Contest to say Thank you Subscribers: Jun 2010 issue, Expiring Monthly

Announcing a contest for subscribers to Expiring Monthly.  Details to be announced in the June 2010 issue, available June 21, 2010.

If you are a serious trader, you will find this prize to be very useful.


Non-subscribers may enter. The prize is a one year subscription to Expiring Monthly.

There will be two winners: One subscriber
and one non-subscriber.


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Contest: Suggest a Slogan that Promotes Options Trading

Encouraged by a recent blog post by Michael James (Michael James on Money), I've been looking for just the right term to describe a style of options trading that could receive positive attention from the media. However, the term must be original and not be used elsewhere.

The first term that occurred to me was SmartOptions.  Alas, it's already in use as the title of a newsletter published
by Big Trends. 
I don't have access to their track record, but the methodology used to
make option trades does pass my 'smart idea' test.  In fact I blogged
about the methodology they use (when buying options choose ITM).

I'm looking for a phrase that may make the use of options as a risk-reducing tool ('OptionHedge' is available) more attractive to the huge segment of the population that either ignores options or has a negative attitude towards option trading.  Many have no idea why they distrust options or why their feelings are negative.   I'd suggest that most of those impressions are based on media stories.  Over the past couple of years, all derivatives and derivative trading stories involved financial disasters, making bad press well deserved.

However, using options as we do at Options for Rookies bears no resemblance to the trades made with credit default swaps or other newly invented derivatives.  It does not make use of 40:1 leverage that makes a financial collapse far more likely than the use of a sane amount of margin.

I'd like to restore options good name, but it probably never had one.  Thus, my goal is to find a way to present options in a favorable light.  The primary goal is to attract new investors into the options arena.

Most of the older brokers do not encourage options trading , and one (Raymond James) forbids its customers from using options.  In recent years several new brokers opened for business, and each is dedicated to educating option traders.  Some have the word 'options' in the corporate name; others don't.  But the success of these brokers has not been enough to overcome the bad image that options still have among the trading public.

The few of us who play the no-hype game when writing about options attract a loyal readership.  But the huge majority of people who have money in the stock markets of the world are, and remain, options illiterate.

I'm hoping to make a dent into that situation.


The next phrase/name I considered was TradeSmart, but there is a 'university' and software using that name.

Then I thought that the whole negativity behind options trading is that too many people compare options trading with gambling.  By that I mean making a blind wager with no idea whether it's a good or poor bet. So I tried 'Safe Options.'  When I searched for that word pair, I discovered a web site by that name that recommends safe option strategies.  Sounds good.

When I took a look, and noted that the primary strategies are covered call writing and its synthetic equivalent, the sale of cash-secured puts, I was again discouraged.  I have nothing against these strategies.  In fact, I believe in using them as an educational tool for people who are first learning how options work.

And it's true that these methods are safer than owning stock (buy and hold).  But, 'safer' is  not 'safe.'  These strategies provide plenty of risk when markets fall.

Even eHow.com got into the act.  This site that tells visitors how to 'build just about anything,' had an article on 'safe options.'  Once again it discusses covered call writing.

I admit that my first book was subtitled A Conservative Strategy for the Buy and Hold Investor, and it is about writing covered calls.  But I never called the strategy 'safe.'  It is what it is, and it is safer, or more conservative than buy and hold.  It increases the chances of having a profitable trade and cuts the frequency and size of losses.  But the risk of a large-loss is always present, and I would not want to get my investment advice from anyone who considers covered call writing to represent a 'safe' way to invest.

So here I am with no satisfactory idea.  Thus: a contest.

Contest

Suggest a name, phrase, or ? that I can use to describe option trading that satisfies these criteria:

  • It's honest.  No hype allowed ("Win with Options" is hype)
  • It's not trademarked or copyrighted
  • It reasonably short
  • It presents options in a positive light
  • It makes a good 'slogan' or tag line

If possible, but not required, use the phrase in an appropriate manner:  In a sentence, as a tagline, as a headline etc.

I have no idea how I will
judge this contest, but I want the phrase to appeal to me.

I'll keep this contest open for 10 days.  Entries must be submitted before midnight CT on Sunday, June 20, 2010.  The only way to enter is to post your idea as a comment on this post.

Prize: One year subscription to Expiring Monthly magazine.

If the winning idea turns out to be something that is of practical value and can be used as hoped, I'll try to find a suitable bonus prize.

713


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