Lightning Round. Q & A.

Hi Mark,

You responded to one of my emails a few days ago – and just wanted to say
that I set up a side by side Collar and Put Spread in a spreadsheet and
now I COMPLETELY understand why you said what you said below [The positions are equivalent].

The two positions basically have the same profit/loss profile, and yes,
the temptation is there to put on more spreads because they're more
"affordable". But with each additional spread, the risk mounts.

You have succeeded in teaching this Rookie an important lesson. It's
also become clear through this what leverage really means. Wow!

The pieces are falling into place.





Good news.  Thanks for sharing. 

When you see the P/L graphs side by side that makes it easier to understand that the positions are equivalent.  I tend to avoid using such graphs because I assume the 'proof' that the positions are equivalent should be enough. 

When managing risk, the primary consideration is position size.  Get that right and you will not have any extra trouble if the position moves against you and an adjustment becomes necessary.  When you trade too many contracts for your risk tolerance or pocketbook, you begin with a position that can quickly move out of your comfort zone.

Any of these call or put spreads is equivalent to one collar (long or short).  Thus, the admonition:  don't trade too many spreads just because it appears that the cash at risk is small.


I looked at the blog, but haven't seen this covered.  The question is:

you ever sell your condor spreads separately?  For example, let's say
you believe that there is more likelihood of a downside move than
upside.  So you sell the call spread first, then wait a bit to sell the
put spread.  Or vice-versa.



Good question Brian. 

It seems natural to do just as you suggest and 'leg' into iron condors by trading either the call or put spread first.  I've done this enough times to tell you that it does not work as efficiently as you would anticipate.

a) Selling the put spread first.  When you anticipate a rally, it's okay to sell the put spread portion of the iron condor.  The plan is to sell the call spread on a rally, and thus collect a higher premium for the call spread.

If you sell option spreads that are out of the money by a significant amount, then you will discover that the call spreads don't get any wider unless the up move is big.  And if it's that big, you may no longer want to sell the call spread.

The reason that the spread doesn't widen is twofold:  First the spread has a small delta and it takes a decent move to make the spread worth more.  Second, and more importantly, the spread has positive vega.  Thus, when the market rallies, most of the time implied volatility (IV) decreases.  That IV decrease causes the value of the call spread to decrease – at the same time that the long delta increases the value of the spread.  These counter forces tend to keep call spreads from becoming more valuable on rallies, unless the strike prices are near enough to the stock price to have a significant delta.  When that happens, the delta overwhelms vega and the spread widens.

The only good news to this scenario is that the put spread has been narrowing – due to delta and IV working together. That means you may prefer to take a profit on the put spread rather than sell the call spread.

b) Selling the call spread first.  If you have a bearish bias, this plan actually works.  If you sell a call spread and the market declines, two good things happen for you.  First, the put spread widens by a small amount due to delta.  Second, the spread widens even further as IV increases.

Thus, taking the bear leg is a much more successful plan than taking the bull leg.  Warning:  Do not allow this factor to convince you to take bearish legs.

Another interesting situation that I discovered when I used to leg into these trades is:  When the market falls, the put spread widens.  But the call spread narrows by so little that you gain little with your successful leg.  In other words, the fact that IV increased is enough to widen the market price of the whole iron condor and the benefit of taking the successful leg is small.  Depending on your point of view, it may turn out that there is too little reward for taking a successful leg, to bother.


Tomorrow's webinar: 

Tuesday October 27, 2009 at 6:00 PM (Eastern Time). 

Title: Collars; Combining Covered Calls and Married Puts


Register for webinar by clicking here.  All events are free and open to everyone.

webinar platform is by webex.  To participate, you must download the
platform to your computer.  You can do that as you register.  No
telephone lines will be used for the event.


10 Responses to Lightning Round. Q & A.

  1. Steve 10/26/2009 at 12:57 PM #

    Mark: If you sold a call spread, don’t you have negative not positive vega? The near-the-money strike’s higher negative vega (since you sold it) outweights the further out of the money and lower postive vega (since you bought it). Thanks.

  2. BB 10/26/2009 at 2:03 PM #

    Terminology: I’m not clear on what you mean by describing the spread as “widening”. Are you saying the premium for any given spread is changing, or that your choice strike price separation is different (wider)? Thanks, Mark

  3. Mark Wolfinger 10/26/2009 at 2:45 PM #

    Yes, if you sold a call spread you would have negative vega. But this discussion is about legging into an iron condor.
    AFTER selling the call spread, you want to SELL the put spread at a higher price. That’s what happens when the market declines. Both delta and vega work for you in getting that higher premium from the put spread.

