Q & A. Iron Condor and Butterfly Spreads

This was originally posted as a comment.  I made minor changes for clarity.

Hi Mark,

I've enjoyed the lightning round and the quizzes. I am
reading about IC and DD and have condensed what I believe you have been teaching
about adjustments and I want to see if these are your thoughts and basic

1. Any position that is uncomfortable has too much risk

Not necessarily.  It could have too little reward.  Or no longer suit your trading style – I assume it suited when position was initiated.

2. When
looking at adjustments examine whether or not the new position is one that you
want to be in.

3. Sometimes closing is the best option.

4. IC benefits when
Vega drops after the initial purchase and DD benefit when Vega increases.

Vega is a property of the option and it's value changes as the price of the underlying asset changes,  The term you meant to use in place of 'vega' is 'implied volatility.'

Typically 13 weeks before expiry is a good purchase time and attempting to be
out 2 weeks prior.

No.  This is what makes me comfortable (most of the time).  I never recommended that anyone else adopt this idea.  I talk about it so that others can consider this as one alternative.

My question today revolves around Iron Condors that you want to hold, but one of your inside (sold) legs is being threatened (moving too near its strike).

You mention buying an ATM Put or Call [I recommend buying OTM options – but they should be closer to being in the money than your short option]  as
applicable to minimize risk.

How do you figure how many to buy?  For example if
you have a 1-lot (meaning all 4 legs X1) or a 10-lot, 10 point RUT IC, is
there an equation or some other information in the Greeks that would assist
in providing how many you would buy as protection?

The Greeks, coupled with the P/L graphs provided by your broker should be all the information required.

How many to buy?  I do not use rules.  You could arbitrarily decide to cut delta by X %.  Or decrease negative gamma by X  %.  If you are adjusting late (short is almost ATM), then X is a higher number than if you begin adjusting in stages

I think cutting delta and gamma by 20% is enough – when the adjustment is made early (early is a flexible term and depends on how YOU look at the position).  If you don't adjust until the short option is already ATM, that's 'late' in my opinion and 20% is not going to be good enough.

One other aspect of 'how many' depends on which strike you choose.  If short 10 of the 800 calls and decide to buy calls, I might buy one 770, but would want at least 2 of the 790s – again assuming this is a stage I (early; not in trouble yet) adjustment.

You can also buy insurance when it's not needed (I do that frequently).  I buy put protection on rallies and call protection on dips.  Then I am not pressured (as much) when the market moves against my position.  Because there is little urgency, if I were holding a 10-lot IC, buying 1-lot would be good enough.  Then I'd buy another, if available, at a better price later.

How much to spend on these adjustments is usually a consideration.  I don't dwell on the credit collected from the original iron condor.  I buy portfolio protection when the price is right and see some portfolio risk.  Again, no rules.  No guidance I can offer – other than to post my trades and discuss as time passes.  But right now, I don't want to do that.

Also, I read on another web site about IC's that are traded for a  $1.00 premium.   But even at a 90% win rate, if you don't
adjust or exit, or consider your max potential loss, one month could wipe out
the year's profits.  Why would they settle for such a low premium -or is this personal

You know that everyone looks at investing/trading from an individual perspective.  The $1.00 IC trader may be very happy with a 90+% win rate.  We don't know if he/she ever adjusts, or whether he closes his eyes and hopes for the best.  My point is: just because he collects only $1.00, it does not mean he is careless with risk management. But it's very likely that he doesn't cover early and holds to expiration in an attempt to collect each penny.  Not the risk I take, but that does not make it 'wrong' or a poor investment style.

Lastly, what are your thoughts on using a butterfly to extend your break-even
in the event one of your legs is threatened? For example you have a 550/560 Put
spread and see movement towards the short 560 strike.  You could take that out with a
540/550/560 butterfly and push that leg out-just wondering if this is an
adjustment that you consider?

Butterflys also seem to have a high reward to risk, do you ever use these as
a part of a short month IC, for instance looking at November?

Like to hear your thoughts.

I do occasionally buy a butterfly to move my short options from one strike to another.  But not often.  It really does depend on two major factors: 

a) How much does the fly cost and are you willing to pay that much for a TINY (TINY TINY) bit of protection.  Remember that 10 points is essentially nothing in a $600 index.  To me, the butterfly is often just too expensive.  I'd pay $0.25, but not $1.00.  You may be willing to pay more.

b) Does this adjustment move you from uncomfortable to comfortable?  I don't think that's possible.  It's just 10 points.  If you were to buy a condor (see tomorrow's post) instead of a butterfly, you could move the short strike more than 10 points – and that could easily be worthwhile – at the right price.

You obviously just discovered butterfly spreads.  I get that you want to learn more about them.  But, as with any new toy, you cannot expect to jump right in and use it with maximum efficiency.

By coincidence, I already prepared the blog post for tomorrow and it's about butterflies and condors.

I do not trade butterflys as part of a front month plan.  What I used to do, when I needed FOTM protection, is bid 15 or 20 cents for a FOTM  butterfly – but only if I needed protection.  Example, with RUT near 570, if my downside looked bad, I would bid 15 cents for the 450/460/470 Jan or Dec fly.  Probably would not get filled.

Yes, good risk/reward.  But VERY low probability of collecting anything resembling the maximum reward.




11 Responses to Q & A. Iron Condor and Butterfly Spreads

  1. Steve 10/29/2009 at 4:08 PM #

    Lets just say you sell 4 500/490 Dec put spreads and purchase a 1 520 Dec put for protection, effectively making this a debit spread.
    Lets also assume the RUT rallies thereafter, do you unload the protective put after a certain dollar loss on that put or do you use another metric to determine when to sell it?

