Q and A. Using the Greeks to Adjust an Iron Condor

Hi Mark,

Would appreciate an article about adjusting an iron condor related to the greeks (delta) or about Sheridan´s methods?.




Hi Slait,

As you know there are many possible methods you can use to adjust an iron condor position.  The ultimate purpose of any method is to reduce, or eliminate, risk.  By exiting the whole position, risk is eliminated, and that's the most extreme, and effective, adjustment possible.  But when we are ready to adjust a position, it's too soon to think about exiting, and we look for risk-reducing trades that give us a good chance to earn a profit going forward.

Regarding Dan Sheridan, his methods can be found elsewhere (Click on 'Dan Sheridan archives' in left column, after you sign in).  But one of his ideas is to open a position 4 – 5 weeks prior to expiration and to exit, after holding just over two weeks.  I approve of this general approach:  Make a decent profit, then eliminate all residual risk by not having a position as expiration approaches.  

I use a longer time span (enter 13 weeks prior to expiration, and exit 8 to 9 weeks later), but the idea is the same:  collect a profit (if the market co-operates) then eliminate risk by closing the trade.  The reason for the early exit is to avoid holding when negative gamma increases and becomes more of a threat.  And yes, I do understand that it's difficult to pull the trigger and exit a trade – as time decay is accelerating.  Thus, I want traders to understand that this is my decision for my comfort zone, I'm not recommending that anyone else trade that way.

Adjusting with Greeks

It's always a good idea to know the risk factors associated with your iron condor (or any) position, and the Greeks provide a quick and easy method for tracking that risk.  Every morning I enter the portfolio delta, gamma, theta, and vega into my daily diary.  Doing that prevents me from closing my eyes to those numbers.  There's nothing like writing something on paper (or in a computerized document) to help you be aware of your situation.

Let's assume you open a 10-lot iron condor position, expiring in 45 days, and that you sell options with a delta of 12 (that's just a random choice for the purposes of discussion).  You buy the wings, choosing options that are 10 points further out of the money.  Note: these options are chosen on 'distance' symmetry,' not delta symmetry.  Thus, the original iron condor may not be delta neutral.

[If you prefer delta neutral, then choose different options to sell.  This is not too important for this discussion, and although I prefer to leave no questions unanswered, this is not the place for more details on this point.]

As time passes and the underlying stock or index moves higher or lower, the Greeks change.  At some point, the position reaches an uncomfortable level and it becomes advisable to make a stage I adjustment.  You cannot use a set formula to determine when that point is reached.  Instead, each investor has his/her own comfort zone that helps choose that point for you.  I wish I could make a recommendation on how to choose that point, but cannot do so with any assurance that it represents anything but a random number. 

It's up to you to find the right time for making an adjustment.  For example, if you own a position with 200 negative delta and 10 negative gamma, you can assume (IV holding constant) that a 5-point move in the underlying index will cost more than $1,100 as your negative delta moves from 200 to more than 250.  Can you tolerate that loss?  Are you willing to take that chance.  If the reply is yes, you have not yet reached Stage I.  If that potential loss is too high for you, then do something.  Perhaps cover 50 to 100 delta plus at least 2 gamma.  You can do that by buying some naked long options or by reducing the size of your spread. [This paragraph updated 2 hours after original posting.]

The one piece of advice I offer is this:  Don't let yourself get hurt.  If you have a reasonable fear that the position can lose more than you are willing to lose on a single position, then do something to reduce that risk. 

[Full disclosure: I believe this advice to be wise, intelligent, and reasonable.  But I do not follow it 100% of the time, and take more risk than I should.  I'm much more disciplined that I was earlier in my career, but I truly wish I could blindly follow my own heart-felt advice.]


4 Responses to Q and A. Using the Greeks to Adjust an Iron Condor

  1. Gil 04/15/2009 at 6:58 AM #

    IC RR Ratio
    For a non IC investments a common practice is to calculate the, so called, RR ratio, and to enter a position only when the ratio is 3:1 in my favor (for instance based upon stop loss versus target value).
    Adpoting the above approach for IC tells never to use them
    :-)..? unless you analyze the RR based upon the asset(stock), rather than upon the IC spreads. I’m not sure how adjusuments or rolling fit into this model (other than recalculate evrything after adjsuting/rolling).
    I wonder is you can share with us your perspectives.

  2. Mark Wolfinger 04/15/2009 at 9:05 AM #

    First, somebody else’s desirable R/R (risk to reward) does not apply to you, unless you agree with the rationale behind selecting that specific number.
    Second, the idea of a stop/loss and target are difficult to use when trading options (the stop loss part is difficult), and IMHO this ‘rule’ applies to stock trading.
    My perspective is that this rule is totally inappropriate for trading options – with the possible exception of buying naked long options – something I never consider.
    Consider this: When you use the RR ‘rule’ you are playing for the stock to move higher or lower. Assuming the probability of either is about 50%, and that you are going to lose at least half the time – it’s a good idea to allow yourself the chance of making more than you can lose. If you don’t do that, it’s almost impossible to win.
    Iron Condors are very different. The proability of winning is MUCH higher. Thus, you can afford to use a ratio that is much less than 3:1 because your chances of having a winner are much greater than 50%. Depending on how long you intend to hold the trade, it’s likely (when entering the position) that your odds of winning are 4:1 or greater. That cannot be ignored.
    Assume you have a 1:4 RR, lose 20% of the time, and that your gain is $200 and the loss is $800, your expectation is:
    + .8*200 – .2*800 = ZERO.
    Thus, keep those losses from reaching the maximum and you will come out ahead. Or close positions sooner so that the odds of winning move much higher (less time open, less chance of loss – even if gains is no longer $200, the max loss may be only $300). Or collect more than $200 in premium, so that maximum loss decreases. Etc.
    It’s the probability of winning that make all the difference.
    You can find a spread that suits your RR needs when probability is considered. but not when it’s 3:1

  3. lynx 04/15/2009 at 4:26 PM #

    I agree, risk/reward strategies do not apply here. Personally, I see the iron condor strategy as having limited risk already. Currently, I favor trades six or seven weeks out. My own comfort zone stops me from trading three months out due to the current RVX levels. (I trade RUT almost exclusively). With volatility so high, I hate to think of what could happen in a three month period.
    Still trading and still learning,

  4. Mark Wolfinger 04/15/2009 at 5:25 PM #

    The ‘still learning’ should never end.
    I must say that it’s tempting to trade shorter-term options, with the intention looking to earn a fast profit. Then to sit o the sidelines with no further risk.
    But right now, cannot bring myself to make that move.