Tag Archives | iron condors

When is an Iron Condor Trade too Aggressive (Risky)?

A question from a loyal reader brings up a very important topic that I have not addressed.  I've mentioned that my personal choice is to collect ~$300 for a 13-week, 10-point RUT iron condor.  Stating that it's a comfort zone decision, I did not go into much additional detail.  Then comes this question, which is far more important that it may appear:

Hi Mark,

Wondering about $3 out of 10-point spread.  Please correct me: do you mean something like: puts you collect about $150 and calls collect the same $150, total $300/$1000 margin?

To me that is very aggressive, 30% premium collected out of $1,000 margin. Thank you for sharing.



Hello Dauddy,

Yes, I collect ~$300 for a 10 point spread.  Margin requirement is $1,000 (but many firms allow you to use cash collected, reducing margin to only $700).

In my opinion, aggressive is not the appropriate term.  However, I understand that you are stating the obvious: Anyone who attempts to earn so much money from iron condor trades is taking too much risk.

'Risk" is a matter of perspective.



At one extreme, consider the trader who sells very far OTM call and put spreads and collects a premium of $20 (after paying commissions) for a one-month, 10-point, iron condor.  The margin requirment is $980 and the trader's potential return on investment is 2%. 

Or, to translate this into a 13-week trade similar to mine, let's say he/she collects $60 (after commissions) for the same anticipated 2% per month return.

How would you define these trades?  Surely you would not consider them to be aggressive.  In fact, some traders consider this to be a very safe methodology and claim to use it to earn steady income.

We know that traders all over the world would love to have a fairly safe method for collecting 2% per month on a very consistent basis. It may take all the fun out of trading, but it would allow for very early retirement for anyone who has a reasonable sum to invest.  At this rate of return, account value doubles every three years.

So I ask – why is this not the investment method for a huge percentage of the trading population? 

You know the answer.  Because it doesn't work.  There are enough big market moves that the trader has two uncomfortable choices: 

  • Cover a dangerous position, paying $300 – $500 (depending on  the trader's exit plan), thereby losing between five and eight months of earnings
  • Hold and hope that the loss disappears and does not turn into a maximum loss of $940

Neither of these choices is fun to make.  My point is that this is an aggressive way to trade.  This is tilting at windmills and hoping that nothing terrible happens.  But, it's a continuous strategy and we know that something unwanted will happen.  And too often for this method to work over the long term.

Which is more aggressive, trading 13-week iron condors and collecting $60 or $300?

With my strategy/plan, I will lose $300 on an iron condor far more often than the FOTM trader.  Far more often.  However, I'll have some good (lucky) results and earn $250.  Not only that, but my maximum loss is $700, not $980. One more point:  I'll trade fewer contracts that the other guy.  If that FOTM trader wants to make any money, he/she must trade a bunch of contracts.  And that's where real risk enters into the discussion.


Larger Premium

There are professional traders who believe that collecting an even higher premium is the best and safest method for trading iron condors. The rationale is that the trader has smaller positions and any bad result is not going to wipe out the trader's account.  And yes, the number of wins is reduced, but consider this:  If you take in $500 to $600 as the initial credit, there's no urgency to make adjustments. I have  no experience managing these, but if time passes and the market is ever near the original starting price, I'd guess that the trade can be closed for a good profit.  Years ago there was a discussion of this topic on the Elite Trader forums (but I canot find it)

To make any decent money, the $60 premium trader must continue to build size in an attempt to grow the account.  A single disaster can easily destroy an entire trading career.

Risk can be defined as the most money that can be lost for a given trade.  It can also be looked at as the probability of losing any money on a given trade.  Or some combination.

I feel my risk is right where I want it to be.  My worst loss should be in the $300 range and my best gain is about $250.  Obviously the vast majority of my results fall between those ends.  I don't have any records of my trades because I own multiple iron condors at any one time and manage the account risk as well as the risk for an individual call or put spread.

This is not aggressive in my opinion.  However, if you would feel better trading iron condors with a $200 or even $150 premium, then that's what you must do.  There must be a premium level that provides the chance to earn enough – but with an accceptable level of risk.  However – opening the trade is just the first step.  Risk management is the factor that will determine how well you do over the longer term


December 2010 issue will be published next Monday.

