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Trading iron condors with negative gamma

I'll be giving a webinar for TradeKing on Tuesday Feb 16, 2010.  Covered Call Writing from a Different Perspective.


For space considerations, I've cut some of the wording that's not directly a question.  Here's the entire comment.


I came across your blog as I was looking for ideas about hedging iron condors. I have to admit, you have a lot of great info, but I do have a few

1. Obviously, maintaining a delta neutral portfolio is a challenge
since the delta changes as the underlying changes, and maintaining a
delta neutral profile can result in a lot of trades. Is there any sort
of guideline about what is an acceptable delta or what may be
considered excessive delta? I realize that if you have many IC
positions, you can't view the delta on a per position basis, but rather
the portfolio as a whole.

2. Can you provide some 'layman' examples of how negative gamma can
impact a position(s)? Is it possible for negative gamma to impact a
portfolio of ICs in both a positive and negative trending market?

3. In
your posting called "Iron condors: Diversification and VIX options as
hedges", I understand why VIX options should not be used…  Have you ever considered, or ever heard of
someone, using something like the Proshares Index ETFs options as a
hedge?  Specifically, since I almost exclusively trade SPX, I was
looking at buying options or debit spreads on UPRO and/or SPXU – which
are directly correlated (in theory, at least) to SPX.

Thanks again.


1) Simple answer: No guideline that's universal.  But, you can discover your own as you gain more experience.  Keep a daily diary that contains the portfolio Greeks.  Enter comments about your comfort level, whether you considered adjusting, and whether you did adjust.  Track daily P/L.  It's going to take a bunch of days before anything meaningful can be learned, but merely examining the Greek levels every morning is beneficial.  Over time you will build a record of where your discomfort level lies.  Track any statistics that you believe are important.

With negative gamma, you cannot (as you say) adjust all the time.  You must pick your spots.  There are many methods for trying to keep delta in line.

  • Adjust every time SPX moves one (or 1.5 or two) standard deviations from the last time you adjusted
  • Adjust when you are 100 (or 500 or 1000) delta from neutral.  Your own comfort zone and portfolio value help you decide
  • Adjust when you will lose 1% (or 2% or X%) of your portfolio value if SPX moves an additional X% from its current value.  Note this is percentage of total portfolio, so don't allow the number to be too large.  Your comfort zone will be a guide

Delta is not the only Greek to adjust.  When making an adjustment resulting from negative gamma, give serious consideration to picking up some positive gamma when adjusting.

Most iron condor traders disapprove of spending money on option premium, but it's often best to buy some positive gamma to reduce the ongoing problem.  I am not referring to options that are farther OTM than your iron condor.  The gamma must come from options that are closer to the money than your short option (or it's okay to buy in a small number of your shorts). Why? Because your plan is to hold the IC, and when time passes you know those OTM options will lose much of their protective value.

The best way to handle negative gamma is to find a reasonable solution that allows you to sleep at night and not worry about losing too much money.

Any time your delta total seems too large, then it is too large.  I know this is not the specific reply you had hoped to receive, but there is no 'number' or 'percentage of portfolio delta' that suits each trader.

There is no doubt that a single iron condor position is easier to manage, but you and I carry multiple positions and it's best to manage the portfolio as a whole.

WARNING: That last paragraph does not relieve you of the responsibility of seeing that no iron condor ever approaches its maximum loss.  Sometimes you must exit a single iron condor position and find another.

2. Yes. Negative gamma hurts regardless of which direction the market is trending.  When your position has negative gamma, your portfolio accumulates positive delta as the market falls.  It also loses delta as the market rallies.  That's why time decay is good and volatile markets are bad.  That's as near as I can get to describing this is the simplest (layman) terms.  You get longer when you don't want to do so (falling markets) and you get shorter when you don't want to do that (rising markets).

3. Whatever else you do, please do not hedge with leveraged ETFs.  Unless you plan to get out of the hedged position the same day, you will be very disappointed in how they perform.  You do not want to own these vehicles.  Ever. Trading a spread is not as bad, but these are items you do not want to trade.

You can use SPY instead.  Yes, you must trade a few more shares and that may cost commissions, but you must avoid these leveraged devils.

From my perspective hedging with the equivalent of stock is a poor idea.  I know many people adopt such a technique, but to me you are setting yourself up for getting whipsawed (buy high, sell low) when you have negative gamma.  Buying stock or an ETF is equivalent to buying delta and zero gamma.  Yes, it has no negative time decay.  So if that's what you want to do – then that's your decision.  BUT DO NOT buy those despicable leveraged ETFs.


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