Examining Adjustment Alternatives

When it's time to adjust a position, most of the time, it's easiest to exit the trade and find another.  At other times there are multiple – and all satisfactory – choices.  Let's consider one example.

The market has been marching higher in recent times, so iron condor traders may be facing a difficult time with their call positions.  In today's example, I'm looking at a portfolio that has two trades:

Position one:  An iron condor that is in trouble.  In fact, many traders would have closed this position long ago.  But a good number would still be holding because the short call is still out of the money.

Index is currently priced at 850, after a nice rally

Bought 10 (not recently): Oct 720/730P; 860/870C  iron condors

Collected $325

Position two:  A pre-adjustment, bullish spread with a naked long call, bought earlier

Bought 2 Oct 850 calls;  sold 8 Oct 880/890 call spreads. 

Paid $1,000 total debit for this trade.

Net credit: $2,250 (10 x 325 – 1,000)

Where do things stand:

a) The October put spread was covered by paying $0.20.  Cost $200

b) The 860/870 call spread is in dangerous territory and your action may depend on how much time remains before expiration; your market outlook (if you have one); your comfort zone; the size of your portfolio (is this a large or small position for you?), etc.  There is no 'one-size fits all' solution.

c) The 850; 880/890 (1 x 4 x 4) spread looks great.  This position never loses more than the original cash debit (if all options expire worthless), and has unlimited upside profit potential – above 890.

With your long call being ITM by 10 points and the OTM still away, this is a profitable position (at least right now).

What now?

You have two basic choices.  Manage these positions separately, or combine them and use the total Greeks to help manage risk.

There's no set of rules for anyone, but I prefer to combine the trades and make a single position.

Viable ideas

1) Cover the 10-lot of call spreads that remain from the iron condor.  To pay for those spreads, sell your two long 850 calls.

The advantage of this trade is that: Your 'naked' call spread position has been moved from 860/870 to 880/890 and the number of short spreads is now only 8, rather than 10.

You used your 2-lot of long calls to good advantage.  You sold them to pay for the losing side of the iron condor trade.  There should still be some cash left over, after these closing transactions.

If you want to refine this position further, you can close the 8-lot 880/890 call spread to exit the trade; sell an 8-lot put spread against the calls to create a new iron condor; hold the call spread, knowing that you may be forced to close it at a higher price later.

2) This is an example of rolling down the position.

a) Cover the 10-lot of 860/870 spreads and roll down by selling 10-lots of the 880/890 spread.  Your position is now short 18 of these call spreads.

b) Roll down the 850 calls

If it's more important to you to bring in some cash to offset the roll, then sell the 850/870 call spread 2 times.

If it's more important to have a less risky position, then sell your 2-lot of 850s and buy 3,4, or 5 of the 870 calls.

Rolling both positions down is likely to cost cash out of pocket, making it more difficult to end up with a profit by the time expiration arrives, but I prefer to ignore that.  If your position makes you uncomfortable and you must make a change (or exit), then that takes priority over taking extra risk in an attempt to salvage a profit.

c) It's always reasonable to reduce the position and you can do that here by cutting each position in half.


11 Responses to Examining Adjustment Alternatives

  1. Josh 09/30/2009 at 7:35 AM #

    Greetings Mark:
    First thanks for your blog (book and other options education work). You do a great job giving people good information in a area all too often filled with hype.
    Second, in the above post when you say roll down you are talking about buying spreads that are closer to the money (860/870) and selling spreads that are farther from the money (880/890). Since these are call spreads I would think you should call this rolling up (i.e. to a strike or set of strikes farther to the up side). That made me have to read the post twice.
    Third, can you comment on adjusting by simply adding an offsetting position. Here my thought would be to either add another iron condor or a put spread so as to cut the present negative delta of the position in half. (Also I am ignoring you debit spread hedge.) Of course some of this depends on how far and over how much time the hypothetical underlying has moved. But the idea is to put on an offsetting position to make it more comfortable to leave the original position on. There are two caveats here (for me anyway): 1. It might be a bit late in the OCT cycle to adjust this way given. I am not quite sure here if it would be better to just take the position off or maybe hedge in NOV 2. I would still plan, at some point, to take the short 860/870 spread off or roll it up if the market continued to move against me. That point would either be a based on dollar amount loss on the position or perhaps a close and subsequent open above the short 860 strike.
    Please let me know what you think about this sort of adjustment strategy

