Q and A. Questions From Twitter

From jcvictory:

"In re: 'the one penny per trading day' rule, does that apply for condors sold 30 – 40 days to expiration?

The rule to which he is referring is my advice to close inexpensive call or put vertical spreads when they become so inexpensive that there's too little to gain by continuing to hold them.  [That's part of my plan not to carry any positions all the way through expiration.]  If that advice sounds reasonable, the difficult part is knowing how much to pay when exiting the winning side of the iron condor.


For my comfort zone, I usually open new IC positions about 13 weeks before the options expire and I collect at least $300 for each.  My buy back price is one penny per trading day remaining, before expiration arrives, with a maximum price of 35 cents.  Because I don't want to take the risk of holding any spread, no matter how far OTM, I seldom allow a spread to decline to less than ten or fifteen cents before I buy it – even if there are only a few days until the options expire.


However, JCV asks a good question.  When selling shorter-term options, the premium collected is less than my usual $3.  So what price is reasonable to pay when exiting these trades to lock in a profit?  If the original premium is $1 or less, then it doesn't seem right to pay 25 cents per spread to cover.  That's giving up half the potential profit.


There is a large benefit when covering: risk is eliminated and the profit has been earned.  And you have no residual position – until you decide it's time to play again.  That's good risk management!

But, when you open a new trade, you are taking risk – for as long as you hold the position.  To justify that risk, there must be a decent potential reward.  My recommendation is to find an acceptable price to pay for the OTM spreads based on what's comfortable for you.  I would be VERY happy to pay 30 cents for each side of a $3 IC.  I don't get to do that very often, but it would allow me to keep 80% of the original premium.  If you want to play the 'exit early for safety' game, I suggest trying to keep 70-80% of the original premium (thus, pay 10 – 15% of the total premium for each individual spread).  NOTE:  This discussion refers to the voluntary closing of a position.  If the spread becomes too risky to hold, that's a very different scenario.  The risky position is exited based on the boundaries of your comfort zone and your need to protect yourself from large losses.


Milktrader asks:

"so if you had an iron condor with short strikes at 20 deltas, would you perhaps buy an extra 5 delta put?"

No.  As I've mentioned previously, I don't believe it's a good idea to purchase options that are further OTM than the options you are already short – unless your objective is to own protection against a catastrophe.  The longer you plan to hold your original iron condor, the more important it is not to own those far OTM options – because they are going to decay, and be of no use.

Assuming you decide to buy protection that expires at the same time as your iron condor, my preference is to buy options with a higher delta.  If your first adjustment point occurs when the short option reaches a delta of 20 to 25, then my recommendation is to buy a small quantity of the option that's one (or perhaps two, if you are trading an index) strike prices nearer to the price of the underlying. This is what I refer to as a Stage I adjustment.

Example:  if short a 600/610 call spread, buy the 580 or 590 call; if short the 450/460 put spread, but the 470 or 480 put.

These options are not cheap, but in return for paying a higher price, you know that you have a long option that works for you – if your position gets into trouble.  And that's true no matter how much time remains before the options expire.

If making a one-sided adjustment feels uncomfortable, you can always buy protection for the other side of the iron condor – even if it's not (yet) in trouble.


20 Responses to Q and A. Questions From Twitter

  1. Alex S. 04/14/2009 at 11:02 AM #

    Hi Mark, I have been told that you should close a position if you have more than 6 or 7 % loss. In my opinion, this percentage is very easy to be written off even in an normal , volatile market, so I would prefer at least a 12-15% loss What is your opinion?
    2)Do you also agree that you should take your profit quickly? So what do you think should be the minimum profit % for trading option? Is 20-30% too low, should 50-80% reasonable or over 100% be ideal in option trading ?
    3) I am a beginner and just learned some basic strategies on trading options, mainly buying Calls and Puts. I live in Hong Kong so it is unlikely that I am going to buy any covered call or put or buy the actual stock because it involve quite a considerable amount of funds in US dollars. So I intend to profit by selling the up and down of the call and put premium. Is my strategy too risky? What advice you could give me?

  2. Mark Wolfinger 04/14/2009 at 12:05 PM #

    Excellent questions.
    I’ll reply in detail as a blog post. Probably Thursday morning, 4/16/2009

  3. TR 04/14/2009 at 11:25 PM #

    Hi Mark
    It has been a while since I asked you a question. I have decided to step back into the options trading world after about 4 months when I decided to focus on other things.
    I bought a JUNE RUT IC 340/350/570/580 for $190 this monday (1-lot) and I was thinking of getting into a gameplan where I buy one lot of a RUT 8-13 week out IC every week with the goal that I close each with it gets to about 3-5 weeks out. Each time I plan to buy an IC with short strikes at a delta of 10-12 and aim for a premium of close to $2. By spreading my purchases over time I believe I will have some form of diversification against the ups and downs of the market (of course I will still exit if any short strike is breached). So on average, at any one given time I will be holding about 6-8 positions. As I was planning to start with one lots, insurance options don’t make sense.
    My question to you is this…What are your thoughts on the above approach vs sinking 6-8K of margin into one RUT position (i.e. buying a 6-lot to 8-lot) and then supplementing that with an insurance put and call each one or two strikes inside the short strike of the IC. Both are risk mitigation strategies, and I wanted to ask for your perspective on the pro’s and cons of each.

