Q and A. Iron Condor Position Switch Near Expiration

Blue cat asked this question:

Hi Mark,

With respect to insurance — or other danger mitigation strategies — what do you think of splitting a spread in two?

Let's assume one were short the APR RUT 470/480 call spread. After today (RUT at 468.2) one would probably be
fairly uncomfortable. At current prices it would cost about 3.80 to get
out of the position.

One could pay for it by selling a 450/440 put spread for about 2.1 and a 480/490 call spread for 2.6.

These are all mid-point prices, and provide a
credit of 0.9.

After this trade, one would have at least the breathing room between
450 and 480. It's not much breathing room, but it's better than
being short at 470
. In addition, as premium sellers, time is on our side –
so any breathing room helps. And we did take in a bit more

One might even plan to get out of either or both positions Monday if
the market is fairly quiet between now and then. In this case, with  expiration coming next week, even the few days between now and Monday
should help quite a bit.

(I did the arithmetic for all this in my head. If I made a mistake,
look at the strategy rather than the numbers in this example.)

Hi Blue Cat,

I agree that the specific numbers are not important and that the strategy is the point of discussion.

As an aside: If you want to get out Monday, when are you planning to make this trade?  There are no days between 'now' and Monday. There are calendar days, but no trading days.

First a comment:  It is typical for investors and traders to want to collect a cash premium when making any adjustment.  The obvious thought pattern is that if you take in cash, the loss from the original trade is offset and you have a chance to earn a profit that's even larger than the previous potential profit.  Or, extra cash gives you room to pay up to exit the trade, and still have a profit.  And that makes sense to a point.

But, in my opinion, the cash is not important.  You cannot salvage every trade and inevitably there will be losses.  You want to manage your portfolio to give you the best chance to not get hurt (big loss).  You also manage a portfolio by balancing potential profits with your perceived risk for a given position.

Thus:  If you are not comfortable with the current position, the priority is to take care of that problem.  You can close all or part, you can buy calls for protection, etc.  Choose the risk reduction alternative of your choice.

Next, decide:  Do you want to get back into an April iron condor in an attempt to recoup losses NOW?  I'm not saying that's would be the wrong thing to do.  In fact, it's very tempting.  But for you and your comfort zone, do you want to make that trade?  If 'yes' – then do it.  You may even prefer to sell fewer contracts to compensate for the fact that you will be taking in extra cash.

Look at the new iron condor you proposed.  Do you truly like that position?  Is it one you want to own, or is it a desperation gamble to turn your current problem into a very profitable win?

My advice is:

Don't do it, if it's a panic move.

Do consider it if you feel it's a better position.

You are trading an immediate problem for a whipsaw risk.  If that's good with you, then sure, this is a very viable idea.

If I understand your question correctly, you are asking my opinion about this as a strategy.  I'm sure you understand that's not a question I can answer.  This is very much a comfort zone decision.  if you would be comfortable with the new trade, then it's a good strategy.  As for myself, I don't like holding near-term positions so close to expiration.  But, I must confess I do have a residual April position that I'd prefer not to have, and your proposed 'solution' is very tempting, but I would not want to do this myself.  My reason is that with two spreads, each close to the money, there's just too much chance of having one of them become a large loss.  Your current position has only upside risk.  But, that's my comfort zone speaking.

As a strategy it's okay.  You also have the choice of taking the loss, ignoring April, and moving on to May.  There is no right answer, unless you think it's fair to look back afterward and then decide what you 'should' have done.  There's nothing to be gained by doing that.

There are several very reasonable actions you can take here, and the one you suggest is among those.

BTW, if you do make this trade, I strongly suggest you cover your residual April put spread (if you have not already done so).  There's no reason to risk a gargantuan disaster.

Addendum, two hours later.

I appreciate the feeling that moving your ATM iron condor to new strike prices – a bit further out of the money, appears to give you some 'breathing room.'  But, when you look at the facts, you see problems.

Let's keep this simple and assume you will hold the position through expiration and that you want to choose between:

a) Short 470/480 call spread

b) Iron condor:  440/450 put spread; 480/490 call spread

The Apr 480 call has a delta of 34.  That means there is roughly a 34% chance than your current position will move to it's maximum loss.

The Apr 440 put delta is -11 and the Apr 490 call delta is 23.  Thus, the probability of incurring the maximum loss is basically identical (it's a fraction worse for the new IC) with either position – 34%.  It may appear to be less less risky, it may feel as if there is breathing room, but that's merely an illusion.

If your plan is to cover the position very soon on a market decline – thereby salvaging a small profit or accepting a much smaller loss, I don't see how the IC is any better – especially when you would have to make extra trades to open and close that new IC.  Those trades deal with slippage from those wide bid/ask differentials two additional times. And for some traders, those extra commissions become significant.