  2. Mark Wolfinger 09/30/2009 at 10:05 AM #

    1) Thank you
    2) Up and down can lead to confusion when people have different perspectives.
    When looking at any page of option quotes, the higher strikes are at the bottom.
    Thus, to me, rolling down means down on the ‘picture’ of option prices – as seen by the trader. Thus, ‘down’ refers to higher strike prices and ‘up’ refers to lower strike prices.
    This is industry standard – at least as far as I can determine.
    3) Almost any trade that offsets risk is a good adjustment.
    With the excption of increasing ‘size.’ In general, it is a poor idea to make the position larger in an attempt to get neutral and salvage the trade – i.e., hoping that it becomes a winner.
    In other words in you have a spread with 20 longs and 30 shorts, making it 20 x 40 is not a good idea. That just adds extra risk. If you want to change this spread to a 1 x 2 ratio, make it 15 x 30 instead. The idea is that it’s better to buy back a 5-lot rather than sell a new 10-lot.
    To your examples:
    IMHO it depends on the new iron condor. Is it’s a good trade (other than not being delta neutral)? Do you like the new, improved portfolio? If yes, and if you have not increased risk beyond your comfort zone, then – yes, it’s viable.
    But be careful. You will have increased the size of your position. If you made this trade with the sole purpose of reducing rissk and not becasue you TRULY want to own the new position, then it is NOT a good idea. Why own a new position, with it’s risk/reward profile – when you don’t love the trade?
    Adjustments should be done for two reasons: To lock in profits and to redcue risk.
    Thus, your alternative suggestion: selling put spreads to offset your ubalanced positon, does not work in my opinion. It looks good; it provides some positive delta. But that’s not good enough. Why?
    1) The protection is minimal. If you are short a 10-point call spread that is now trading near $4, how much protection do you gain by selling a $1 put spread? Not nearly enough. If the market rallies, the position still gets pounded.
    2) If the market reverses, that newly sold put spead places you in jeopary, when you previously had no jeopardy. True, the smallere number of put spreads makes the downsie better than the upside, but that’s not good enough for me nand my comfort zone. Is it good enough for yours?
    And if – to save cash – you have not already covered the original iron condor put spread, you can be in big trouble on a big declne.
    I understand the rationale behind getting that extra cash and some good deltas – but it’s too little of either to do much good. My experience tells me that it’s far better to reduce the call spread – and then – if you still want to do so – you an initiate a new iron condor. The good news is that the new trade will be more neutral.
    But selling puts spreads to ofset a bad call position ONLY works when the market moves higher and higher and you sell enough put speads to compensate for the loss on the call spreads. Please consider how risky that position would be – especially if you feel safe and neglect to buy in the FOTM put spreads as you continue to sell more put spreads.
    I’ve done this early in my trading career and it does not work.
    If you insist on this trade idea, then here’s what you must do: cover the outstanding put spread. Sell some put spreads with real delta – and for real cash. No cheapie spreads. Then you would have a new iron condor [yes, you would only have half as many put spreads as call spreads, per your diea of covering half the delta]. This gives you downside risk – but it does make the current trade safer without increasing size. This approach must be taken with caution.
    The new trade does not have to be in Oct. It is OK to have puts on Nov and calls in Oct, but I would prefer to close the Oct, if I were in your shoes. But that’s my comfort zone.

  3. Jeff 09/30/2009 at 10:53 AM #

    I would find your posts more credible if you would transition from the hypothetical to your real-time actual trades and your active management of those actual trades.

  4. Mark Wolfinger 09/30/2009 at 12:49 PM #

    I’ve discussed this previously.
    Your’s is an important comment and I’ll shortly post it as a separate blog entry.

