Tag Archives | iron condor

The American Dream

The American Dream

Is there a definition for this term? 

James Truslow Adams coined the phrase in 1931: (From Wikipedia): "in his 1931 book The Epic of America. His American Dream is "that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position."

That's very different from how most of us define the term in today's world.


Suze Orman is one of the most influential of those who offer investing advice to the general public.  I find it difficult to believe that there is any reason to mention her name in this blog.  However her audience is the true novice – the mom and pop investor – who truly needs her help.  The sad truth is that the majority of such investors lack sufficient knowledge to make their own investment decisions. They don't even know enough to take the passive approach.

As an aside, I have neither a love of, nor a quarrel with, passive investing for the right investor.  Buy index funds, save a ton of money on management fees and expenses – and own a portfolio that should come pretty close to matching the performance of the chosen benchmark index. That's far better than paying a fee to mutual funds that cannot outperform the market averages.

Suze's advice is neither fantastic nor terrible.  However, the reason I am mentioning her name at this time is because of a recent splash she made by proclaiming that "The American dream is dead."

In her blog, Jenna Goudreau wrote " financial guru Suze Orman is peddling her dark side.  Now, I take a look at her outlook for the country—and it isn’t the sunny, you-can-do-it optimism that I’d expected.

When asked about her financial fears, Orman said: “My only fear in life, when it comes to money, is what’s happening in the United States of America. The American dream is dead for the majority of Americans.

The dream she is referring to is not even a Cinderella story; it’s much more practical. Orman believes the hope of someday owning a home, of working one job for life and retiring at 65 has been crushed by the financial crisis. “The middle class has disappeared,” she continued. “We have a highway to poverty and no roads coming out. I fear for [those] who have been kicked out of their homes, could be living on the streets and don’t know how to find another job. Many of the millions of jobs lost, I don’t think are coming back. I am really afraid for the majority of Americans today.

The cynicism is interesting from Orman, as she is the embodiment of the American dream"


What does any of this have to do with options?

Nothing.  However, there is a lot of gloom and doom in the press and in the blogosphere. I believe that if this upbeat, optimistic personality is truly concerned, and this is not merely publicity for a new book, then perhaps too many investors are taking too much for granted. 

We all see the market rise, we see businesses making lots of money, and we see banks that went belly-up get rescued and prosper.  However, we also see Main Street suffering.  It's very discouraging.  If Suze Orman can join those who believe the 'recovery' is a mirage, then I can see only two alternatives:

  • There really is too much optimism and this stock market and the economy are headed for disaster
  • This is the ultimate in capitulation by the small investor, and the market rise hasn't even begun

In either scenario, within another year or two, the market could easily be 50-60% higher or lower from current levels. As an iron condor trader, that is a big concern


Premium version of Options for Rookies

Planned Launch March 1, 2011


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Volatility Skew

'Volatility skew' is one of those topics that many traders ignore.  It's not something that was understood in the early days (1973 +), when options began trading on an exchange.

According to Wikipedia (quoting John C Hull): "equity options traded in American markets did not show a volatility smile before the crash of 1987, but began showing one afterward."

A volatility smile is defined as 'a long-observed pattern in which ATM options tend to have lower IV (implied volatility) than in- or out-of-the-money options. The pattern displays different characteristics for different markets and results from the probability of extreme moves'


image courtesy of investorglossary.com


In other words, black swan events occur more often than predicted by mathematical models, and far OTM options trade with a higher implied volatility than ATM options. 

In today's world, this volatility smile is so skewed to the downside that the IV of OTM puts is significantly higher than that of ATM options, which in turn have higher IV than OTM calls.  This is considered as rational in light of the 'frequent' market crashes.  Frequent is defined as far more often than any mathematical model would have predicted.


Kurtosis is the mathematical term used to recognize that not all tails of the curve are created eual and that market crashes are far more common than market surges.  Thus, PUT IV exceeds call IV.

The early texts could not mention 'volatility skew' and many of us 'grew up' in the options business with no understanding of the importance of volatility skew.  I now shudder to recall that one of my favorite strategies (late 70s and early 80s) was to own ratio spreads in which I would buy one put with a higher delta and sell 2 or 3 times as many puts with a lower delta.  I thought I was capturing theoretical edge by selling puts with a higher implied volatility.  Today, if anyone were to use that ratio strategy, it would not be to capture edge.  It would be more of a bet on where the market is headed next.

Volatility skew is easy to notice.  All one has to do is look at IV data for any option chain.  Nevertheless, the concept has often proven difficult to explain.  Saving me the trouble of attempting to do just that, Tyler Craig at Tyler's Trading recently described volatility skew in a nutshell.  Thanks Tyler.


When teaching traders who have not yet discovered the importance of volatility skew, the skew can be used to explain why one specific strategy is more profitable under certain market condition that others.  This is an important topic for future discussion. 

Mark Sebastian at Optionpit.com suggests one good method for following the volatility skew for a specific underlying asset.  It takes a bit of work, but owning a good picture of skew, as it changes over time, is probably worth the small amount of time that it takes to track the data. 

