Front Month Iron Condors Bite Again

Question from Mark:

Assuming you did open some RUT spreads. Let's say you have
some on the books around the 580 level. Market gets crushed today.
Shorts double. 12 days to expiration. Still some breathing room but been
stung before.

Adjust now and quick big loss. Wait for market to bounce and
adjust/close down the road. Wait and market falls, suffer more.

When do you mostly make your adjustments?



I have many comments explaining how I feel about your situation and my way of dealing with it.  Obviously my method may not be suitable for you.  I cannot tell you how to trade, but hope to offer some thoughts that you find useful and logical.

1) Two of your phrases are: 'shorts double' and 'quick big loss'

  • That tells me that you sold these spreads recently and at a relatively small premium
  • You are paying careful attention to the price at which the original trade was made

I strongly believe that it is bad policy to pay any attention to the original trade price.  Your primary concern right now – is the risk and reward potential for this position – as it stands right this minute.   Are you comfortable holding, or it feel too risky.  If too risky, would you hold anyway just because closing locks in a loss?  I hope not.  My point is that you are either comfortable holding this trade or you are not.  Original cost is immaterial.

If not comfortable, one decent option is to reduce position size.  It is not necessary to cover the entire position. 

Alternative suggestion:  Roll down:

  • Perhaps you can roll down by covering
    the 570/580P spread and selling the 550/560P spread.  It appears that
    you can make this trade for about $0.50
  • If size is not the issue (but how far OTM is), and if your position is less than your maximum size, you may want to roll down on a ratio:
    buy 2 570/580P spreads and sell 3 550/560P spreads.  Cost is approximately zero cash – but do not ignore the real risk associated with this trade, and that's being short additional spreads

Although it is the method of choice for most traders, using front-month iron condors is much more risky (yes, it's also more rewarding) than trading positions with a longer lifetime.  I believe that the high negative gamma is too difficult for the majority of traders to handle.  As you say, hold and you may be saved by a market reversal.  Holding may also result in additional losses that quickly mount on a further decline.

This risk is much less when options have a longer lifetime (gamma is less).  For my comfort zone, that makes them easier to trade and more comfortable to hold.  In addition, I collect a larger premium for spreads that expire later, so if I am concerned with P/L at a later date, I may still be able to exit profitably. [Honest, I pay no attention to original entry price.]

I recommend avoiding front-month options despite the rapid time decay.  But that is a decision for you and your comfort zone.

I also recommend against selling spreads
and collecting a small premium.  We each have our own comfort zones,
but front-month options have far too much negative gamma to suit my taste.  Sure, the rapid time decay is nice, but I prefer to trade the
less risky 2nd and 3rd month options. 

I'm not telling you what to do, but I do suggest that you consider your choices and decide whether front-month is the way you want to go.  You probably will not change styles, but at least when you consider alternatives, you should be more confident that your eventual choice is appropriate for your needs.

Having 'been stung before' I know you understand the problems of trading with increased negative gamma

2) I don't have set rules for making adjustments because I find that market conditions can be so different from one time to the next that I only have basic guidelines.

I tend to adjust early, but not always.  I may make a stage I adjustment when my short RUT options are 4 to 5% OTM.  At other times, I may wait for 3%.  Much depends on which adjustments are available at favorable prices.  When IV is high, I am more willing to roll down on a ratio because the roll can be made at a low cost and I can roll on a small ratio (when I am not 'all in' and have room to expand my position size).  It's amazing how high IV allows a good-looking roll down opportunity.  I recently rolled my short RUT options down by 3 strike prices on a 2 x 3 ratio for essentially zero cash cost. 

This opportunity is available when options are vega rich – and that means they are not front-month options.  

I do not enjoy moving the position by selling more spreads than I buy (to close), but will do that when IV is high and the prices are attractive.  But watch out for position size. This is not risk free – the black swan is in hiding – he has not disappeared.

3) Being a poor market prognosticator, I do not hope for a bounce in this situation.  It's strictly risk of holding vs. likelihood of earning a reward, and the size of that reward.  That's a discipline that does not come easily.  Trading without emotion (fear and greed) is also essential for the successful trader, but not so easy to achieve.


4) To avoid being in his situation, my trade plan calls for exiting when expiration is three weeks away.  I don't always meet that objective.  But, if my risk management persona is okay with the trade, then I hold a bit longer. 

I covered some Jul call and put spreads when they became inexpensive (25 to 30 cents in this volatile market is cheap in my book) but  I never was able to buy the Jul 570/580P spread.

5) Like you, I am short a some of these RUT Jul 570/580 put spreads, and if I felt compelled to cover, paying near $1.50 would be a relatively inexpensive exit for me.  Yet, I feel no urgency to exit. 

The Jul 580P has a 21 delta, and at that
level I'm willing to hold longer.  However, this is a small part of my
portfolio, and if this specific spread gets into trouble, the loss is
well within acceptable limits.  If this is your only position (and I
understand that is likely) then you must think about your ability to
withstand the potential loss.

NOTE:  I don't know whether holding is within your zone.  This is a personal trade decision each trader must make.  I hope you can base the decision on something other than fear.

Good trading.


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11 Responses to Front Month Iron Condors Bite Again

  1. Mark 06/30/2010 at 1:45 PM #

    Very insightful and helpful, especially ratio approach. Yes, I’ve traded front month simply from the fact that there was initially more information on this approach than multiple months.
    You counteracted my thoughts as to risk of this approach as longer time frame on sold options to me implied additional risk, not less.
    That being said, that approach may actually suit me better. Potentially less trading and micro managing, higher credit, strikes farther out of the money. Much difference in managing these vs front month?

