Q and A. More about Portfolio Insurance

Josh posted a very lengthy question.  I'll be replying in batches.

Greetings Mark:

Thanks for your blog and your dedication to teaching people about options. I bought the book, have not yet had a chance to take a look at it… There are a couple things I want to ask you that are related to this post [Portfolio Insurance].

Could you outline the IC trade that the above insurance was used with. That way I can plug it into my software and take a look at how moving the various bits around affects the risk graph. Also, did you not buy any insurance on the call side? Also, if you have any more sort of whole model trades along these lines where you use the strangle buy, maybe you could put one of those up so that I (and others) could take a look at the risk graph. I find I need the graph and the Greeks and the ability to move the parameters around to be able to get a feel for any new strategy.

Josh

1) I have a bunch of different iron condors in my portfolio, so this trade was 'portfolio insurance' rather than insurance (to protect against a market collapse) for one specific iron condor.

I bought Mar 340 puts which are very far OTM and don't look like much real-world protection.  However, the put spreads were sold up to two months ago and are also far out of the money.  If those short put spreads become worrisome, then my extra long puts will provide decent protection.

2) I did not buy protection on the call side for two reasons.

First: I don't need it yet.  I covered many call spreads at prices between $0.25 and $0.35, and my upside looks pretty good.  

Second: if the market rises, it's very likely that IV will shrink and that I will be able to buy upside protection at better prices than I can buy it now.

3) It will be educational for you to 'roll your own.'  I know you haven't read the book yet and may not be sure how to choose an appropriate iron condor.  However, you can get some good ideas from some of my blog posts.  Paper trade an iron condor (20-lots so you see see the effect of insurance.  One-lot won't do it for a practice account, although it's fine for a real money account).  Once you see the risk parameters for that IC, decide at what price level of the underlying asset you want the graph to look better.  Buy appropriate options to give you that boost.  Then try different, less expensive options.  I believe you can discover what you want to know.  That's probably better for you in the long run than seeing how my specific trades use insurance.

4) I understand why the risk-graphs help you get a better feel for the situation.  The book contains a bunch of them in the chapter that discusses advanced risk management.  In the near future, I'll make up a position and post the risk graph, along with a risk-reducing adjustment. 

(I post  many of my trades on Twitter) but my trades suit my comfort zone and I do not recommend them for anyone else.

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