I don't know what your positions are exactly, but let's say you
have a few kite spreads of 650/670/680 and most of your credit spreads
are at 670/680.
If RUT continues its march upwards near 670, the kite
spread hasn't reached its full potential yet (I'm not considering at
expiration – assuming there's like 30 days left). Do you plan to roll
the 670/680 position, buy back the credit spreads, or what?
what is the plan with purchasing kite spreads with strikes near
the strike you are already short?
In general, the kite affords protection, and I may be in (a little) less hurry to make an adjustment. But I still adjust as I would without the insurance policy. The kite allows flexibility, and I find that I make adjustments that were previously not a consideration. The kite allows me to do that comfortably.
Yesterday's post explained how kiting the kite (adding a kite spread to a kite spread) represents a sound risk management technique than can provide significant profit potential when the market moves against the original iron condor position.
That post looked at the kite in isolation. This time, let's look at it in conjunction with an existing iron condor position.
April expiration is 42 days in the future
Short 20 RUT Apr 670/680 call spreads as part of an iron condor
Own 3 RUT Apr 650 C3 kite spreads;
+3 Apr 650 calls; and -9 Apr 670/680 call spreads
+3 Apr 650 calls
-29 Apr 670/680 call spreads
The position is short delta. Today, the maximum loss is less than $2,500 and occurs near 690. As time passes, the two plots merge. The lighter blue dots represents the position with only one day remaining in the lifetime of the options. On Apr 16, the settlement price is determined at the opening of trading.
This position is too risky to hold that long, but it's instructive to see how the position behaves. As time passes, the two risk graphs merge. There is far more risk with RUT above 670 later in the game, than there is today.
Let's pause in this analysis to discuss why that is true.
If the market reverses direction, risk is reduced and previous losses are reduced or eliminated. Thus, let's consider the position as the market rises.
The first problem is that the value of the 670/680 spread increases. To offset that, the 3 lots of Apr 650 calls pick up value.
At the present time, with 6 weeks remaining before expiration, there is substantial time value in the 650 calls that you own. As time passes, theta does what it does and the time premium in the option becomes less than it is today. Thus, time is not on your side.
Of course we are also subject to the whims of a change in the implied volatility of the options, but most of the time, IV is not making big changes from week to week. Discussing each possible scenario converts a blog post into a book, so we'll ignore IV changes.
Now, lets look at the effect of time on the 670/680 call spread. When RUT is well below 670, the spread heads slowly towards zero. That's good. But that's not the area of concern. If you own this trade when RUT is near 660 there is plenty of opportunity to exit and eliminate the ever-increasing risk.
Once again, let's only concern ourselves with the upside. Above 680, the spread is still trading with significant time premium (today). Thus, the value of the spread increases towards it's maximum value of $10, but it moves slowly. And slowly is the point.
The increase in the value of the 20 spreads is almost offset by the increase in the value of your 3-lot of long calls. In fact, on a huge upwards move, this position earns a good profit, regardless of when it occurs.
But – there's always a 'but' – as time passes, not only does the time premium in your long call disappear, but so does the time premium in the call spread. In other words, above 680, the spread quickly moves to $10. Double whammy as time passes – the calls lose and the call spread loses.
That's the reason it's so difficult to hold this position near expiration. Risk is simply too large (for most of us). This is clearly apparent in the light blue graph. Late in the game, the portfolio value moves form +10k to -15k as RUT rallies from 670 to 680.
Thus, a market rise is fine now, but becomes a danger later.
Back to the question: Should you adjust now, making it safer later on – or is it okay to hold because risk is well under control for the immediate future.
As usual, I have no definitive answer. Each of you must find his/her individual comfort zone. But I prefer to adjust.
to be continued… Is this position okay as is, or is an adjustment advisable?
"Your message of being careful, deliberate
and conservative came through loudly and clearly. It is one of the
aspects of the book that appeals to me the most, it is not a “get rich
quick” book." DE