Flexibility is Essential When Choosing Trading Strategies

As I've discussed previously, when you trade options, managing your positions is far more important to your overall profitability than choosing the 'best' strategy.  More money is lost by mismanaging risk than is made by adopting one specific strategy over another.

At the moment I admit to being undecided about how to proceed with my trading.  I still own some RUT June positions (they began life as iron condors, but most of the put spreads have been covered @ $0.25 and $0.30).  One thing I know for certain is that the unidirectional markets of recent times have made the iron condors I chose unprofitable. 

My methods are not designed to profit from markets such as those we encountered recently (huge down followed by a huge up).  Owning pre-insurance would have solved all my problems.  But I strayed, buying some, but not enough insurance. 

Discipline is still the name of the game for traders and investors.  And over-confidence remains a killer.  I had been doing well and became too confident.  Thus, I backed off when buying insurance.  Somehow I didn't believe I needed a 'full load' of insurance over the last two months.

A recent comment by GMG made me glad to see that those methods worked for someone else.

"Using pre-insurance was a key reason that I expect to end up with a (meager)
profit. The April rally would have stopped me out long ago without those extra
calls I bought."

Recognizing that pre-insurance (the purchase of extra options) works wonders when the market makes a sustained move in one direction, and noting our profitable (if hypothetical) diagonal back spread (latest update and original post), makes me want to own extra options.  The steadily decreasing volatility makes that strategy less expensive to adopt, but one not-to-be-ignored risk is that IV will continue to decrease, and these spreads are rich in vega.

Another of my favorite ideas for providing insurance for iron condor positions is to open an insured half-iron condor.  In other words, sell a put spread and own extra puts, or sell a call spread and own extra calls.  For anyone who believes the market may re-test the bottom, this is a decent proposition.  If the markets reverses big-time, those extra puts will work nicely.  If the rally continues, there's nothing to lose from the put spread – and a call spread may become wildly profitable.

In this scenario, all roads lead to backspread positions.  For a dedicated premium seller, it's not that easy to make the temporary change.  But one of my premises is that market conditions change and a successful trader must be flexible.


6 Responses to Flexibility is Essential When Choosing Trading Strategies

  1. Gil 05/06/2009 at 5:59 AM #

    the idea of a pre-insured IC sounds great.
    I usually refrain from 2-3 months ICs, and purchase only short term (about 1-1.5 months) ICs.
    I believe that such pre-insurance will not work for my short term ICs, since it will eat most of my collected premium.

  2. Mark Wolfinger 05/06/2009 at 7:44 AM #

    Not all ideas are worthwhile for all investors.
    If your positions are small, you may not need pre-insuance.

  3. rluser 05/06/2009 at 8:32 AM #

    I agree, Gil. My modelling and limited experience suggests that preinsurance does not work for the front month. One would be better off buying strangles and forgetting the spreads outside thereby saving commission. That is how such positions appear to me to behave (depending somewhat on sizing). When the preinsurance falls in an earlier month than the spreads, the situation is much more interesting and useful.

  4. Mark Wolfinger 05/06/2009 at 8:38 AM #

    And on’t forget it’s easier to purchase options with strikes that are closer to being at the money.
    One convenient method for managing risk is to own small positions.

  5. Dave 05/06/2009 at 6:00 PM #

    I’ve cut my trades to at least half size and just continue selling IC’s at various each week no matter how wrong it feels. Results could be worse…
    One of the things I like most about your book (and blog) is the consistent lack of directional conviction. When I look at the fundamentals of our economy I can’t fathom why this market continues to rally. But then there’s some really plausible ideas why we could just be getting started. Who the hell knows where it’s going?
    Hoping and guessing market direction hasn’t been real kind to me. I appreciate the methods you teach. I know they’re right for me. I suspect they’ll get even righter in a month or so.
    Thanks for what you do!

  6. Mark Wolfinger 05/06/2009 at 7:07 PM #

    It’s so difficult to pick direction, and I’m not going to attempt to become a momentum trader.
    But these unidirectional moves make me want to either own positive gamma (too expensive) or at least have the tails of my risk curve tilt upwards, rather than down. That can be done with insurance.
    Thanks for your comments. I do appreciate them.