Does Entry Price Affect Decision To Adjust?

Jim made this comment: "I sold an IC as one unit. Now I realize that I don't know how much credit I received for each leg which will make it more difficult to make adjustment decisions."

Jim,

Your simple lament offers much food for thought.

Let's start with the initial iron condor trade. 

1) You bought the iron condor.  When you sell the call spread and sell the put spread, that makes you long the iron condor.  Taking the advice of a reader, I'm going to try to remember to say that I 'trade' iron condors, rather than buy them.  Less confusion for everyone.

2) You do have the specific prices at which you traded each of the four legs of the IC.  Your broker must report that information.

3) You collected a specific premium.  For the sake of discussion let's assume your strike prices are 10 points apart and that you collected $3.00 for the iron condor.

Does it really make any difference to you whether you collected:

  • $1.50 for each spread, or
  • $1.20 for the put spread and $1.80 for the call spread. or
  • $1.99 for the put spread and $1.01 for the call spread?

In each example, you have a position and you have $300 cash.  I don't believe you should care how much cash you collected for each of the two spreads – unless you are keeping a trading diary (a good idea).  Write the numbers in your diary, and my advice is to promptly forget those numbers.  You don't want any extraneous information playing havoc with your future trading decisions.

4) Your job is to manage risk and decide whether to hold the position, close all or part [you won't always be trading one-lots], or add to the position.  You should do that as often as feasible.  If you work full time, then be sure to take a look each night.  If something bad is happening, i.e., the risk of holding makes you uncomfortable (or is threatening to do so) , then it's time to do something.  What that adjustment should be is not part of today's discussion.

5) Good news. Time passes, three weeks remain before the options expire, and the underlying index (or stock) is trading near your sweet spot (midway between the strike prices of your short options.  Everything looks great for this trade.  You can buy the put spread by paying $0.30 and the call spread is offered @ $0.25.  What should you do?

There is no 'right' answer for everyone, but I buy it in, say thank you, and decide what to do next (new position in another expiration month, or wait).  Your reward for holding is the possibility of earning another $55 per iron condor.  The risk, although unlikely, is that you lose up to $945 (from today's price, not from your original trade).  Do you hold or close?  Do you pay the full $0.55, or try for a lower price (if you choose to close)?  Those are your choices and you must make one.  Doing nothing is a decision to hold.

Does it matter what you collected when selling the call spread?

Does it matter what you collected when selling the put spread?

Not to me, and I don't see why it should matter to anyone.

6) Bad news.  Two weeks have passed, there are 6 weeks before the options expire, and the index is trading at 645.  You are short the 630/640 put spread.  Let's assume this is uncomfortable because the possibility of taking a big loss is staring you in the face.  What do you do?

Does it matter what you collected when  selling the put spread?

Does it matter what you collected for the whole iron condor?

Does the premium collected change the current risk?

Many people answer 'yes' to all three of these questions.  That makes no sense to me.  You own the position at today's price.  Do you want to continue to own it, or would you prefer to make an adjustment?  If you are truly outside your comfort zone and no longer want to own this position, would you hold – simply because closing results in a loss?

When you recognize that you own this position at today's price (assume you can close for $5.00, or a loss of $200), why would you want to hold just to avoid taking a $200 loss, but might consider closing if the loss were only $50, or would surely close if you had a $20 profit?  How can any of those things make a bit of difference?  How does it affect the risk of continuing to hold?

Today, right now, this position is worth $5 and the underlying can move in either direction – even though it has moved lower over the past two weeks.  This position can earn up to $500 from today.  It can lose up to (an additional) $500 from today.  How does that suit your risk tolerance?  Isn't that what matters?  Why should the price you bought this position be given any consideration?  You 'like' this position and the risk/reward profile, or you don't like it.

I know it's human nature to love profits and avoid losses.  But, in my opinion, thinking that way does not lead to success as a trader.  If you continue to trade iron condors, you will have many more winning trades than losing trades.  And you will have losing trades.  Count on it.  To succeed, you must do whatever is necessary to prevent those losses from overwhelming profits.  That does not mean that anytime the index moves in one direction or another you should close the trade in a panic. But when you are aware of the boundaries of your comfort zone, you will avoid holding positions that moved out of that zone.

If your risk manager persona tells the trader part of you that you are taking too much risk, it's usually right to allow the risk manager to have the final word.

228

4 Responses to Does Entry Price Affect Decision To Adjust?

  1. income trader 01/30/2009 at 7:20 AM #

    Hi Mark,
    How does the price paid for each legs of the spread not affect the trader who wishes to capitalize on an exagerated 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!

  2. Jim Lindor 01/30/2009 at 8:31 AM #

    Hi Mark,
    6) If I’m short the 630/640 put spread and the index is trading at 645 then I agree it does not matter what I collected and I should just get out. But I don’t know if that is actually a good point at which to adjust though or if earlier would be better.
    I know that if I constantly close out positions that have a small loss then I won’t make any money. I know that if I don’t close out my positions at all, then one day I’ll have a large loss. But there is a large gray area in between those two extremes where I don’t know how to evaluate the position.