  4. slait73 04/15/2009 at 6:33 AM #

    I expect your answer Mark, about the last question, ´cause it´s a system I have thougt about many times.

  5. slait73 04/15/2009 at 6:34 AM #

    Sorry, thks for your today lesson….

  6. Mark Wolfinger 04/15/2009 at 8:27 AM #

    Welcome back
    1) Assuming commissions are not important (broker with a per ticket charge), each plan has its merits.
    2) Most iron condor traders prefer not to pay for insurance until it’s needed. I buy it part, but not always.
    3) I would base your decision on this: Do you prefer to own pre-insurance? If not, I like plan A better.
    4) One problem with plan A is that you are going to want to sell your long option (and buy another) some weeks. You may find that to be awkward – especially if you keep careful records of positions.

  7. Mark Wolfinger 04/15/2009 at 8:28 AM #

    I got to it as soon as I could.
    Hope it helps.

  8. “4) One problem with plan A is that you are going to want to sell your long option (and buy another) some weeks. You may find that to be awkward – especially if you keep careful records of positions.”
    Please could you be more explicit?
    I don´t understand what you mean.

  9. Mark Wolfinger 04/15/2009 at 11:12 AM #

    In week one, he may sell a put spread with strikes 620 and 630.
    Next week – because the price of the index has changed – he may want to sell a spread with strikes of 660 and 670.
    In week #3, he may want to buy 630s and sell 640s. He is already short the 630 – so if he buys it, the new posiiton will be the 620/640 spread. The 630 position will be gone.
    Or, he may want to buy 610 and sell 620. Because he is long the 620, when he sells it, he will no longer have a position in that specific option. Instead the posiiton becomes 610/630.
    That is NOT a problem, but some traders find that an uncomfortable thing to do. Many simply make the best trade available and don’t worry about the previous positions. Others prefer to keep original position unchaned to allow them to keep careful records of profits and losses.
    Thus, the possibility of making a trade that removes part of the previous position is only a problem for the trader who believes it’s a problem. It’s umimportant for everyone else.

  10. OK, thks Mark I understood. Could be a litle bit embarrasing.
    But do you mean it´s the only difference between the two strategies?.
    If I understood, what TR is porposing is trying to avoid risk by time diversification: So he sells every week an IC (or every 10 or 20 days…).
    I´m not sure bettween the diference of results of your strategi, selling high amount of ICs per expiration with 3 months of live or selling lower quantity of ICs but 3 or 4 times per expiration)
    Surenly you choose your strategy ´cause you think it´s better but I cannot guess why, and if the only thing you don´t use this kind of time diversification it´s because it´s embarrasing or if there are other reasons.
    Antonio(really grateful).

  11. Mark Wolfinger 04/15/2009 at 12:54 PM #

    I’m happy to help you understand what I’m trying to say. [Tell your firends to visit this blog!]
    1) I choose my strategy because it makes me more comfortable. I don’t think it’s ‘better.’ I prefer not to hold positions near expiration and therefore choose 13-week iron condors.. Others prefer the rapid time decay that come with near-to-expiration positions. Neither is ‘better’
    It’s a different risk vs. reward profile.
    2) I like TR’s ‘time diversification’ method. All I did in my reply was to make sure he understands that he may have to choose a trade that he believes is second best when choosing the ‘best’ spread would force him to buy an option he is already short – or sell an option he already owns.
    3) Trading every week has one big advantage:
    If the markets move aginst him, his positions are smaller and his losses are smaller. And if IV increases, he may get a great price for the new iron condor.
    Trading every week has one major disadvantage:
    If time passes and nothing bad happens, he is forced to open a new position at a lower price. And if IV declines because the market is ‘doing nothing’ then he gets an even smaller price for his new iron condor.
    This discussion doesn’t consider which specific expiration to choose for your iron condors.

  12. OK I (thik)understand,
    You mean that the hole credit collected is less (in case IV drops)than if you do it in one time, because the IV afects more to the positions you open close to the expiration. So if you usually get 3$ per IC with your strategy, with TR strategy if IV drops the credit of the last IC can be pooer and with the sum of all he won´tr get the same amount. On the other hand he will have less losses because the amount of the ICs.¿mmm?

  13. Mark Wolfinger 04/15/2009 at 2:44 PM #

    He will collect less premium for the iron condor he does last, when compared with the iron condor he trades first.
    But, he also has less risk. So that’s a normal exchange: You take less risk, you earn a smaller profit.