Sebastian also makes the important point that it's not a good idea to constantly trade the same strategy, using the same underlying, month after month (Guilty.  I'm a RUT iron condor trader.)  Instead volatility skew, among other factors, should be considered.  Iron condors work well when skew is steep and less well when skew is flatter.

Obviously this discussion is incomplete, but just knowing that volatility skew exists and that it can help a trader get better results, makes it a topic that we should all want to understand.



Lessons of a Lifetime: My 33 Years as an Option Trader

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As expiration nears, how does theta behave?


I am currently on my second round reviewing the greeks, and this time I am going into more depth. As I am putting together my notes I found references that describe time decay for both OTM and ATM positions. To my surprise, the shape of the graphs is different.

The graph that we are all accustomed to seeing shows that time decay accelerates as expiration nears. Most of the theta decay occurs in the last 30 days in which theta is increasing as the remaining time value of the option is decreasing.


When it comes to OTM options, according to the authors, the shape changes significantly. In the last 30 days, decay decelerates and the majority of the decay occurs before the last 30 days. This is the graph of an OTM option and its time decay.


I have been looking at various option series for both stocks and ETFs and I have not been able to confirm this.


If the above statement is true, when trading iron condors, why wouldn't you pick a timeframe for opening the position near 60 days to expiration and probably closing ~30 days before expiration? This would allow the trader to capture a larger portion of the time decay – because OTM positions make up the iron condor.



This is a very thoughtful question and illustrates why spending time trying to understand the things we are taught is such a good idea.  Thank you.

The general view regarding time decay is correct.  Theta accelerates as expiration approaches.  However, we must recognize that some siturations are different.  Let's say that a stock is trading near 79, there's a week left prior to expiration, and the option under consideration is the 80 call.  Surely that option has time value and with that comes time decay – and the option loses value every day.  Just as you anticipate.

However, consider the call option with a 50 strike.  Unless this stock trades with an extreme volatility, the call has already lost all time value (except for a component due to interest rates) and trades with a bid that is below parity. 

Or you can look at the corresponding put (which has the same theta) and see that it doesn't trade and the bid is zero. It has already lost every penny of it's time value.  Its theta is zero.

These are the situations to which your references are referring when stating that time decay decellerates into expiration.  When options move to zero delta and 100 delta, the time decays disappears prior to expiration.

Most traders who are talking about options and their time decay, are not interested in such options (there is nothing of interest for a trader to discuss).  Thus, options such s the 80 call mentioned above (and the corresponding 80 put) have time value, accelerating time decay and an increasing positive gamma.  These options decay according to your first, or 'standard' graph.

FOTM options

There is more to the rate of time decay than the time remaining.  When options are far OTM or deep ITM, things are just different.  Once you understand that situation (as I'm certain you do now), the theta problem goes away. Once an option has only a small time premium remaining, it cannot keep losing value at the same rate – or else it would become worth less than zero.

Iron Condors

Time decay is what makes trading iron condors profitable. Sure it may be good to own the position when time decay is most rapid, but that is not the 60 to 30-day iron condors that you envision.  That would work only when the calls and puts are both quite far OTM.  That means a tiny premium to start the trade.  That's a non-starter for me.

In the real world of condor trading, most options are not that far OTM and have enough time premium to belong in the standard decay group.  When markets behave for premium sellers, the last 30 days are the periods with the most rapid time decay.  For most iron condor traders, that is the ideal situation. However, that's also the period of highest risk – due to negative gamma.  For me, collecting the fastest time decay is not as important as owning a less risky trade.



Peace on Earth.  Liberty for all.  Best wishes for 2011



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Premium Selling in Low IV Environments

I've received a few questions about selling option premium when IV is low.  This is one example:


For approximately 1 month stocks have gone up without the volatility that we had become accustomed to in the fall.  At the same time the vix has gone down to approximately 16.

It pays to look at the multi-year picture to get a better feel for what can happen to implied volatility.  We are indeed below long-term averages at this level, but as recently as Jan 2007, VIX was 10.  The point is that we may look back at these IV levels and think of them as being relatively high. I have no idea which way IV will be trending in the coming months.

I usually sell option premium and with such low implied volatility on individual stocks, it has become very difficult to sell premium without being exposed to higher touching or expiring risk to get the same premium.

Those last four words describe the problem.  Whether you are trading credit spreads, iron condors, or even selling naked options, the decision on which options to trade MUST be based on something other than option premium.  Premium is one of the important consideations, but allowing that to be the one and only factor is a big mistake, in my opinion.

I urge you to think seriously about collecting the same premium when that involves taking greater risk.

When IV is low, it's low.  You must accept that fact and adapt your trading habits.  If you want approximately the same level of risk as your previous trading, then there is no alternative: you must accept a reduced premium.