  5. Josh 09/30/2009 at 5:40 PM #

    Greetings Mark:
    Thanks for your response. So, there are a couple things that I think I should clarify. First, my idea is predicated on starting out with a half position. I assume that I am going to need to make at least one adjustment per month (I trade front month positions initiated 30-50 days from expiration). So if I want to have ten iron condors on I would initially sell 5 and look to sell another 5 (collecting about the same credit as on the first 5 spreads) to cut any delta imbalance about in half.
    Second, when I put on the adjustment I am not really thinking of it as a stand alone position that I want. I think the question is do I want to lock in a loss (when probabilities are still on my side) on the initial spreads and then put on another position. Or do I want to own the new combined position, that is the one were I sell an equal amount of iron condors for equal money, where the delta of the original position is now offset by half or so. I think in a way the loss and new position is not that different in terms of aggregate risk from what I am proposing. But, I admit I might be wrong here.
    Third, as to just selling one side of the position (in this case a new put spread) to re-balance delta risk, I think that is less than idea but I do not want to put on a new IC with fewer than 20 days to expiration. Also, I am not excited about putting on a back month IC to balance a front month position, though this might just be a mental block on my part. If I take off the back month position when I close out the front month then it should not matter in terms of delta. But I would think that differences in theta and gamma would mean that the back month hedge would not be as effective. Is that the case? To get the same effects for theta and gamma in the back month position I would imagine that I would need to make it significantly bigger (riskier) than the front month position, and I would not want to do that. This is the (winding garden) path that leads me to the idea of just selling a spread on one side in the front month to offset delta. So if, continuing with your example, I were short the call spread and had already bought in the puts I would not sell half as many put spreads as I had on call spreads. I would sell the same number. And, as you said I would try to sell them for, as you put it, real cash. I would look to cut the delta in half, and would focus on that more than the credit. I know that this created downside risk that I did not have before.
    Part of this is predicated on the idea that there is (except for some points during the recent [and continuing?] rally) a tendency for mean reversion. That is why I would use a rule of thumb of cutting the delta in half and not try to make it flat. (In fact I should probably cut the delta by less to counter an up move since a down move is likely to also increase IV and thus the ICs price). So the underlying is likely to have moved a ways and thus likely to have some move back down.
    Anyway, that is probably more than enough for this comment.

  6. Mark Wolfinger 09/30/2009 at 7:22 PM #

    Quibble: There is no nomenclature authority, and thus, there is no universal agreement. When you say sell an iron condor (sell and collect cash), I use the term ‘buy’ (sell a call spread and sell a put spread) an iron condor. Further discussion, if any, will have to wait.
    1) You neglected to mention how long you wait before trading the 2nd half of your position. Obviously the passage of time is going to make it difficult to receive near the same credit, unless you move closer to the money. I usually opt for accepting a smaller credit (my comfort zone decision) when adding to a position in the same month.
    2) This is difficult. I have much to say here, but lack the time now.
    3) Let me assure you it is not a mental block. Regardless of whether it’s a winning strategy (I don’t know that it is, this is hypothetical) to have a front month/back month combination, the fact that you don’t want to do it – for any reason (even if it’s a superstition) – tranlates into the fact that the posiiton would be outsdie your comfort zone. And you MUST avoid that.
    I have very few rules when trading, but remaining within your comfort zone at all times is one of them.
    Front month positions are more gammacious (a word I made up. It means ‘have more gamma’) and are thus riskier from the point of view that they can get into deep trouble very quickly. To offset that risk to a degree, theta is greater and time is on your side. But, I dislike front-month positions at all times. That means I am constantly wrestling with the decision: are the benefits of my remaining fron-month positions are truly within my zone.
    You are not forced to put on a new position with <20 days remaining. I've blogged a good deal on various types of adjustments. Some allow you to modify the call spread and ignore the puts side. That idea works for me.
    You are correct. You cannot easily equalize front-month theta and gamma against a positon in a different month.
    3a) Selling an equal number of pout spreads for 'real cash' is a good idea. It balances the delta to a significant degree, it leaves you market neutral, and it redues risk. Nice.
    I have apersonal problem with this specific trade. It my problem and there is no reason why it should be yours. When I lsoe money on a bull move, I am psychologically badly hurt when the marekt turns around and I then lose more money on the market decline. Rooting for that decline as the market rises, I am devastated when that decline comes and I do not score a win. Thus I simply cannot easily sell puts into a rising market. Call it a putsellingphobia.
    Money is money and a loss is a loss. But the loss resulting from a whiplash is bad for me. Not logical. Not market neutral tradding, but I try very hard to prevent that from happening. That's why I sell fewer put sprads. You must trade positions that make you comfy.
    4) You seem to have a handle on things and are taking the opportunity to think out loud. That's reasonable.