  14. lynx 04/15/2009 at 4:38 PM #

    I do not recall if I read it or came up with it on my own, but I like the rule of “80 and out!” Simply put, once 80% of the profit in the IC or credit spread is made, I close the position. Sometimes, particularly with a credit spread, this can happen very quickly if the market makes a big move in the favorable direction. I typically enter my closing orders as soon as the opening trade is filled. That way the close is on autopilot if things work my way. This strategy has closed me out prior to a sharp reversal more than once.
    I also never pay more than $0.35 to close and prefer to pay less. Depends on how much time is left.

  15. Mark Wolfinger 04/15/2009 at 6:13 PM #

    That’s a fine rule. My only objection is that 80% will not suit everyone.
    It’s funny, but I trade iron condors, collecting about $300 per. I also close either leg if it drops to about 30 cents, or 60 cents for the IC. Thus, I’m also using that rule – but not intentionally.
    I’m convinced that closing the winner is a wise independent decision. If the losing side is in trouble, making adjustments is a separate decision. I assume that’s your style also when paying that 35 cents (or less).

  16. TR 04/17/2009 at 7:58 PM #

    Thanks for your response to my question. As usual you give me more to think about in your awesome response and that leads to more questions.
    I understand this issue of buying a short option and creating this 20 point spread. I want to be clear on my adjustment strategy when I get into the sitution and the market moves against me. For the purpose of my question assume my adjustment comfort zone is to adjust as soon as the short strike is breached.
    My gut tells me that if I have a bear 620/640 call spread position and the the 620 strike is breached then I need to buy the 620 and sell a 630 which will leave me with the 630/640 bear call spread (hopefully I would have closed the put side by then, and if not I would close the put side at this point). Then as I am left with the 630/640 and if the market continues to run up when the 630 strike is breached I will buy to close this 630/640 position.
    Can you comment on whether the above is the right approach (vs. closing the 620/640 call and both corresponding put spreads when the 620 strike is breached)?

  17. Mark Wolfinger 04/17/2009 at 8:22 PM #

    My first comment is that your suggstion is not the right solution. Why? because there is no “right’ solution. There are many alternatives and any that you believe suit your comfort zone is right for you.
    That said, I don’t like your approach.
    1) I understand and agree that when your adjustment point arrives, you ‘must’ do something.
    2) But why do you believe you ‘must’ buy the 620/630 spread? There is no ‘must’ here. There are many, many choices.
    3) When dealing with a 600 point index, I believe it is foolish to adjust 10 points. That’s gives you another very risky position. 10 points is nothing. This is not a good idea.
    3) I’d be more inclined to buy the 620/640 spread, closing the position and finding something else to sell. Perhaps a new iron condor (after buying in put spread); perhaps another call spread (avoiding a whipsaw, but remaining delta short); perhaps same expiration month, and perhaps the next. Lots of choices.
    I might be comfortable selling the 680/690 or 680/700 spread when covering the 620/640. But that’s not really far enough OTM. Better yet, the 700/720 – if the premum is worth selling. You must have a minimum you’d be willing to accept. But that’s me.
    Yes it costs cash, but that’s not the end of the world. And there are methods to avoid paying that cash, but that’s not the point of this discussion.
    Again, I’ve given an example of how my comfort zone works and you shouldn’t care. Your comfort zone is what counts. But, I do believe moving the strikes one and one half percent higher accomplishes nothing. Unless you WANT to be very bearish. That’s a very different story.

  18. TR 04/18/2009 at 6:07 AM #

    I hear what you are saying and I suspect you are right but I think this is probably one case my “science” oriented brain struggles with the “art” side of options investing.
    My thought process in my suggested aproach I was boucing off you is that I was treating the 620/640 bear call spread as two distinct bear call spreads: 1) 620/630 and 2) 630/640 . This is what I would have if my two IC’s bought weeks apart were actually bought in separate trading accounts.
    So my thought process was “just because I have two IC positions and the proximity of the call side of the two positions created a 20 point spread call, I should still act as if they were two separate 10 point spreads, not one 20 point spread”. Or another way of saying this “just because I have 2 IC’s in one trading account, why should I act differently than if the two IC’s were in 2 separate trading accounts.”
    I believe the most important part of my suggested adjustment is that I reduce the spread from 20 points to 10, not that I moved the short strike by 10 points or 1.5%.
    I would appreciate your thoughts on this and let me know what I am missing.

  19. Mark Wolfinger 04/18/2009 at 11:23 AM #

    This reply deserves a separate post

  20. TR 04/19/2009 at 9:13 AM #

    Fantastic response. I now get it and I am convinced that in cases like this I should close
    the entire 20 point spread, for my comfort zone.I was not thinking about the slippage
    before. Thank you Mark.