  2. Don 10/29/2009 at 4:23 PM #

    Thanks for the insight, it really helps a lot with the concept of trading. I am working on something with a lot of focus and that is experimenting with different adjustments now in my papermoney account so that I have a plan, in advance of what I want to do when (and I know that it’s not if but when) I am presented with threatened short positions in the IC.
    I’ve looked at the DD, butterfly, covering in stages and buying additional calls or puts for insurance and am exploring my comfort zone and ability to use these tools to my advantage.
    Your views around these different ideas do help with that process.

  3. Mark Wolfinger 10/29/2009 at 4:34 PM #

    Good question Steve,
    No rules. And a complicated situation. Negative theta is difficult to live with for a premium seller.
    But knowing that the puts are wll protected, I can sell a new iron condor at any time. I won’t feel I am doubling up my risk.
    I assume the call side is also protected. If you buy puts on declines (when protection is needed) and buy calls on rallies (when protection is needed) you will wind up paying very high prics for that protection.
    If the 4-lot position is a reasonable size for you, there should be no rush to buy protection.
    Truly – this response could coinsist of several lessons on how to mnage a portfolio. Far too much for a single post or response. I don’t mean to shortchange you – But so much depends on so many variables that I cannot supply good guidance on this topic as it.
    Let me see if I can devise a way to write a better response. It will not ne immediately

  4. Mark Wolfinger 10/29/2009 at 4:37 PM #

    Ypu have tried many things in paper trading. But, when you begin trading with small trades – and I hope you do – it’s difficult to manage risk with one- and two-lots. There is no such thing as a ‘small’ adjustment.

  5. Henri 10/30/2009 at 5:29 AM #

    You said: “I buy put protection on rallies and call protection on dips.”
    Does that mean that you choose market direction for your IC’s?
    Or when you have a neutral IC, wont you have to do the opposite to have protection? I mean when you have a neutral IC, and the market rallies, you want to have some calls, right?

  6. Mark Wolfinger 10/30/2009 at 8:37 AM #

    Yes, I would have to do the opposite to have protection.
    I do something unusual for iron condor traders, and premium sellers in general. I am willing to own a portfolio with negative gamma. Thus, instead of have a nice, fat, positive theta, many times my positive theta is small – and sometimes it’s negative.
    I am playing for protection first, and am willing to settle for smaller profits. But this way, I don’t incur a large loss. In fact, I earn money on a black swan event (either up or down).
    To that end, when the market rallies, I open a put spred that costs a premium, but which give me good protection if the market falls – but not by enough to harm my iron condor – and if the market tanks. And I get it at a good price because I am buing it when the market is moving higher.
    Specifically I do spreads similar to those described
    here .

  7. Marty 10/30/2009 at 10:04 AM #

    Since your personal preference is to be a premium seller, I think I can guess what your answer will be…but I’d like to hear it anyway.
    You mention above that there is a “VERY low probability of collecting anything resembling the maximum reward” on a butterfly. That makes sense, but would you say that the probability of good returns is low enough on the sell-side to make “buying” butterflies a decent play (at least relative to “buying” ICs, which I would not be comfortable with)? I know you use a different terminology, but I’m referring to buying in this context as putting on a winged spread for an initial debit.
    My question is: Assuming the trader could guess with a decent rate of success when periods of higher actual volatility would occur – I realize that’s a big if – is the deck fundamentally stacked against the “buyer” of a butterfly? In the strategy I’m imagining, the trader would need to 1) identify when a period of strong underlying movement was about to begin 2) determine when the period of movement was exhausted (not holding until expiration…so when to take full or partial profits) and 3) decide when to pull the plug if the underlying looks like it’s going to settle in the zone of maximum pain.
    What other factors am I missing? The strategy would also benefit from a rising IV enviroment, correct? And just to reassure you, this all purely speculative and academic at this point…I don’t have money on the line.

  8. Henri 11/03/2009 at 1:55 PM #

    “I do something unusual for iron condor traders, and premium sellers in general. I am willing to own a portfolio with negative gamma.”
    I guess you meant theta instead of gamma? Is it possible that sometimes the protection eats away all your profits from the IC?

  9. Mark Wolfinger 11/03/2009 at 1:59 PM #

    I must be more caraeful.
    Yes, I did mean negative theta and/or positive gamma
    The protection ALWAYS eats away at the profits. But, I pay that for protection. I have become too cautions, and no longer try for bot (10%) months. Just looking for steady growth.

  10. Jean 03/29/2011 at 2:58 PM #

    Hi Mark,

    What kind of protection we can use for a butterfly spread ( such as 1P / -1P / -1 C / 1C ) when we initiate the trade ?
    For the iron condor, as you wrote on this blog, we can use a kite spread.


    • Mark D Wolfinger 03/29/2011 at 3:54 PM #

      Hi Jean,

      The (iron) butterfly is similar to the iron condor. However, the kite spread is inappropriate as protection for most narrow butterflys.

      If your position uses strike prices that are far apart (and that is a trade which can lose a lot of money) then insurance is appropriate.


      Long Jul 950 calls
      Short Jul 900 calls
      Short Jul 900 puts
      Long Jul 850 puts

      You could make a trade that earns a profit when the underlying moves towards the 850 or 950 (maximum loss) strikes.
      One choice is to buy some 930/940 call spreads and/or 860/870 put spreads).

      Another expensive choice is to buy the kite spread (do NOT hold these to expiration – that is very costly):
      Buy 910 calls
      Sell three 930/940 C spreads

      Buy 890 puts
      Sell three 860/870 put spreads

      I have no experience with any of these, but because the fly is very similar to the condor, the basic protection idea should be viable. be certain to create the potion in a practice account and then take a careful look at the risk graphs – especially as time passes.