Continuing The Discussion: Does Original Trade Price Affect Future Decisons?

Income Trader asks this question (as a follow-up to this morning's post):

Hi Mark,

How does the price paid for each leg of the spread not affect the trader who wishes to capitalize on an exaggerated move in one of the spread legs? I like to trade in and out of the legs of the Iron Condor especially in volatile markets.

I can understand the trader who buys and holds the Iron Condor and places a trade to buy back at some point and closes the position. Just trying to understand what you mean by it not being a factor!

Thanks!

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Hello IT,

I believe this is all a matter of perspective, but to me it's important because certain perceptions prevent traders from making good trade decisions.

Let's agree that you decide it's time to buy in your call spread (half of an iron condor) because you believe the next market move is higher.

  You can trade any call spread on the board, but for your own reasons, you decide the spread you are short is the only one you want to trade.  So, you enter a bid to buy that call spread.

Why should the premium you collected when you sold this spread – as part of your IC position – be of any concern?  If you are bullish now, then isn't now the right time to buy back this spread in an attempt to sell it again, at a higher price?  Why should it matter to you if making this trade results in a taxable gain or loss?

To me, it makes no difference.  In your situation, I'd want to buy the spread because I am bullish now.  I don't want to choose not to make this trade decision solely because it results in a loss.  The reason for this trade is that you believe that you will earn a profit by selling this spread again at a higher price.  The reason for the trade is not to lock in a profit now.  That comes later.

I'm not trying to convince anyone that I am right, nor anyone who doesn't see it this way is incorrect.  It's truly a matter of how you see things – and not everyone agrees on what is logical or reasonable.

I'm saying: to me, it's logical to make trades you want (must?) make.  Sometimes it's to seek profit (as in your case) and sometimes it to reduce or eliminate risk.  If the trade idea is good, if the timing is right for you, I don't think it's in your best interests to skip the trade because it would lock in a loss from a previous trade.  Do you?

Mark

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3 Responses to Continuing The Discussion: Does Original Trade Price Affect Future Decisons?

  1. income trader 01/30/2009 at 10:07 AM #

    Hi Mark,
    I agree that the original price should not affect your future decision in regards to modifying a neutral position to a directional position or vice versa for that matter. The market waits for no one!
    On the other hand there are differences in how you go about getting the desired effect. Many times, as you obviously know, simply adding or removing delta from a position with a purchase of a call or put may do trick just as well. There are obviously many other factors to consider such as time to expiration, position size, your volatility projections which all should come into play when deciding what to do!
    My point is that over the years I have found it very difficult to successfully trade the legs of a condor when the original fill level on the full spread is skewed substantially either way. Reason being that, in my opinion, in very volatile markets it is almost always best to “leg” into these 4 legged spreads even though the pricing on the full spread may be slightly better executed all at once.
    Thanks!
    IT

  2. Mark Wolfinger 01/30/2009 at 10:18 AM #

    Hello IT,
    Your final paragraph says it all. If you find it difficult to do something, then it’s best avoided.
    If legging suits your style and risk management, then legging into into iron condors is better for you.
    If your overall plan is buy back one spread because the price has dropped significantly, then that’s something I do on a regular basis. The difference is that I have no plans to re-sell – while you anticipate the opportunity to sell again.
    Here’s a thought: Let’s say you sell a 590/600 call spread and collect $150. Later, you anticipate a rally and repurchase for $0.60. [That’s more than I’d pay, but we are discussing your methods.] Instead of buying that spread – now reasonably far OTM – is there a reason why you don’t buy the 570/580 (or some other appropriate strikes) if you are bullish – and leave the iron condor unchanged?

  3. income trader 01/30/2009 at 10:41 AM #

    Yes I agree that would be a consideration. I would evaluate the best strategy to accomplish the desired effect based on all the components that will potentially affect the value of the strategy going forward. There is a time and place for every strategy!
    Thank you for your responses Mark!