Taking on more risk is always wrong – unless the extra reward more than compensates.  If you must take more risk, trade smaller size.  You are dealing with statistics. Unlikely events will occur at random times.  If you do not trade as if that fact were the gospel, then you must get rich quickly (and then retire from trading) because you have almost no chance of surviving over the longer term.

Positions that originate when already outside your comfort zone have too much probability of not working.  You may not like my answers, but I implore you: 'Please' do not take more risk just because the markets have not been volatile. 

This is a different market, and perhaps a different strategy should be used during these times.  Positive gamma can be added to your premium selling portfolio, but that would cost some cash, and your note tells me that spending money for any options is not something you are anxious to do.

In your webinar (at Trade King, on debit spreads) you discussed how the debit spread was very similar to the credit spread with a small advantage to the credit spread as you can do whatever you want with the cash.

In times of low volatility such as this holiday season how does it impact the strategies?  Selling credit spreads with such low volatility is very likely to result in problems with vega increasing faster than theta decay making it an unattractive strategy.  

More than similar, it's equivalent when the trades are initiated at equivalent prices, using the same strike prices and expiration dates.

You have drawn incorrect conclusions: It's not 'low volatility' that is 'very' likely to result in problems.  It's your personal need to collect the same premium.  You are increasing substantially the probability that those 'problems' will arise.  It is not mandatory to do that.

Remember that premiums are smaller for a good reason.  The market has not been volatile and thus, the expectation is that low volatility will continue. In fact, the market has been less volatile than predicted by VIX, and that's one reason VIX is still trending lower. 

You could be happy with a non-volatile market.  You could look at it as a less-risky situation.  Yes, it offers less profit potential per spread, but it also increases the probability of earning a profit.  What's so wrong with that?  You may prefer the higher risk/higher reward scenario, but that is not what this market is offering.  You have chosen the higher risk/SAME reward strategy.  Surely you must understand that this may work for you, but it is not wise and it fights those statistics mentioned earlier.

One reasonable solution is to alter your methods.  My solution to these 'IV is too low' situations may not suit you, but I try to own positions with less negative vega.  Thus, if I trade iron condors (I do), then I may add some OTM call and put spreads – just to add positive vega and gamma.  That reduces risk. But be sure to add positions that reduce risk, and do not add to it.

Or I may add diagonal or double diagonal spreads to an iron condor portfolio, making it more vega neutral.  You may decide to go long vega – if you expect that IV will increase quickly.  There are alternatives to your chosen methods.

More often I do not sell credit spreads but sell uncovered options further out of the money and this too is very unattractive with low volatility.

This is a strategy with higher risk.  I have nothing extra to say about this except that moving strikes nearer to the stock price is not the way to go. 

Another possibility for careful traders is to sit on the sidelines until finding something comfortable to trade.  You are not forced to trade right now.  As a compromise, trade one half as many contracts as you do now.

We must be prepared to modify our strategies when market conditions make those strategies less comfortable to use.  Flexibility – not increased risk – is the way to prosper.

Please explain your spread strategy preferences pro and con for very low volatility. 

This is more of a 'lesson' than a quesion, and I respond to questions such as this in the comments area (nor via e-mail.

Answer: I trade iron condors in smaller size – i.e., I trade fewer spreads and just accept that I'll try to make less money.  If you are successful, if you are making money, then it has to be okay to earn less when you feel risk is too high.   I also consider owning a portfolio that is far less vega negative.  I also consider buying insurance (naked strangle)

And please explain your spread strategy preferences pro and con for very high volatility.

Again, this reply required a book chapter, and I cannot go into detail here.

Answer: As an iron condor trader, or credit spread seller, I go farther OTM when IV is high.  I do not go after the higher premium.  I anticipate more volatility and move farther OTM to accept the same, or even less credit.  I like being farther OTM and will take 10% less premium to move another strike OTM.  I trade negative vega strategies and  recognize that some months afford larger profit opportunities than others.

For spreads one is always buying and selling volatility.  For deep in the money there is little impact for volatility as there is no time premium, but in most other circumstances one option is being sold and one is being bought and it seems to me that a change in volatility will have in general a similar impact on spreads of nearby strikes.

Similar, yes.  Nearby strikes and DITM strikes, yes.  But when selling OTM spreads, there is enough difference that the spread widens as IV increases.  This is more obvious with put spreads, where the skew curve plays a larger role.

There is no best answer to this situation and there is no set of rules to follow.  There is only good judgment and risk management. 

There is a lot of hit and miss when trading – it is not an exact science.  I suggest avoiding extra risk, even when that means trading less size.  I advise accepting smaller premiums, and maybe taking a trading break.  However, there are appropriate alternative strategies when you believe IV is moving higher. When it is low and you don't know where it is headed, it seems to me that vega neutral trading is the safest path. I know safety is not your current concern.  It's not too late to reconsider.


If you are interested in writing an article for ExpiringMonthly:The Option Traders Journal, send an e-mail to me at: mark (at) expiringmonthly (dot) com with a proposal for an article.  This is not a contest and there is no guarantee any ideas will be accepted.  Nor is here a limit on how many may be accepted.  Any topic relating to options meets the initial conditions for acceptance. More detials available.  Just ask.