As long as you understand that the probability of success is not increased, it's okay to make this trade for your comfort zone.  But, it's not really any better.


10 Responses to Q and A. Iron Condor Position Switch Near Expiration

  1. GMG 04/10/2009 at 12:38 PM #

    “There is no right answer, unless you think it’s fair to look back afterward and then decide what you ‘should’ have done. There’s nothing to be gained by doing that.”
    This is a great statement and it highlights one of the biggest fallacies in any decision-making process, but especially investments. We can become obsessed with second guessing our choices and asking how the outcome would be different if we had picked Door #1 instead of Door #3.
    It’s perfectly natural to wish that things had turned out differently and identify mistakes, but we can’t undo what’s in the past. Everything is in motion and we can only go one way with our trades – forward.
    IMO, the best way to fix a mistake is to learn from it, cut your losses at the appropriate point to conserve capital and move on down the road.

  2. Blue cat 04/10/2009 at 6:20 PM #

    Hi Mark,
    Thanks for thinking about the question and for sharing your thoughts.
    The problem that there were no trading days between yesterday afternoon when I wrote the question and Monday highlights my status as a rookie. I hadn’t realized that markets would be closed today! It came as a surprise when I found out later yesterday evening.
    My question really was hypothetical. I don’t have the position I described. After asking it I realized that you (especially) wouldn’t allow yourself to hold a position that was so close to the money. I know enough about your comfort level to know that you would have done something a lot earlier.
    But to get back to the real point — is this a viable strategy — what it really comes down to is whether a strategy that expects to duck and weave until the bell sounds might work. (The bell being option expiration.)
    As a seller my thought is that it just might. If one can put off losses and dodge bullets while time passes, eventually the options will expire–which is one reason for not wanting to go out to May. Of course one could get oneself into more trouble by making a misstep during the ducking and weaving.
    But that’s what motivated the question: if it falls within one’s comfort level could a strategy that consciously plans to duck and weave until expiration be successful?
    The difference between this strategy and most option strategies is that most option strategies are static. They expect not to “adjust” unless forced to. This strategy is dynamic; it expects to be adjusting all the time. Most option strategies are like (short term) buy-and-hold investing; this strategy is like riding a bucking bronco.

  3. Blue cat 04/10/2009 at 6:34 PM #

    It’s something like slow motion day trading. Call it week trading.

  4. Mark Wolfinger 04/10/2009 at 7:04 PM #

    No. It is not viable in my opinion.
    In your example, you are ignoring the put spread. You simply cover the calls and move the iron condor a bit further away on the call side (that part is okay), but because you are trying your best to avoid losses, you also simultaneously sell a put spread that is relatively close to being ITM – giving yourself downside risk when you currently have none.
    By doing that, you have not improved your chances for a better outcome. You don’t seem to be convinced that the chances of incurring the maximum loss remains unchanged at 34% (in your example). And that ignores the negative value associated with added commissions and slippage.
    Duck and weave requires a lot of trading. And each time you are going to have options that are less far out of the money – and that does nothing for improving the probability of a happy outcome. Your example would not look so good to you if you had to cover a ‘not so far out of the money that it can be ignored’ put spread. the strategy that you propose involves exiting the current iron condor to enter into another. Too much trading. And think about this: How are you going to pay a specific number of dollars to buy a new iron condor and exit your current one – FOR THE SAME, OR GREATER, AMOUNT OF MONEY – and come away with less risk? Impossible. This looks viable only because there is no accompanying put spread to cover.
    You may dodge bullets as time passes, but that’s not what counts. As expiration nears, you can collect very little premium for the spreads you sell – unless you deliberately sell call and put spreads – per your example – that are not so far OTM. What’s the point of that? You are ignoring the fact that negative gamma can kill you – especially when time is short.
    There are too many lessons to learn. But if you pay a bunch of dollars to cover a risky trade, and if you are unwilling to pay a significant debit, then your new position is going to be no better than the old. And if you are willing to pay that debit, then pay it and give up. Why sell a cheap call or put spread with so much risk and so little to gain?
    To prove it to yourself, paper trade that idea for the next expiration cycle.

  5. Mark Wolfinger 04/10/2009 at 7:05 PM #

    I call it suicide by slippage.