  2. Mark 06/30/2010 at 1:51 PM #

    BTW – How much credit on avg do you collect up front per spread and how far out of money % wise are you usually able to get? (Assuming avg volatility)

  3. Mark Wolfinger 06/30/2010 at 2:54 PM #

    There is not that much difference in managing 2- or 3-month iron condors vs 1-month. After all, they become front-month spreads quickly enough – assuming you don’t exit.
    The major difference is that early adjustments are less drastic – fewer delta to adjust, less gamma etc.
    No significant differences.

  4. Mark Wolfinger 06/30/2010 at 3:01 PM #

    Trading 10-point spreads in RUT, I tend to sell as far OTM as possible and still collect roughly $3.00 for the iron condor.
    With IV higher, I’m collecting 3.20 to 3.60 – but I could just as easily move one strike farther OTM on one side to take in a bit less premium.
    I don’t pay attention to % OTM, but it you want to use that as your primary strike selector, that viable. Perhaps the best way to choose strikes is by the delta of the shorts, but that is secondary for me.
    If you plan to hold to the end, then risk of seeing one option move into the money is NOT small for 90-day positions. If you plan to exit 2 to 3 weeks sooner, that makes a significant difference on risk. It also means you must accept less for the maximum profit.
    Today I covered two different Sept call spreads. Paid 30 cents or one and 24 cents for the other. That’s more than 2 months away. Pretty cheap cover in a volatile market. Hope to get the puts eventually.

  5. Mark 06/30/2010 at 6:08 PM #

    Thanks Mark. Your info from experience is invaluable.

  6. Mark 07/06/2010 at 5:20 PM #

    Did you decide to cover your 580/70’s? I rolled to 70/60 last week but more uncomfortable with today’s drop and amount of time left. You ever recommend closing say half the shorts and keeping longs open?

  7. Mark Wolfinger 07/06/2010 at 6:28 PM #

    Hi Mark,
    I did not cover. I moved them down to 550/560, but increased size because my risk profile had room to spare. Sold 3 spreads for each 2 that I covered.
    I had a (low) bid in to buy back that spread this morning, but the rally faded.
    I NEVER recommend that idea that you suggested. It’s a personal choice, but feels VERY wrong to me.
    If you want to own some put options as a ‘play’ or as insurance, that’s always a reasonable thing to do. Buy why choose to buy the options that you are short? Why not buy the specific option you believe is best?
    Why remain long the specific option you are long now? Isn’t there a better put to own that that specific put?
    If you cover half the short, it’s not likely you will own a position that fits the description of something you want. I believe some traders get blinded by being thinking as you suggested: “I’ll just cover half my shorts” without considering alternatives.
    Here’s another problem. Opening backspreads into expiration is very risky – with a decent reward potential. But owning OTM puts is so much against the odds of success that I don’t ever consider doing that (I’ll own them for protection, but not as a play to earn a profit). I do NOT want to be long the 550s, so I will not cover the 560s.
    I’d much rather exit the trade while the cost is still reasonable than own 2 550s for each short 560. That position would prosper on a debacle, but lose money under more realistic scenarios.

  8. Mark 07/06/2010 at 6:47 PM #

    Makes sense.
    Fear of loss causes improper brain storming at times. Just trying not to repeat my March “learning experience” when I got 4th degree burns by not adjusting correctly.
    Currently about 3.5% OTM and exiting completely would produce triple or 4 x’s credit loss at this point. Rolling now seems to not be much more advantageous cost wise than possibly seeing how the next few days go and rolling if RUT hits 580. Unless of course the RUT gaps down at open and gives you little “option” other than rolling down further with increased spreads, out a month (which I dont feel to be prudent in this market), or close the coffin and move on.
    There is no easy solution it seems once you are in a situation like this and just trying to save your skin.

  9. Mark Wolfinger 07/06/2010 at 6:58 PM #

    Only in hindsight do we know if we adjusted ‘correctly.’ Your goal should be to own a position worth owning – after the adjustment. And if the adjustment is too costly, I suggest taking the loss and exiting instead.
    You are doing it again. “exiting completely would produce triple or 4 x’s credit loss at this point”
    Here is my question to you: How can it possibly make any difference how much credit you collected when initiating the trade?
    In my opinion (and yes, I feel it is a minority opinion), all that matter is this: Consider the current price of the spread. Do you want to own it? If yes, own it. If no, exit. If undecided, reduce size by covering a portion. Future risk has nothing to do with how much you have already lost.
    Mark – this is my perspective. It’s my philosophy. It does not have to be your way of trading.
    I see you have a plan. You have alternatives if such and such happens. Good. But the part I believe you ought to rethink is ‘gives you little “option” other than rolling down further.’ You always have a choice. You do not have to roll down further.
    Rolling is not a cure. It is one way to work with a risky position.
    Are you truly trying to save your skin? I don’t see it that way. What I see is someone desperately trying to turn a specific position profitable. And I understand why. Expiration is not that far away and 3.5% seems to be reasonably out of the money.
    But you know it’s almost ATM in these markets.
    Good luck. I have no idea what you should do.

  10. Mark 07/06/2010 at 9:52 PM #

    Thanks. I really appreciate your input. I love this journey that you have already travelled.

  11. Mark Wolfinger 07/06/2010 at 10:37 PM #

    I hope you love the whole journey. But you would be well advised to not follow my path. It has far too many ups and downs. It’s amazing I survived my market maker years.
    That’s why I place so much importance on managing risk. I strive to help others learn what I learned – but more quickly.