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Follow up: Real Life Iron Condor Trade


Great post as always. I know this would be a bit labor intensive, but is there any way to show a cumulative P&L and risk vs. return for this group of trades?

Thank you Burt, but I have no way to collect the data.

Risk vs. return does not apply. There is no 'return' to measure.  The P/L for one day's closing prices bears no resemblance to prices you get when making real trades to exit.

Neither is there risk to measure. I assume it can be done, but I have no idea how to determine risk for holding a position for a few days or weeks.

For educational purposes this is probably one of the best posts I've read. It provides one with a lesson on how complicated from a risk perspective and number of trades to maintain a position one might want to get. It also makes me wonder whether the opportunity cost (not to mention the trading costs) associated with so many adjustments is worth it relative to a risk-adjusted return.

I don't understand what you mean by 'opportunity cost'.  When you make the original trade, you have no idea what lies ahead or how else the money might be put to use.  I see zero opportunity cost.

You have money to invest.  Then you must select your trade(s).  How else can you operate?  If you don't like the idea that managing iron condors involves serious work, then don't trade iron condors.

Even if you don't go through the P&L, what is your sense of the cumulative risk relative to the after tax and trading cost return?

After tax?  I don't see that either.  All earnings are taxable.  That is independent of the trade.  All I am saying is that I have no idea what you are asking about taxes. 

Burt, there is no way to know the return or the costs before the trade is over.  And the next trade will be different.  My sense is that if you are a good risk manager you will like the return to risk.  If you don't want to bother managing risk, you will fail.  That's my opinion.

Trading costs should never be a consideration when trading.  If they are, you have the wrong broker or are choosing the wrong strategy.  Managing risk is far more important. I cannot imagine failing to make a needed risk adjustment because the commissions would be too costly.  When this trade was opened, our trader had no idea that he would be making so many trades or using as many commission dollars as he did.  Thus, risk does not change.  The risk associated with opening the trade is what matters. Sure tack on some extra dollars to the maximum loss to allow for expenses, but you never know the future.  At any point that risk/reward is no longer satisfactory, that's the time to adjust or exit.

Of course, "complicated" is a relative term. As a former market maker, this "trade" may seem rather rudimentary to you. Would you be able to tease out how "advanced" this number of trades appear to you. What I mean is that a true option rookie would not be likely to handle all the various decisions required. But with experience might approach the amount of adjustments that occurred. Where along the line of rookie to experienced trader would you place this trade?

Burt, there is nothing really complicated about any of the individual trades, and that's how we trade: One step at a time.

Nonetheless, I don't consider this entire series of trades to be suitable for the rookie. That said, if that rookie plans to trade iron condors, then it's important to have some idea of how to make adjustments, when to make them, and some ideas for possible adjustment trades.  This post offers that to any trader.  One cannot just open an iron condor trade and allow it to run to expiration.  There is almost no chance of avoiding blowing up a trading account if a trader adopts that methodology.

For the rookie, this post offers an opportunity to see adjustments made by a real trader.  The rookie can try to discover the rationale behind each move and think about whether that seems logical or misguided.  If unable to make that judgment, then it's a perfect excuse to paper trade iron condors and practice that (or any other) adjustment type.  The rookie is not born as a trader.  there is no substitute for experience.

The whole point behind a post such as that is to enable new traders to understand why the trades were made, how they reduced risk, and whether that specific adjustment is one that suits the individual trader's way of trading. 

There is nothing gospel about the traders choices.  Some traders, not fearing the downside, would have sold more puts when exiting current puts.  Another trader would wait, and then pay less for the puts.  Someone else might buy different insurance  when the trade was initiated.  Following someone else's trade is just an opportunity to see some trades in action and think about them.

To get the most out of this post takes a certain level of understanding about risk management.  That takes experience.  But this is the key point:  Even if your risk management skills are not yet well-honed, even if the idea of managing risk has never previously occurred to you, the idea that it's important to take some action to reduce risk is the idea that must be transmitted.  The rookie trader may not yet make the most appropriate or efficient adjustment, but any adjustment is better than none.  If the rookie learns that doing nothing is unacceptable, that's lesson enough.

So Burt, some of this is for advanced traders, but the concepts can help the rookie trader get a foothold into the idea of risk management and how important it is to survival.

Thanks as always,


You ask about cumulative P/L.  To me it's immaterial.   When you have a position – you have two choices: hold it or don't hold it.

How can it possibly matter whether the position is profitable?  You want it in your portfolio (good risk/reward from right this minute into the future) or you don't.  If you don't want it, exit the trade.

If you keep a position in your portfolio just because you do  ot want to exit and record the loss, then you are going to have a portfolio of high risk trades.  Why would you do that?  When you do not like the trade for any reason (perhaps you have already earned 90% of the maximum profit and are happy with that), get out.  Eliminate the risk and find a better trade.

You can agree or not.  It is gospel in my book.


