Look at the Position Now; the Original Trade does not Matter

Mark,

Thanks for the detailed reply.

In some ways my example was too obvious (and I bought back the put a
couple of days ago) because I had already taken 77% of the value of the
trade.


At the other extreme, if the position were:

I originally sold a far out of the money SPX put option for $1.10 with
49 days to expiration, with a potential profit of $2.24/day.

Currently the option is priced at $0.60 with 27 days to expiration.
This gives the same potential profit of $2.24/day. Then I see no point
in closing the position.

Somewhere between the two cases is a transition point.
It was that transition point I was trying to identify – and as you
indicate, it's probably not mathematically identifiable!

Steve

***

I consider this to be a very important point – one that keeps too many traders from being profitable. It requires that you think about what you are doing – and looking for formulas is one way to be certain that you do as little thinking as possible.

I was trying to help you solve a problem, but this entire discussion is inappropriate.  I've written about this previously, and I know that many readers believe I'm as wrong as one can be.

But, if you learn to trade with logic and without emotions, the common sense of this approach should overwhelm any hesitancy you may have to adopt a similar trading philosophy.

The decision on whether to HOLD or CLOSE has nothing to do with the original trade.


Let me say that again.  It does not matter whether you sold the put and collected $6, $2, or $0.50.

The option price – at the time you made the trade – already reflects your trading style, tolerance for risk, your preferred time frame, delta and theta requirements for the trade etc.

The decision to hold or exit must look at the position NOW.  Does it still fit within your comfort zone?  Do you want to be short this option?  Do the parameters of the option – right this minute – still work for you?  Are you confident that $2.24/day time decay is all you need to know about an option to make a decision on whether to sell it?

Look at it another way.  If you were forced to exit every trade every morning (no commission expenses) and given the opportunity to keep that closing trade, or re-establish the position at the same price you just paid to temporarily exit (again no commissions or fees), would you re-establish the position?  Is the risk/reward acceptable? 

If the reply is 'NO' – then why are you holding?  How can the original selling price play any role in the decision?  It cannot and it should not.

624



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6 Responses to Look at the Position Now; the Original Trade does not Matter

  1. John Doe 02/25/2010 at 4:05 PM #

    Completely off-topic here Mark, sorry!
    Do you know if IB, or any broker for that matter, allows retail investors to directly short US Treasury Bills / Bonds?

  2. Don 02/25/2010 at 4:32 PM #

    Hi Mark how are you? I wanted to ask you about your comment in an earlier post about selling front month Iron condors. It’s a general question as to how you look at trades-and has to do with the standard deviation comments from the other day as well. When trading front month options you incur a different set of risks and have removed the possibility of some of the adjustments that are possible in 2-3 month condo or trades. Is the reduced time differential enough to compensate for that? For example, if you are making your trades for somewhere along the lines of 21 to 28 days with this reduced timeframe for things to go wrong compensate enough for giving up the ability to add a kite trade or other condors adjustments. Thanks

  3. Mark Wolfinger 02/25/2010 at 8:11 PM #

    JD,
    I don’t know. IB: 877-442-2757
    You should be able to do so. I don’t see any reason why they cannot be borrowed. But I have no true idea.

  4. Mark Wolfinger 02/25/2010 at 8:18 PM #

    Don,
    I’m doing fine. Just busy. Thanks.
    1) In that post, I recommended front-month options ONLY for the person who liked high theta and rapid time decay.
    2) I do not like to trade these myself. too much negative gamma and too much risk for me.
    3) “Is the reduced time differential enough to compensate for that?” Don – you must already know there is no way to answer that question. Is it enough for Don? It’s not enough for me. Your comfort zone and risk guidelines are your own. Don’t copy mine.
    4) There are always adjustments that can be made – including size reduction. No. The reason I don’t trade front-month iron condors is that it’s a strategy unsuitable for my individual comfort zone. it has nothing to do with possible adjustments. It’s 100% related to negative gamma.
    I make no recommendations about which specific strategies others should adopt.
    I try to explain your options when trading options. I explain the advantages and disadvantages of a given method. The rest is up to you.

  5. NK 02/26/2010 at 3:13 AM #

    Hi Mark,
    I have a question in regards to a position I’ve just put on. I just feel like I’m missing something as the position appears to be a bit ‘too good’.
    I bought an Iron Condor on ITMN, March expiry
    Bought 20.00 C – $2.09
    Sold 17.50 C – $2.67
    Sold 10.00 P – $1.76
    Bought 7.50 P – $0.74
    For a total credit of $160 each position (I bought 2). Considering I’ve been selling spreads for about 15c for every $1 of risk – this looks like a very good position risk/reward-wise. The way I see it – I am risking $500 for $320 in credit, effectively risking $180 for $320 (assuming 1 side of the Iron Condor gets taken out).
    Is there something else that I am just not seeing?
    I understand that the volatility for this stock is off the charts, which partly explains why the premiums are so high. It wouldn’t be surprising for 1 leg of the trade to just get taken out in a day.
    Your opinion is appreciated.

  6. Mark Wolfinger 03/03/2010 at 10:45 AM #

    You nailed it.
    It’s the high implied volatility that tells you there is news in the air and there is a high probability that this stock will not be priced anywhere near it’s current level at March expiration.
    But don’t panic. There is always the chance that whatever is expected (earnings?) will be less drasic than anticipated and this can be a very big collect for you.
    My opinion is: If the risk/reward looks attractive – under the circumstances – then by all means go for it. And the 2-lot limits loss, so risk is acceptable.
    Best of luck with this one.