Hedging a Portfolio of Index Iron Condors


As a way of reducing risk from a downward move, could you recommend the
most appropriate hedge for a portfolio of index iron condors? I have
considered OTM puts, debit spreads, VIX calls & other calls on other
VIX products, even Gold & bond ETFs.




I apologize for the delayed response.

There is no 'most' appropriate method or adjusting iron condors.  For some traders the primary objective is to get rid of that risk.  For them, exiting the trade is often the simplest solution.

For others, finding a good method for keeping the trade alive – and worth owning – is the objective.  To do that, trades must be made that are appropriate for the given situation.

But – here is one piece of advice: To find the best hedge for an IBM position, try to trade IBM options.  For SPX spreads, try to hedge with SPX options.

Let's take a look at your suggestions:

1) OTM options come in two categories: 

a) Those that are farther OTM than the option you are already short.  Those puts help in a black swan dive.  Not otherwise.

Why don't they help 'otherwise?'  When you own any extra OTM options and look at a risk graph, you will see that the tails of the curve point to rapidly increasing profits.

That seems to provide all the risk protection needed. The problem with that scenario is the ticking clock.  Those puts and/or calls do provide great protection.  However, you are buying these options to protect an existing position, not to deliver a huge profit on a huge market move.  Sure, that would be a nice bonus, and if you want to own black swan protection, that's okay.

But here you seek a good hedge for your iron condor portfolio.  With the iron condor, you plan to hold the trade for a while.  When you plan to hold until expiration or plan to exit sooner doesn't matter here.  The point is that as time goes by, the effectiveness of those OTM puts  that you bought or protection decreases.  They still serve as black swan protection, but do almost nothing to cut losses as your short option becomes ATM or moves ITM.

Quick example:  you are short the 900 calls.  If you buy some 920 calls, the upside looks great.  But consider that it's expiration week and the index is 895 to 905.  Your original position is causing pain (if you still own it).  And you may still own it, being mesmerized by the risk graph that shows how well you do on a move to 930.  But a move to the 910 area is a lot more likely than a  move to 930.  And time is short.  Thus, if the market trickles higher, not only does your iron condor threaten to lose the maximum, but the options you own for protection are quickly fading to zero.  The worst possible result:  Insurance is a total loss and so is the original trade.

For this reason, I do not recommend buying options that are farther OTM than your shorts – when your objective is protection. 

b) Those that are less far OTM than your current short options.  These are wonderful options to own, and afford fantastic protection.  But – they are probably more expensive than you are willing to pay.

In the example, if you owned 880 or 890
calls (bought before the market moved near 900), you would own REAL
protection.  It may be insufficient to prevent a loss, but those options
will have real value if and when the iron condor gets into trouble.

The price of these options can be reduced by applying the kite spread.  Before using kites, be absolutely positive that you understand risk as expiration nears.  Study those risk graphs.  This trade can be tricky to handle.

2) Debit spreads – which are less far OTM than your short put – help.  But they offer limited protection.  Many times the cost is too high for limited protection, but it does help.

In the example, you could buy 880/890 call spreads as partial protection.  The obvious limitation of this method is that this spread can only move to 10 points, and that may be far too little protection.  But it is one way to hedge – if it appeals to you. 

Warning:  If you pay a big price for these, then the profit potential is too small to do you any good.  If I buy these, I consider $4 for a 10-point spread to be as far as I am willing to go.

3) When looking for a debit spread to purchase, do not eliminate the spread you are currently short.  Even though that would close the trade, if that is the best spread to buy, then buy that one and lock in the loss.  Don't buy the wrong spread just to keep a poor position alive.

4) Stay away from VIX options unless you are 100% certain you know what they are and how they work.  For example, VIX is not the underlying for these options.  VIX futures are the underlying and I believe you will be best served to stay clear of VIX options.

5) VXX options may be better, but I am have not used them and do not want to offer advice that may not be accurate.  Ask Adam Warner or Bill Luby for advice.

6) Gold and bonds are out of my league.  That type of hedge does not work for me, and truthfully I know ZERO about those products. If that is your plan, you must get advice elsewhere.


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6 Responses to Hedging a Portfolio of Index Iron Condors

  1. Jorge 09/09/2010 at 10:13 AM #

    What do you think of a calendar spread further OTM of the threaten short?

  2. Mark Wolfinger 09/09/2010 at 10:39 AM #

    I approve of such spreads.
    1) They offer limited protection.
    2) The profit protection they offer can disappear. Thus, it is VERY important to take profits on this type of position if and when they become almost ATM.
    Yes, it’s tempting to hold longer and allow time decay to do it’s job. But you bought this spread as PROTECTION, not as a separate money-making trade. Use it as insurance.
    If the market continues to move against the position being protected, you not only lose move money on that iron condor or credit spread, but the calendar spread can quickly become a loser instead of a winner. When potential gains are limited, you must take them at some point.

  3. dave 09/09/2010 at 6:40 PM #

    mark ,
    I have never used insurance as far as extra long puts and calls to hedge condors. But i have read a ton about it in options for rookies the book as well as the blog here. I have actually never used it because of my position sizing it wouldn’t make sense. How ever I have thought about upping size and using it. How many lots would you say is worth it ? Are we talking a 20 lot condor ? The book uses the example with a 40 lot. I wouldn’t trade that large but i could do a 10-20 lot across various accounts I trade. Just really interested in picking your brain not only on position size but the dynamics of insurance as well.

  4. Joe 09/09/2010 at 8:42 PM #

    Thanks for the feedback Mark. How about using other such stretgies such as butterfly on the side under threat or a put or call diagonal?

  5. Mark Wolfinger 09/09/2010 at 9:31 PM #

    I have used as few as a one lot of a kite spread or a naked long option to hedge 10 iron condors. I prefer to use a two-lot to hedge the 10-lot, but it really depends on how early it is when I buy that insurance.
    If the options are still pretty far OTM, or if I buy insurance when the condor is initiated, 1 per 10 ought to be sufficient – for now.
    Dave: ‘Insurance’ helps when needed. But IT IS NOT GOOD ENOUGH as a strategy that you should up your size to adopt it. Correct position size is far more important as an overall method for managing risk.
    If you anticipate October volatility, you may feel more comfortable to get some units in place soon.
    Remember, you can add SPY or IWM spreads as a hedge. One of these per single lot of SPX or RUT is pretty much the same ratio as 1:10. Not 100% correlated, but close enough.

  6. Mark Wolfinger 09/09/2010 at 9:37 PM #

    This is a discussion without end because options are very versatile.
    If you want to get some downside protection, THEN ANY POSITION that makes money when the market declines is beneficial. Period.
    But the calendar, butterfly, and diagonal have one thing in common. They may make money on a decline – and that’s what you need. But if you hold too long and the market declines too far, all these spreads lose money.
    Thus, putting the spread in place does NOT DO YOU ANY GOOD UNLESS YOU ARE PREPARED TO EXIT THAT SPREAD WHEN ADDITIONAL DOWNSIDE COSTS MONEY. (In other words, exit when you get delta long, if not before that).
    Of course, you will be losing far more from the original trade than you earn with the adjustment – BUT THERE IS NOTHING YOU CAN DO ABOUT THAT. Exit the calendar or butterfly at the appropriate time and find some new insurance to own. Or perhaps it’s time to exit the original trade and take the loss.
    Your questions don’t go to the heart of the problem: HOW DO YOU ADEQUATELY PROTECT YOUR IRON CONDOR OR CREDIT SPREAD? There is no answer to that. To get complete protection costs far, far too much. Your job is to limit risk to acceptable levels and protect yourself from larger losses.