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Real Life Iron Condor Trade

A reader submitted an iron condor trade, along with each of his adjustments – seeking comments.  He gave me permission to anonymously discuss this trade and how he managed risk.  Overall I believe this represents a well-managed position, worthy of discussion.  The trade was still open when I received (Dec 2, 2010) the details.

This trade represents a real-time scenario in which you can evaluate each idea and think about whether you like what was done or would have considered an (unspecified) alternative.  Does the insurance purchase, or each of the adjustments go along with the way you trade?  If not, it's an opportunity to sit over a trader's shoulder and judge his activity.  I offer this as an opportunity to learn how another trader thinks.

Trade data can be seen in the table at the end of this post.


(1) Sep 16: Trade 20 RUT Dec 530/540;730/740 Iron Condor. Premium $2.815

(2) and (3) Same date, he bought a strangle for insurance:

a) Buy 1 RUT Dec 720 C @ $7.80
b) Buy 1 RUT Dec 560 P @ $4.00

The initial trade involves buying a December iron condor with the strike prices of the short options being 190 [corrected] points apart.  I know that feels as if it's a pretty safe trade with each option being quite far out of the money.  Cash collected: $5,630

Our trader, taking a conservative point of view (which I would never discourage) adds one December strangle to provide some protection against loss.  Cost: $1,180.  Remaining cash: $4,450

(4) BUY +20 CONDOR RUT 100 DEC 10 730/740;760/770 CALL @1.5075 (cost: $3,015)

Two weeks later, trader buys condor [not to be confused with an iron condor], thereby rolling the short call spread from 730/740 to 760/770.  This trade uses almost all of the original cash credit.  Remaining cash: $1,435.  Please note that I'm keeping a running total of the cash premium because I understand that the vast majority of traders want to see that number.  My perspective is that we should make necessary and desirable trades, ignoring the profitability of the original trade because it's necessary to manage the current position well – not the original – to make money.

(5) and (6) On same date, trader covers the short put spread and sells a new put spread – but he sells only half as many (10 vs. 20).  This time he sells the RUT Dec 590/600 put spread. Net cash in: $225.  Remaining cash: $1,660

This type of trade is worthy of special discussion. The put spread was moved for two reasons:  To collect additional cash and to move the position a bit closer to delta neutral.  For some traders, this is perfectly normal.  If you began with no preconceived notion of where the market was headed, it's likely you still feel that way, despite the big rally.  With that in mind, moving the put portion of the iron condor makes sense.  Other traders, fearing a retracement, may not be willing to move the puts. 

Of course, he sold only half as many puts, so did not collect much cash.  From my perspective, $225 is just not enough incentive to make the trade.  And don't forget, that small sum comes before commissions.

My objection is that he did not collect enough cash for this trade.  If this idea of rolling the puts has appeal, then I think another strike or two (i.e., moving the short put to the 610 or 620level, instead of 600) would have been a good idea.  And this is extra true when selling only half as many puts. If he had collected more cash, he could have moved his insurance put (Dec 560) to a higher strike price.  Nevertheless, this is a risk management decision and he did nothing wrong.

(7) Approximately one month later (Nov 3) the call spread is rolled higher once again.  This time the condor costs $0.96 and moves the strikes of the short call spread to 780/790.  Cost: $1,920.  Remaining cash: $260 in the hole.

(8) At the same time, the trader sells another 10 call Dec 780/790 call spreads, increasing the call position to a 30-lot.  This presents significant extra risk.  I like the fact that he resisted selling extra call spreads until now, but am concerned that risk may be moving beyond his comfort zone.

[I have no details regarding our trader's account size, or tolerance for risk, but he is an experienced trader.  What I don't know is how much experience he has with options]

Cash collected: $1,150.  Remaining cash: $890

(9) and (10)  He sells his extra long Dec 720 call (bought as insurance) and replaces it with one Dec 750 call and one Dec 760 call. Cash collected $440.  Remaining cash: $1,330.

I like this trade. This is a good risk management decision and makes me feel better about the fact that he sold those extra 10 call spreads.  Apparently the plan was to buy extra protection, and this does the trick. 

Those who look at this trade in isolation may feel that it's a bad trade because the trade has negative time decay (theta), and the whole purpose behind trading iron condors is to collect that time premium.  However,  this specific trade is not designed 'to make money' as a standalone trade  It is to own an improved insurance policy.  He now has two calls protecting 30-lots of calls instead of one call protecting 20-lots.  How to manage risk and how much insurance to own (if any) are personal decisions.  All we can do is examine his trades and offer comments.  And hopefully learn something.

(11) (12) (13) This series of trades can be broken into two parts.  First, he bought back his 590/600 put spread and once again moved to higher strikes, selling half as many.  Thus, he is now short only 5 put spreads. Cash collected $115.  He then sold 10 Dec 640/650 spreads, collecting $0.90 for each.  That's another $900 and the remaining cash is: $2,345.