  7. Josh 09/30/2009 at 10:33 PM #

    Greetings Mark:
    Thanks for taking the time to write back forth on these topics. It is really helpful for me and it might even provide some help to others.
    (BTW, as I am writing this I can see and hear the tanks rolling by below my window. They are coming back from the Chinese National Day Celebrations on Tian’anmen. It is very strange and a bit disturbing to see actually).
    If you have time and the inclination I would like to get your thoughts on point 2 above; the one about wanting to own the new aggregate position vs. taking the loss. Which brings up the questions of whether or not taking a loss and putting on a new position (rolling) is equivalent, or in what way equivalent and what ways not, to delta hedging by putting on a offsetting position.
    As to terminology, I know you say buy an iron condor when you are short the closer to the money spread. But since that position is net short options (by dollar value or gamma) I think of it as selling. I understand your way of putting it and you understand mine so maybe we can think of it as a difference akin to one of accent.
    It is interesting to see your concern about the market coming back down once you have sold put spreads into an up move to re-balance delta. It helps me to really understand what you mean about comfort zone and how it can be an idiosyncratic thing. I too have that fear of the whipsaw and that is why I would think of trying to cut the deltas of the original position by only 1/2 or 1/3. Another thought might be to buy an OTM put calendar just above the sold put spread. That way if the market comes back down the OTM put calendar should get a big pop from both delta and vega and can be taken off to ease the pain in the put spread. I suggest a calendar instead of just a straight put buy because I think it would have less change of turning into a big loss.
    I know you don’t really trade calendars or butterflies but I have some questions about adjusting those. The questions/thoughts are along the lines of what I have written about iron condors above. If you are willing maybe I could write you about that directly and you can use it as a blog post if you think it might have value for others too.
    Thanks again for your time, effort and expertise. I really appreciate your help.

  8. Mark Wolfinger 09/30/2009 at 10:43 PM #

    To avoid confusion, I try to remember to say: ‘trade iron condors.’ That confuses no one.
    Sure you can write directly, but I have appreciated that you post comments online.
    The one problem: You write long questions and I write long replies, and I’m getting busier all the time and there’s just less time to devote to replying to e-mails.
    Give me a week or so and I’ll complete my replies to you.

  9. Don 10/01/2009 at 11:54 AM #

    Hey Mark, Congrats on your success at Amazon!
    Reading the above comments brought something to the forefront for me and I wanted to ask you. I always figured that “rolling down” meant lower price rather than physically looking at a price chart and “rolling down” THAT i.e 100 to 110 versus rolling down as in towards -0- i.e rolling down from a 100 meant 90 NOT 110 so many of the comments become crystal clear.
    Also in the comment aboce you reference the 2 850 calls and then the 8 880/890 but you have 1x4x4 listed- why is that?
    Hope all is well,

  10. Mark Wolfinger 10/01/2009 at 11:13 PM #

    T-Squre is certainly an interesting place to be.
    1) I will get to point to asap. Swamped right now, with very limited time.
    2) Terminology. I try to say ‘trade an iron condor’ whenever I can remember to do so.
    3) Comfort zone is important. Do what makes you feel satisfied to own whatever position is is that you own. And if you cannot find a suitable adjustment, then just close and begin again.
    4) There are many ways to adjust. I’ve discussed several that appeal to me. Calendars can be profitable and I know of a successful premium seller who places a LOT of confidence in them. I trust his methods, even though I am not totally familiar with them.
    5) A butterfly IS an iron condor. With zero space between the short strikes. So adjustments should be quite similar.
    6) Happy to help.
    7) If you send separate email, I’ll do what I can to reply.

  11. Mark Wolfinger 10/01/2009 at 11:37 PM #

    1 x 4 gives me a naked long call. That provides some great upside protection.
    My only risk of loss is the debit paid for the spread.
    There is also a profit zone form 850 (+ cost; to somewhere above 880).
    But the real reason for 1 x 4 is that the spread that I am selling reaches it’s maximum value of 10 points when the long is 40 points ITM and is worth 40 poins. the same 40 points of value in the four qo-point spreads. In other words, except for the debit paid, there is no point a which this spread loses to the upside. It’s one of my favorite methods for buying upsside protection.
    If I had sold the 870/880 spread instead, the ratio would have been 1 x 3.
    Objective: own a GOOD srike call at a low price – with virtually no upside risk and upside profit potential. It’s a cheap bullish play. I’ve discussed this play before.