Iron Condors, Margin Efficiency, and Trading Small Accounts

Note: The most interesting part of the discussion often occurs in the comments. If you find the post of interest, visit the blog to read the comments and join the conversation.


Hello Mark,

Thank you very much for taking time to respond to people’s questions and giving your experienced points of view.

I started selling cash covered puts and buying covered calls. I
didn’t lose money but I wasn’t very successful either, mainly due to my
inability to determine market direction and my account size, only 8k. I
realized that I needed more capital to view gains big enough to justify
the time spent doing research and follow up.

However, I then found the
great IC strategy and I fell in love quickly – non-directional strategy
and nice returns.

The only problem is that my account size doesn’t give me much room to
work with adjustments, because once the trade is open, margin locks up most of
my capital. Do you have any suggestions on what type of percentage
should I invest and what percentage I should keep for adjustments?

I
tried trading SPY with 2 point spreads, but the credit collected is not
big enough to close the position early and forces me to keep the trade
open for longer than I would want to. However, moving to bigger indexes
like SPX or NDX would mean trading 1 or 2 contracts and would not leave
room for stage adjustments, like closing 20% then 30% then 50%.

Thanks again.

Jorge

***

My pleasure, and please keep those questions coming.

1)  Compared with your former
trades, iron condors are margin friendly, but $8k is still a small account.  Not too
small, but it does limit what can be accomplished.

Don't ignore one advantage when trading small – it's an excellent time to gain experience and hone your skills.

2) 'Nice' returns are definitely available.  I must warn you that
certain markets are wonderful for iron condors, while others are
killers.  DO NOT GET OVERCONFIDENT IF YOU ARE DOING WELL RIGHT NOW. 

It's easy to state that warning, and I know it's difficult to accept – especially if you have a winning
streak going. But iron condors do not always work well.  Be vigilant.

3) My suggestion for most iron condor traders is to keep 10 – 12% cash available for adjustments. Small accounts may need a bit more ($1,500).  

I'm pleased that you recognize the importance of keeping a cash reserve.  But, this is one of
the unspoken problems when trading a small account.  Adjusting becomes a real headache.

If you choose to trade SPX (10-point spreads) in 3-lots, you will never be able to cover the 3-lot of calls and roll them to a new call spread with another expiration because that requires an additional $3,000 margin.  To make this trade, you must also exit the put half of the iron condor.

Covering the winning half is often a good move, but you may be forced into doing it, even when you feel the price is too high. 

There is no denying the fact that this is a ticklish situation:

  • Too little cash and you can't adjust
  • Too little margin and you cannot roll efficiently
  • If you want to avoid these problems, you must trade even smaller and keep more cash in reserve.  And I know just how difficult it is to do that – especially when you are earning profits.

If you do trade a 3-lot position, then you are almost forced to cover the entire iron condor when rolling.

This is a bigger
decision for you than for most traders.  Margin manipulation and
efficiency become very important when you have a small account.  Don't
do something stupid (risky) just for the sake of margin, but do be aware
when it's inexpensive to give yourself some breathing room. 

When you
'need margin room right this minute' is NOT a good time to try to exit
that low-priced, winning side of the iron condor.  I suggest setting a
price for yourself (assuming you elect to trade the big index) and buy
in the cheap spread when possible.  I enter those low bids every day,
just in case.  I fully understand why you cannot do that with the
smaller ETFs.

4) Be certain your broker does not require separate margin
for the call spread and the put spread of the iron condor (it's beyond
my comprehension, but some brokers do, and there's talk of more brokers adopting
that restriction).

When trading a small account, be certain your
broker's commissions are reasonable.  Trading is difficult enough
without giving all profits to the broker.

5) Two 3-lots are not difficult to manage, and you can have one spread in each of two different
expiration months.

If you do choose the big index, it will be far easier to pay a few nickels to exit the winning side of the trade.

6) You have one additional adjustment alternative.  The correlation between the big guy and the ETF is not 100%, but it's close enough.  If you have a 2- or 3-lot iron condor, you can adjust with a few lots of the ETF – and that's equivalent to making a fractional adjustment in the big index.  And it may not increase the margin requirement (depends on the trade).

7) Trading ETFs is much more
commission intensive.

My bottom line recommendation is to trade the big guys in 3 lots, adjust with ETFs when necessary, and see whether you find this convenient, or too messy.

779

, ,

4 Responses to Iron Condors, Margin Efficiency, and Trading Small Accounts

  1. dave 09/03/2010 at 7:11 AM #

    i think another option here is to try for a much bigger credit although this involves either going closer to the money or further out in time and trading smaller size maybe 1-2 lots . But when you trade a 2 point spy spread and and take in a credit of $1-$1.10 then you have the opportunity to be very relaxed with your adjustments. In the last few months I have become a huge fan of this and it has been incredibly successful. I understand this wont always be the case. We will move out of this trading range eventually . And I will have to reasses but, i think thats where being flexible comes in and adjusting strategy. I would also mention that the djx and mnx are alternatives to the larger indexes . I have also been trading those and have done well with those too.

  2. Mark Wolfinger 09/03/2010 at 9:18 AM #

    Dave,
    I prefer 2 or 3-month plays with decent credits, but that may not suit Jorge’s comfort zone. I am glad that you mentioned it. But a credit of $1.00 for a 2-point spread? Wow – that’s far too close to the money for me. I need options with smaller delta.
    Just one point: From my perspective, ‘incredibly successful’ is the truth. The past three months have been unbelievable. That cannot continue.
    My point is that this plan may be great for now but Jorge is looking for a plan he can live with under various market conditions.
    I have not looked at DJX and MNX – but there is no reason not to consider them.
    Thanks

  3. Jorge 09/03/2010 at 1:27 PM #

    Thank you for the comments, I don’t feel comfortable getting too close to the money, I am happy going just inside one standard deviation. Yesterday I rolled a 3 point spy from oct to nov to get more “centered” and collected 0.7 (low 98 high 120)(10 lots), it was just inside one standard deviation. Of course it’s no longer centered after another rally today, by the way, do you think this rally will be over soon?. The plan is to collect .3 in 4 weeks and then roll to dec to get “centered” again.
    I also have a one oct lot of NDX opened with 500 points spread(low 1650 high 2000) a little bit outside one standard deviation, collected 7.5. Again the plan is hold 4 weeks and rolled to get centered.
    One more question: when would you suggest adjusting both my open postions in case of a big movement?

  4. Mark Wolfinger 09/03/2010 at 2:49 PM #

    Jorge,
    In this question you raise a bunch of interesting issues – that you are probably unaware of raising.
    Full reply tomorrow in a rare Saturday post.
    Regards