(14) The next day he brought in some cash  by rolling his insurance option to a higher strike (750 to 770).  Cash collected: $665 for a 20-point spread.  I like the idea of taking cash out of insurance by rolling higher.  My experience says that the minimum sale price should be 50% of the maximum value of the spread, and I prefer to collect 60%.  However, the trader may have made this play as a way to get a bit bearish over the short term.  Cash remaining: $3,010

(15) One day later, he sold some of his long insurance and collected $265 for his Dec 770 call.  This is a trade I just don't like.  I understand that we all want to earn good money from our trades, and holding this option to expiration is likely going to cost some cash.  However, once again the cash collected is just too small to justify the risk. He is short a 30-lot call spread, which may be ITM in a day or two. That $265 is too small for the upside risk. Cash remaining: $3,275

To me, this trade is micro management – attempting to achieve the best possible result by taking extra risk. Not a good long-term strategy.

(16) Twelve days later, the market has rallied and the Dec 770 C was repurchased at a price of $730.  I'm pleased he was not stubborn, and did not refuse to bite this bullet.  Good discipline.  Please note that it cost $465 to cover this error in jusgment.  The risk/reward for making that call sale was way out of line.

This was not an expensive lesson, but one worth learning:  Cash remaining: $2,545.

(17) Covered the 5-lot short put spread at $0.25.  I agree with playing it safe for a few dollars. Cash remaining: $2,420.

(18) It's now Dec 1, and theta and gamma are increasing.  He bought a one-lot to reduce his short position.  Don't be afraid to trade a one-lot, if that seems appropriate at the time.   Cost $103. Cash remaining: $2,317

(19) Covered the last of the put spreads at $0.20.  Cost $200.  Cash remaining: $2,117

(20) Sold five dec 690/700 put spreads @ $0.80.  Cash +$400. Remaining cash: $2,517. 

This is the killer trade.  This is the play that can destroy your career.  First, it only adds $400 of profit potential.  Next, it sets up a potential dilemma for the trader.  If the market takes a quick tumble (good for the whole position), it's likely to be too soon (and too expensive) for him to be eager to cover the call spread.  But that little put spread, and the measly $400 it generated threatens to lose a few thousand dollars.  And if he does pay up to cover those puts, then the real dilemma appears: Can he afford to sit by and NOT cover the calls?

Sure, the most likely result is earning part (knowing he will cover prior to expiration) of that $400.  And he will remember how well this worked and may make a similar trade next time.  This is strictly a gambling move.  With so little time prior to expiration, and with a position that already has  negative gamma, it's tempting to collect more and more premium and to move nearer to delta neutral.  However the risk is just too large for the small reward. 

Important note:  He made this trade earlier – and more than once: Selling some OTM puts to collect cash.  The big difference is that this time we are approaching expiration and, as explained above, if this specific trade turns out to be a loser – that would be okay becasue the call portion of the portfolio would earn some decent cash.  But it's much more involved than that.  An increase in imped volatility (due to the market decline) would make it even more difficult for the trader to be willing tp pau u[p to get out of his call position.  And that's the risk.  Taking a loss on the puts and possible still gettting hurt on the calls – that's the worst case scenario.

This is one of those 'let's take the extra cash right now' trades that just feels right.  The market shows no immediate signs of crashing and the trader can make another $300 by covering in a few days – so why not?  Because there is ust too little to gain.  In my opinion, it's already time to exit the December position and making it bigger and more risky is not the long-term winning action.

It's okay to continue to trade December options, but the point is that is too late to increase size and/or risk.

The true risk is not making this specific trade.  Instead it's the fact that winning this bet this time only encourages making a similar, but larger bet next time.  And the next time.  This is one trade that is guaranteed to blow up.  The obvious problem of a potental loss in the trade is not THE problem.  It's the overconfidence that gets a trader to the point where selling extra premium become the #1 choice for adjusting positions.  Although that is an acceptable method when the trader can afford to take more risk, the play is not to be made for insignificant sums – especially when time is short.  If the reward is too small, it's just not worth any risk (in my opinion).

He has been very conservative with the put selling.  Covering early, reducing size, covering again.  But this small trade is just to CTM (close to the money) for comfort.   Obviously it's our trader's comfort zone that matters here, however, some trades have a bad risk/reward ratio – and this is one of them.

If I get a further update, I'll let you know.  This is where the position stands as of December 2