  6. Blue cat 04/10/2009 at 10:52 PM #

    TradeStation’s probability calculator confirms your argument. It says that with RUT at 468.2 there is a 53% probability of its being below 470 after 7 days. It also says that RUT has only a 40% probability of being between 450 and 480 after 7 days. That’s a significant advantage to holding tight (or simply buying out the position.)
    But being on the right side of the short options at the end of a period isn’t exactly what one cares about. Let’s assume that we give up if RUT goes out of range, i.e., if it goes over 470 if we stand pat or if it goes out of the range 450 – 480 if we make the switch. (Call that being stopped out.) I don’t see any easy way to ask the TradeStation calculator about the probability that RUT will not go out of a range at any time during a period, i.e., that we will not be stopped out. That’s more like what we want to know.
    But here’s an interesting data point. The probability that RUT will be between 450 and 480 at the end of 3 days is 58%. The probability that RUT will be below 470 at the end of 3 days is 53%. So for a 3 days period one would be better off trading 470 for the 450 – 480 range. The odds are even better of course for a 1 day period: 82% to 56% in favor of buying breathing room. In other words, if one stands pat, one has a 44% chance of being stopped out, i.e., having RUT go over 470 after one day. But if one goes for the 450 – 480 range one has only an 18% chance of being stopped out after one day.
    Furthermore, if one goes for the 450 – 480 range, one can duck and weave again if RUT gets close to either limit. Admittedly, as you said the breathing room range gets smaller and smaller. But so does the number of days one has to stay alive. So it’s still not clear to me that standing pat is theoretically better.
    I agree completely with you that slippage and commissions are important and that these numbers don’t consider them. One can minimize commissions with TradeStation since they charge a flat $1/contract with no ticket charge. (I’m not getting anything for saying that.) The issue of slippage was my motivation for asking (in a different comment) about options that trade with tight bid-asked ranges.

  7. Mark Wolfinger 04/10/2009 at 11:28 PM #

    1) The conditions I gave assumed holding through expiration. Thus, I ignored the possibility of being stopped out – for the purposes of the discussion. Apparently you don’t accept those conditions.
    2) It’s easy to get the probability for the index moving to (touching) the strike of at least one short option before expiration arrives. One of the brokers offers the ability to make that calculation (thinkorswim??), but Hoadley offers it with his software: http://www.hoadley.net/options/barrierprobs.aspx?
    3) I don’t buy your argument that the difference between 53% and 58% is significant when you must close one position and open another to obtain that advantage. You must trade 6 contracts and the slippage to get that small advantage. That’s not feasible for the traditional individual investor. And you admit to being a rookie, so you are discussing theory – not something you have tried to do in the real world – or even in a paper trading account. Try it there for a few months, then come back and report.
    4) Duck and weave is not as easy as you seem to think it is. If you do it a 2nd time, and the probability says you will, you are trading 8 contracts and the options spreads you sell will give you LESS cash than you received the 1st time you ducked and weaved. Not only that, but buying in your threatened IC is not going to cost any less. This is not viable, in my opinion.
    5) I’m not arguing that standing pat is theoretically better. If you choose not to exit, I’m stating that standing pat is better than trying to buy in the short spread, open a new IC, then stand ready to that all over again if threatened. You do understand that if you choose to hold Thursday at the close, you are at the mercy of the market’s opening Friday morning, don’t you? Because the strikes you are selling in the D & W maneuver are necessarily going to be not far OTM, you will be forced to buy back the IC Thursday or accept substantial risk. Not viable.
    Is there no room in your trading plan to give up? Must you try to profit to the very end? If you must, then why not forget the first 3 or 4 weeks, and just start on Monday of expiration week? [To all other readers: not a serious suggestion.]
    6)I should hope you are not getting paid to mention $1 per contract at Trade Station. Those rates are not very attractive. If cheap rates are your only consideration, you can do much better elsewhere.

  8. Blue cat 04/11/2009 at 12:48 AM #

    Would you mind saying where you can do better than $1/contract with no
    ticket charge? It’s not the only consideration, but it’s certainly an
    important one. It might be a useful post to compare prices at various option

  9. Mark Wolfinger 04/11/2009 at 9:54 AM #

    Interactive Brokers gets 70 cents per (assuming you trade at least 2 lots per trade). No ticket charge. No exercise/assignment fees. If you trade an index, they add exchange fees. I pay 0.18 per contract extra to trade RUT. They give discounts for BIG traders.
    Trade king has a per ticket charge of $4.95, plus $0.65 per contract. A 20-lot is 90 cents per contract. If you trade enough contracts, their rate is very good.
    OptionsHouse is a flat rate of $9.95 – any number of contracts.
    I don’t know how good these brokers are – that’s for you to determine. But I’m sure there are other firms that charge less than a buck per.

  10. Blue cat 04/11/2009 at 12:45 PM #

    Thanks, Mark,
    Since I do small lots, IB looks like the best bet for me.