Iron Condors: Trading Rules and Profit Targets. Part II

The basic question under
discussion is: Is it a winning strategy to close an iron condor position that
meets a pre-determined profit objective, regardless of the attractiveness of
holding that position?

Here’s a strong vote for

your position when your system/method says you should close it. Don’t just take
profits to take profits. That’s a quick road to poor results.”  John Forman, The
Essentials of Trading

Here’s a vote for ‘YES.’

Sheridan, options mentor, believes
in both taking profits and limiting losses. 
When opening 30-day iron condors, he prefers to exit in 14-15 calendar
days. The CBOE offers Dan on video;
click: ‘Dan Sheridan archives’ after logging in.


Selecting the iron condor, intending to close early                                 

As discussed in Part
, it’s probably a good idea to continue to buy iron condors per your
current methods.  That allows you to
trade within your comfort zone.  But,
does that method allow you to achieve an early and profitable exit?

Here’s something you must
understand about time decay if an early exit is under consideration:  Time decay is not linear.  The time value of an option erodes at an
ever-accelerating pace as expiration nears. 
That time value can be expressed mathematically and it’s proportional to
the square root of time remaining before expiration.  What does that mean?

the square root of 4 is 2, a 4-day option has twice the time value of a one day

4-week option has twice the time value of a one-week option.

4-month option has twice the time value of a one-month option.

the square root of 9 is 3, a 9-week option has twice the time value as a 3-week

Thus, three fourths of the option’s
lifetime must pass before one-half of the time value is lost.  When buying a 4-week iron condor, you can
expect half the time value to disappear in three weeks.  That information is important when deciding
how much credit to collect when initiating the trade.  If you plan to earn $1.00 in time decay,
collecting an initial $3.00 premium makes it easier to exit in two weeks (you
only require 1/3 of the time premium to erode) than collecting an initial $2.00
premium (need half the premium to erode). 
The problem is that the $3.00 iron condor is more likely to move in the
money than the $2.00 iron condor.  This
is truly a strategy of compromises and decisions.  Part art; part science.

Time is not the only
factor at work under these circumstances. 
Volatility plays a role.  If the implied volatility (IV) increases
after you buy the iron condor, it takes longer to meet your goal because the
options are priced higher and it takes more time for them to decay.  Of course IV can decrease, enabling you to
earn money more quickly.  The point is
that the passage of time is good for the iron condor buyer, but the importance
of implied volatility cannot be ignored.

Your objective is to find an
iron condor with characteristics that feel comfortable to trade and which
gives you an excellent chance to earn profits on a consistent basis.  Being aware of how long it takes to earn half
the time premium makes it easier to decide how much premium you must collect to
have a chance to earn (in our example) $1.00 in about two weeks,  Among your many alternatives:

Buy a
front-month, 10-point, iron condor with four or five weeks in the lifetime of
the options.  If you earn that target profit
quickly, the chance that something unfavorable will occur is reduced.  If you close the position and take your profit,
all the risk associated with expiration is eliminated.  Yes, it also eliminates the most rapid time
decay, but it’s a trade-off.


Here are a
few of the many choices available:


Buy 10 iron
condors using options that are far out of the money, collecting $1.00
each.  If the options expire worthless,
you earn $1,000.  If you want to consider
commissions, collect an extra $0.05 or $0.10 when opening the position.  These $1.00 iron condors make no allowance
for closing prior to expiration. 


Buy 5 iron
condors, collecting $2.00 each.  Plan to
hold until the options expire worthless.


Buy 10 iron
condors, collecting $2.00 each.  Close
the position when you can pay $1.00.


Buy 10 iron
condors, collecting $3.00 each.  Plan to close when the price dips to $2.00


Buy 5 iron
condors, collecting $3.00.  Plan to close
the position by paying $1.00


Bottom line: Buy any iron condor that feels right to
you.  You may prefer to trade options
that are closer to the money.  These
allow you to collect additional cash, trade fewer iron condors, and have less
money at risk.  On the other hand, these
positions are more likely to run into problems.  


Based on the cash you collect and the
price you are considering paying to close the position, buy an appropriate
number of iron condors, allowing you to meet your profit target.   Plan to close early to eliminate two risks


The longer you
own a position, the greater the chance for something unpleasant to occur


Options near
expiration undergo a violent change in delta when the index approaches the
strike price.  That translates into
significant risk.


Buy a
second-month, 10-point, iron condor, expiring in seven to nine weeks.


