Psychology of earning more takes unusual turn

This morning's post on the psychology of 'earning more' brought an unexpected (to me) reply: 

Hi Mark,

An admittedly piggish thought has been tossed around my head for a few weeks now, but I have yet to implement it. Once the trader has extracted about 70-80% of the time premium in their IC and expiration is nearing (say 4/5 weeks) I thought about buying a butterfly on either side of the market price of the underlying.

Or alternatively selling a smaller (strike price-wise) IC inside of the original position. The thought process is that if there is still a small amount of volatility in the underlying [What if there is a huge amount of volatility remaining?], then the price should swing one way or the other (but hopefully not too far) into one of the fly profit zones or stay withing the short strikes on the new IC.

I want to make more on the trades because I generally write ICs with a high risk/reward ratio as high a 3 or 4 to 1. Maybe I should just write lower risk/reward ICs but they make me a little nervous. I know I'm trying to be a pig here, but wanted to get some feedback from a risk-oriented individual like yourself.


Underlying SPY @ 111.05

IC: Dec 93,95,119,121 @ 0.45 Credit (older position)

[NOTE: Credit received is 100% immaterial]

Flys: Dec 107,109,111 & 112,114,116

Small IC: Dec 106,107,116,117 @ 0.42 Credit



This may seem to be a single issue for you (piggish), but I see several different topics here.  Enough to convert this comment into a separate blog post.

1) Deciding when to exit a profitable iron condor trade is one of those decisions that must be made daily.  Any time you maintain the position, then that day’s decision is ‘do nothing.’

2) If you have near 80% of the profit when there's more than one month remaining before expiration, that’s a great result and I would never be greedy in this situation.  That much profit is seldom available, unless you’ve held this position for at least three months and the volatility has collapsed.

3) Opening a butterfly spread bears no resemblance to closing the trade – from my point of view.  It is a brand new trade, with a brand new risk/reward profile.  I know experienced traders who love the idea of converting a profitable straddle sale into a butterfly, but that’s completely different.

To open the butterfly, you must pay a cash debit that is larger than the cost of exiting the iron condor.  To me the ONLY question that you have to answer is:  Do you want to own this butterfly at these prices today?  This has nothing to do with the iron condor. 

You did not provide details, so when you say open a butterfly, I do not know if that surrounds the iron condor, or uses the iron condor legs as part of the butterfly.  But, to me, it does not matter.  These are different positions.

4) For the butterfly to be profitable, you want the underlying to remain approximately (small move) where it is currently trading.  Under those conditions, the IC would work for you.  Thus, this is effectively doubling your bet.  And IMHO it’s a very bad bet.  You would be opening a negative gamma position just when the effects of negative gamma are accelerating – and that’s into expiration.

5) Regarding trading a new iron condor inside the old, I don’t understand what you are thinking.  It appears to me that you prefer longer-term IC positions.  Why allow the fact that you are holding an IC that has worked well and is now trading at a low price, dictate your trading strategy?

Without this iron condor would you be looking to open those butterflys or new IC?  If not – why do it now?

‘Hopefully not too far.’  Are you kidding me?  That’s what you hope every time you trade an iron condor.  You are thinking differently and I cannot understand what has changed for you.  Unless you want to play double or nothing with the profits from the successful iron condor.  That’s pure gambling.

If you want to hold the current IC and try to milk it for more – although there’s not that much more to gain, that’s one decision.  But to open a brand new iron condor and/or butterfly for the sole reason that you own a profitable position does not compute. 

Again, what has changed that you now like the idea of front month positions with lots of negative gamma?  You avoided that risk when you made the original trade, so what is different now?

If you can explain the rationale for the trade, it may make sense.

Trying to be piggish is not the same as changing your investment style and taking on more risk with a new trade.  Being piggish refers to taking more risk than you believe is best in an effort to squeeze additional profits from a winner. 


2 Responses to Psychology of earning more takes unusual turn

  1. Brad 11/18/2009 at 11:35 AM #

    I will file this under “bad trading ideas.” Thank you for the honest and passionate review of this flawed investment idea. It was never something I was really planning on doing seriously and I wanted to get your feedback on it before I began testing it on my paper trade account.
    Just so I get a general idea of the type of ICs you put on – what level of risk/reward or (put another way) probability of profit do you like to use on your index ICs? Lately I have been putting on ICs on SPY, IWM, QQQQ with a rick/reward of 3 or 4 to 1 with 3 or 4 months to expiration. I plan to close the trade at 70-80% of maximum profit or a couple weeks out if profit targets are not met. I think about adjusting when delta gets too high by either buying back some of the spreads on the threatened side or closing the position in extreme cases.

  2. Mark Wolfinger 11/18/2009 at 11:56 AM #

    I like your approach.
    I don’t look at ‘probability of profit’ but do consider ‘probability that underlying will touch either strike during life of options.’
    BTW, that probability is approximately DOUBLE the sum of the deltas sold.
    My preference is ~ 3:1 for risk/reward. I trade IC and collect a credit near $3 or a little higher. These are 10-point spreads.