1 9/16/2010 SELL -20 IRON CONDOR RUT 100 DEC 10 730/740/540/530 CALL/PUT @2.815 LMT
2 9/16/2010 BUY +1 RUT 100 DEC 10 720 CALL @7.80 LMT
3 9/16/2010 BUY +1 RUT 100 DEC 10 460 PUT @4.00 LMT
4 9/30/2010 BUY +20 CONDOR RUT 100 DEC 10 730/740/760/770 CALL @1.5075 LMT
5 9/30/2010 BUY +20 VERTICAL RUT 100 DEC 10 540/530 PUT @.45 LMT
6 9/30/2010 SELL -10 VERTICAL RUT 100 DEC 10 600/590 PUT @1.125 LMT
7 11/3/2010 BUY +20 CONDOR RUT 100 DEC 10 760/770/780/790 CALL @.96 LMT
8 11/3/2010 SELL -10 VERTICAL RUT 100 DEC 10 780/790 CALL @1.15 LMT
9 11/3/2010 SELL -1 VERTICAL RUT 100 DEC 10 720/750 CALL @12.00 LMT
10 11/3/2010 BUY +1 RUT 100 DEC 10 760 CALL @7.60 LMT
11 11/3/2010 SELL -5 VERTICAL RUT 100 DEC 10 620/610 PUT @.89 LMT
12 11/3/2010 BUY +10 VERTICAL RUT 100 DEC 10 600/590 PUT @.33 LMT
13 11/3/2010 SELL -10 VERTICAL RUT 100 DEC 10 650/640 PUT @.90 LMT
14 11/3/2010 SELL -1 VERTICAL RUT 100 DEC 10 750/770 CALL @6.65 LMT
15 11/4/2010 SELL -1 RUT 100 DEC 10 770 CALL @2.65 LMT
16 11/16/2010 BUY +1 RUT 100 DEC 10 770 CALL @7.30 LMT
17 11/22/2010 BUY +5 VERTICAL RUT 100 DEC 10 620/610 PUT @.25 LMT
18 12/1/2010 BUY +1 VERTICAL RUT 100 DEC 10 780/790 CALL @1.03 LMT
19 12/2/2010 BUY +10 VERTICAL RUT 100 DEC 10 650/640 PUT @.20 LMT
20 12/2/2010 SELL -5 VERTICAL RUT 100 DEC 10 700/690 PUT @.80 LM

 Table. List of trades


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Adjusting an adjustment

September and October are behind us.  There was no market collapse and those who paid high prices for VIX futures contracts (or options) lost money on their expectation of a substantial increase in market volatility.

The holiday season lies ahead, and that is often a period of reduced market action and volatility.  Has complacency arrived?  Is now the time for unexpected market moves?  Who knows?  What I do know is that paying careful attention to position risk continues to be the name of the game.  Keep alert. Avoid the large losses and survive.  That's goal #1.  Find appropriate strategies and prosper – that's goal #2.


Adjusting an adjustment

Let’s say you sold some call credit spreads (either as a standalone trade or as half of an iron condor) before a market rally and that your position became delta short as the market moved higher.  Let’s also assume that you bought 5 Nov 350/360 INDX (a fictional broad-based index with Europeans style options) call spreads to offset a portion of your upside liability.  The original position is probably 25 to 50-lots if this 5-lot is to be consiered as an early (Stage I) adjustment.

Unfortunately (for you), the market continued to rally and you make another adjustment (or two).  The position is still viable, but if INDX moves another 3% higher, your plan is to exit the trade and re-invest your money in a better position.

However, right now that 350/360 spread you bought has done well, and can be sold @ $8. It seems obvious to adopt this thought process: My complete position has upside risk and I need all the protection I can get.

To a point that's true.  However, the cost of that protection must be considered.  From my perspective, paying $8 for a spread that may, if the market doesn't tumble, be worth $10 when expiration arrives is a poor choice for gaining some upside protection.  You, the trader, want to own protection that can earn more than 25% of its cost and which has some positive gamma.  There is nothing to be gained by buying more of these $8 spreads.

However, my suggestion is consider selling this call spread.  First, it affords little protection.  Second, if you sell that 5-lot and collect $4,000, you can accomplish two good things for your portfolio:

  • Take out some cash
  • Reinvest a portion of the proceeds from the sale and buy different protection


The idea of selling a call spread when you are already short delta seems to be a big gamble.  However, I encourage you to look at it this way:  These five call spreads offer a maximum gain of $1,000 and that's not nearly enough to make much difference in the future value of your portfolio.

Note:  If your original trade is 25 to 50-lots, as suggested above, then you can afford to forgo that last $1,000 from the adjustment.  But more than that, you may be able to get better protection.


Original trade: Sell 40 INDX Dec 380/390 spreads when INDX was 320.

Adjustment One: Buy 5 INDX Dec 350/360 spreads when INDX was 340

Adjustment Two: You bought 5 Dec 370/380 spreads when INDX was  360

At this point, the 350/360 spread serves little purpose.  Think about 'adjusting the adjustment' by exiting the 350/360 spread, collecting between $8 and $8.50 per spread.  Make another adjustment to the main position – if you find something suitable to do.  If you find nothing attractive, hold and decide when to exit.  This position can become very costly if you don't exit in time.  However,  the original 5-lot adjustment no longer affords any reasonable upside protection, making it a good idea to sell and look for something better.


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Options Education: Course for Rookies

Options education is a topic that is near and dear to me.  I spend much time and effort helping readers understand how options work, rather than merely presenting a "do it this way" instruction manual.

The better that a trader understands the principles behind making intelligent trades and trade decisions, the better prepared that trader is to continue making good decisions on his/her own.