  4. Mark Wolfinger 10/26/2009 at 2:49 PM #

    Premium is changing. A spread ‘widens’ when it increases in value; and narrows when the value declines.
    In this discussion the strike prices remain unchanged and when the spread widens, you can sell it and collect a larger premium.
    It’s true that we sometimes talk about a wider spread – and that means the strikes are farther apart.
    The difference is sublte and perhaps different language could be used. But when the spread instreases in value, ‘widens’ is a verb. When the strikes are farther apart, ‘wider’ is an adjective (wider spread).

  5. Brian 10/26/2009 at 8:06 PM #

    After watching the spread prices the last several days (both up & down), I can see exactly what you are saying. Nice when that happens. When starting out, I think that it’s beneficial to do some ‘paper trades’ like that to watch and see first hand what happens as the market moves.

  6. Mark Wolfinger 10/26/2009 at 8:39 PM #

    Agree. Paper trades give you some experience in placing orders and in learning to use your broker’s software.
    But keep in mind that what happens when the marekt moves may be very different the next time. But, you learn as you go and that’s the idea.

  7. Steve 10/27/2009 at 7:22 AM #

    Mark: Thanks for answering my question. But I am even more bewildered now than before. In your post, in the section where you discuss selling the put spread first, you say that the call spread does not widen unless there is a big move because, “Secondly, and more importantly, the spread has positive vega.” So I don’t understand how you can say the spread has positive vega unless your were referring to the options before selling the call spread, which would have negative vega.
    Secondly, in your reply you say to sell the call spread and then the put spread, but in your post where the discussion of positive vega enters is in the section “Selling the put spread first.”
    My apologies if this seems nitpicky, but I feel like I’m missing something. Thanks!

  8. Mark Wolfinger 10/27/2009 at 9:06 AM #

    If something is unclear, or incorrect, being nitpicky is ok with me.
    Here is what I was trying to get accross to readers:
    a) You sold put spread first.
    b) You now want to sell call spread at a higher price than you can get today. Thus, hoping for a rally.
    c) But, when market rallies IV tends to decline.
    d) The call spread you want to sell has positive vega, and thus decreases in value when IV moves lower.
    Yes, I am rferring to the spread BEFORE I sell it. I see that this distinction is your problem.
    The spread is the spead. It ALWAYS has positive vega. Before you sell it, while you are selling it, after you sell it and after you close your position.
    If you sell 100 shares of IBM short, it is still IBM. It has no other name. You are either LONG stock or SHORT stock. The name does not change. IBM stock ahs positibe delta. If you own it YOU have positive elta. If you SELL it short, you own negative delta.
    SIDE NOTE: You are thinking in terms of before you sell the spread and after you sell the spread. That’s backwards and confusing.
    The spread is the spread. We are talking about a bullish call spread (buy lower strike price and sell higher strike price). That spread has positive vega. We want to sell the sprad. Thus, we SELL the option with the lower srike price and buy the option with the higher strike price. BUT IT”S THE SAME SPREAD redargless of whether you bought the spread or sold it.
    The proterties of the spread (in this case, that’s positive delta, positive gamma, positive vega, negative theta) are all properties of the spread. If you buy the spred, your position has those specified characteristics. Ih however, you sell the spread, the name of the spread is unchanged. But your posiiton has all the negative characteristics. Nmely you become short delta, gamma, and vega and long theta.
    Thus, when you want to sell this spread at a higher price, the fact that the market has rallied and IV has declined is deleterious to the value of the spread.
    d) Because the call spread you want to sell (NOTE: I have not yet sold it; am hoping to sell at a higher price after a rally) is long vega, and because IV is declining, The value of the spread narrows (becomes worth less than before) as IV increases.
    e) Negating the narrowing of the spread due to vega, is the widening of the spread due to delta. But unless the spread has a high enough delta (in that case, you may no longer want to sell this spread becaaue it is getting too close to being an at-the-money spread), the effect of a declining IV is going to be enough to offset almost all the effects of delta. That menas the value of the spread will increase by very little. That meeans taking the leg did not earn much extra cash.

  9. Steve 10/27/2009 at 11:04 AM #

    Mark: Thanks very much for taking the time to explain everything. Some of the confusion seems to have been due to perspective and semantics. While I might disagree with you with regard to the “spread is the spread” claim, I understand what you mean. In any event, your explanation is now very clear. I particularly want to thank you for pointing out how declining IV offsets delta. Such concepts are not frequently covered by most commentators. Your blog is a great resource.

  10. Mark Wolfinger 10/27/2009 at 11:38 AM #

    Glad you are squared away now.