Buy 20 iron
condors, collecting $1.00 each and plan to let the options expire worthless.
Goal: $2,000 in two months.


Buy 10 iron
condors, collecting $2.00 each and plan to allow the options to expire


Buy 10 iron
condors at $3.00, planning on closing the position by paying $1.00 – hopefully
within six weeks.  Or collect $4,
planning on paying $2, etc.


Bottom line:
Again choose according to your comfort zone.


Buy an
appropriate iron condor 11 to 13 weeks before they expire.


Note that each of the above methods provides a net
gain of $1,000/month when the trade goes as planned.  Please remember this plan is NOT going to
work every month.  It’s inevitable that
iron condor buyers lose money when the markets are too volatile.   As described in The Rookies Guide to Options,
you can sacrifice part of your profit potential to buy insurance.


I’m not convinced that
planning to exit the trade as soon as the profit target is reached is the best
choice.  There are many alternatives when
opening/closing/adjusting.  Because this
is as much art as science, it’s difficult to apply strict rules.  Each individual trader will come to appreciate
his/her own preferred style – and that's not so different from many other things in

If you believe, as I do, that holding through
expiration is too risky, then there must be a point in time that allows you to

  • Close prior to expiration
  • Achieve a minimum profit objective (when
    all goes as planned)
  •  Manage the position for maximum efficiency.

The difficult part is recognizing when the
time to close the position arrives. 


4 Responses to Iron Condors: Trading Rules and Profit Targets. Part II

  1. dave 08/19/2008 at 7:30 PM #

    Hi mark,
    Awesome website ! I trade options on etf’s and futures as well as the underlying etf’s and futures. mostly sp-emini and spys. I definetly feel it is better to close out a trade once you have taken in a profit and have little time remaining. I beleive it is extremely dangerous to let these trades sit there and wait for the potential to move against you be it condors, bull,bear spreads or naked options. I call this picking up pennies in front of a steam roller. the potential reward is far less than the potential risk. I had a nice profit in sp emini puts last year during the july rally and was looking for them to expire worthless. Needless to say they all ended up in the money at one point. I closed the trade for a large loss when it should have been closed for a fat gain. Some times I will sell a naked strangle with 2-3 days left till expiration if the premuim and volatility is there. But that is deep out of the money and after a directional move. I feel it is very hazardous to leave these positions when you still have 1-2 weeks left and a nice profit. Dave

  2. Mark 08/19/2008 at 8:36 PM #

    Glad you like the site. Thanks.
    I agree 100%. I never allow options to expire worthless. I always buy back cheap option spreads when they reach my price level (usually 5 cents per week remaining). Thus, I often pay as much as 25 cents or 30 cents per call or put spread.
    This specific discussion was about buying an iron condor and collecting a premium of $300 or $400 – and then closing the position after earning a pre-determined profit of about $100 (or some number close to that).
    My conclusion is that it’s better to manage the position as the trader thinks best, rather than having a RULE in place that says you MUST close when you make $100, or $125.
    I felt that steamroller myself and I don’t feel the need to collect those last few nickels.

  3. JB 08/20/2008 at 1:25 PM #

    I concur with Dave regarding the awesome website and this thread. I’m still thinking my way through parts I & II. As far as I am now, the real question is when to close. I’m still trying to come up with framework, if not a specific algorithm, of when to do this. I’m leaning toward a “point of maximum acceptable loss”. As yet I have not come up with a method to determine what the “point of maximum acceptable loss” would be. Perhaps some factor multiplied by the maximum credit or ?? Any ideas regarding this?
    All the best,

  4. Mark 08/20/2008 at 1:38 PM #

    I appreciate the kind words. Opening is easy. Closing is more difficult. Perhaps that’s why so many individual investors became buy and hold investors over the years. Just too difficult to know when to close a position.
    I don’t believe an algorithm is the answer, because it establishes a firm RULE. I’ve decided that a bit of flexibility is more efficient – but ONLY FOR DISCIPLINED TRADERS. If a trader lacks good risk management skills, he probably cannot succeed over the long term. But without such skills then an ‘automatic close at this point’ may be appropriate.
    I agree that there must be some maximum loss and that it should be related to the credit (maximum profit) collected. I’d suggest 125% or perhaps 150% of the maximum profit. If you plan to close early for a profit of $X, then $X is that maximum profit, not the cash collected.
    Example: Sell IC, collect $3.25. Plan to exit when gain = $1.20. Then max loss should be between $1.50 and $1.80. Not cast in stone; just a suggestion. Place it within YOUR comfort zone.