Options education is offered in several formats.  There are books, webinars, expensive weekend courses, individual (or group) mentoring, to name the most popular. 

Some people avoid the education process and prefer to pay others to suggest specific trades.  This is a non-starter for me.  I believe the trader must understand the trades being made and the rationale behind the trade.  Consider this:  How can someone pick trades for you and each of his/her other customers when that person has no idea of your investment goals, your risk tolerance, your investment time horizon etc?  It cannot be done.  Trusting your hard-earned cash to such 'trade pickers' is foolish at best.  It's okay to get suggestions, and then make the final decision on your own, but a basic understanding of options is required to make that judgment.

Blogs are a good source of information, with some, such as Options for Rookies, having education as the primary goal,  and others offering intelligent (or otherwise) commentary on a myriad of options-related topics.

Some information is free.  For example, most brokers provide education, usually in the form of written lessons or webinars.  The options exchanges also provide information as does the Options Industry Council (OIC).  Most blogs offer free content.

Other education requires payment of a fee.  Some courses are very expensive.  Some  are available at a more moderate cost.  The quality of the teachers, courses and the material taught runs the gamut from high to low quality and it's difficult to know what you are paying for, in advance.

I am preparing to enter this arena in a more formal manner.  My primary purpose is to fill what I see as a void. Potential option users ought to be able to

  • Get a good feel for options and how to use them
  • Decide if options trading fits into their investing style
  • Decide whether the investor can use options to hedge current and future investments
  • Understand risk and reward potential when using options
  • Learn all of the above at a very reasonable cost

We all acknowledge that options trading is not for everyone, but it should not cost an arm and a leg to discover whether options are a suitable investment tool.

And once the newcomer decides that options offer attractive opportunities, he/she should have an opportunity to get a sound, practical education at a reasonable cost.  The problem is that this newcomer does not know where to turn for help and is easily captured by television infomercials, full-page newspaper advertisements, or other hype on the Internet.  Impossible promises of success are touted, and the beginner has no idea that such promises are not going to be kept.  One such example is the 'promised' return of at least 10% every month.  As a result, many people who want to learn to use options pay large fees and are lucky if they find reputable teachers.

There's not much I can do to overcome the hype, but for people who make an effort to research education opportunities, I want to offer a basic course (plus other courses) that gives the new trader a better than average chance to succeed.  We've all heard the stories:  most beginning traders fail to make the grade.  I'd like to help increase the rookie's odds of becoming a winning trader, and to that end am developing a basic course for those option rookies.

If you are a regular follower of this blog, or if you have read The Rookie's Guide to Options, then you are aware of my teaching style, which includes the following:

  • Details
  • Explanations that make it easier to understand the basic concepts of options
  • Emphasis on risk management
  • Using examples
  • Repetition when necessary for emphasis
  • Replying to all questions

My plan is to construct a course that continues to do all those things.  Plus voluntary homework and optional tests.

I'm using today's post to request input from anyone willing to contribute. Suggestions, comments, questions are all welcome.  Please use the comment link below (all suggestions will be considered).


The beginner courses

I will begin by designing one (or more) course for rookies.  What should this course look like?  Here are some thoughts:

I. A multi-week, comprehensive course that provides a thorough introduction to options, including enough information for students to begin trading with confidence.  It would include all the material below, plus more.

  • Written lessons that look like lengthy blog posts or short book chapters.  Each focusing on a specific topic.
  • Video webinars that similarly cover one specific topic
  • Occasional live Question and Answer sessions.  The difficulty with 'live' sessions is that it's impossible to find a time that is suitable for everyone. A recorded session will allow those who cannot attend to view the content.
  • A special page (for course takers only) where questions, based on the course, can be posted.   'Regular' questions can still be asked through the Options for Rookies blog

Should the course include time for individual mentoring?  The feasibility of this idea would be based on the number of students in the class.

How long should this course run?  How many lessons? Currently, the plan is 13-weeks with four or five lessons per week.  Comments?

These last two items affect the cost.


II. Shorter courses, each dedicated to teaching one specific aspect of option trading

  • A thorough discussion of one specific strategy, soup to nuts. Inlcuding what to look for when initiating the trade, risk management suggestions and making plans to exit the trade.  One obvious course is: iron condors.
  • A general introduction to several strategies.  Enough to get you started using these methods (preferably in a paper-trading account), but  much less in depth treatment that the iron condor example mentioned above.  The benefit of this course is to give a rookie options trader a 'taste' of what can be done when trading options.  This course is truly not designed to be used as the gateway to trading.  It's designed to provide a better idea of where the student's interest lies.  Risk management would be discussed only briefly. 
  • How to design, write and maintain effective trading plans
  • Risk Management for option traders.  An introduction
  • Synthetic equivalents and how to use them
  • My philosophy of trading, as developed over the past 34 years

Intermediate Courses

III. What would an intermediate level course contain?

to be continued…


New issue of Expiring Monthly is available today.  Subscribers can download the October 2010 issue.

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