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Iron Condor Trading: 3 Ways to Define Neutral

Hi Mark,

I know you're sometimes hesitant to provide too much specific info about how you choose positions, but this type of post is very helpful to certain people. I'll admit that when I started learning about Iron Condors and trying to determine my own comfort zone I did copy your method of taking $3 premium on a 10 point spread (or the equivalent for other spread widths). That allowed me to see how those positions played out and see if my risk appetite matched yours…if not, why not, etc. [MDW: That's exactly how I hoped readers would treat such examples: As examples worth considering]


By consistently taking the same premium on ICs, isn't the trader indirectly following the standard deviation method for choosing strikes (assuming inner strikes are equi-distant from the current underlying price)? When IV is high, taking $3 premium will result in a "wider-bodied" condor than taking the same $3 when IV is low. Maybe you have a clearer wording?

However, following along this thought process, if the IC trader wanted to be truly market neutral shouldn't he position his short put slightly farther OTM and position the short call slightly less OTM? When the underlying price drops, IV will almost always go up (bad for a long IC) so the trader would need a bit more "wiggle room" from his puts to compensate. OTOH, when the underlying price rises and IV falls, the trader does not need quite as much "wiggle room" from his calls. So the trader collects a bit more premium on the call side and a bit less on the put side when compared to the equi-distant IC. The risk graph would look like the trader has a directional bias, but after IV is factored in he does not.



This is an important detail and I thank you for introducing it.  I've written about neutrality before, but it's a topic worthy of clarification. I'll get to it below, but I think there are at least three viable methods for defining a market neutral spread.

1) Because both standard deviation (SD) and option premium depend on implied volatility (IV) – then yes – basing strike selection on premium cannot is similar to choosing strikes based on standard deviations OTM.

I find it to be a simpler process to pick the premium than to think of it in terms of SD.

2) 'Market-neutral' is traditionally considered to be delta neutral.  And using that method, yes, the puts would have to be farther OTM because puts have a higher delta than calls – when the options are equally far OTM.

Volatility skew.  For readers who are not aware why this is true, it's based on volatility skew. To state it simply, the implied volatility of all options on the same underlying, with the same expiration date, do not have the same implied volatility.  In fact, the IV can be very different for various options.  The lower the strike price of an option, the higher is its observed IV.   When observing the IV of a string of options, you can see a steady – but not linear – increase in IV as you move from OTM calls to ATM to OTM puts.

OTM puts almost always have higher IV than OTM calls.  This occurs for one primary reason.  Traders have discovered that OTM puts are truly worth more than predicted by traditional option pricing models (Black Scholes).  Because they are worth a higher price, these OTM put options are bid higher .  Long-time option traders (me) who grew up in the era when skew was not part of the options game, have learned to recognize the importance of volatility skew, or else have long ago been blown out of the game (by selling too many puts).  In the 1970s, after puts were listed for trading) it was typical to value OTM calls as worth more than OTM puts.  The rationale was that markets tend to rise over time.  We now understand that even though that may be true, markets fall much more quickly than they rise, and those little puts can become very valuable in a heartbeat.

Bottom line:  Higher IV translates into a higher probability of moving ITM, and thus, delta is higher.  To trade delta neutral, the trader would have to sell fewer put spreads, or move the put spreads farther OTM.

Delta neutral.  Marty – you can trade delta neutral.  If you do, then – voltility skew forces you to do as you suggest – and that is move the puts farther OTM (or sell calls that are closer to the money).  As stated, most people accept volatility skew as rational and when trading delta neutral they own positions which reflect deltas based on real world implied volatility.

However, if you prefer to trade distance neutral, how can anyone argue with that?  It's a trading bias as any other.  The market has been on the rise for the past year and one half, so if trading distance neutral you fared better than if you were trading delta neutral – at least over that time span.  Obviously, you would have done worse over the prior period in which we had very volatile and declining markets.

It's also reasonable to trade dollar neutral.  That simply means that you collect equal premium for the call and put portions of the iron condor.  For my style (13-week options), that would mean collecting something near $1.50 for each side of the iron condor.

This is not an easy decision to make.  The truth is that I don't have any suggestions as to which is the best method.  I suspect that data is available to back test these various methods, but one would have to go back many years. It's probably a worthwhile experiment, but not for me.  I don't have the time.

I believe this is a comfort zone decision.  I know that right now, some traders with a bullish bias love selling puts because they are comfortably positioned for the steadily rising market.  Trading distance neutral works for them.  On the other hand, the bears may be afraid to sell puts that are too CTM, and prefer to be delta neutral because the puts are father OTM. 

One method for claiming to be market neutral may indeed be better than the others, but I lack the proof.  As much as I hated the idea in my early years, I've come to accept that current IV (barring special situations, such as earning news pending) provides as good of an estimate for future volatility as I can get.  Thus, I base my greeks on current IV, and that means taking the volatility skew into consideration.  I can find no argument against those who prefer to open delta-neutral positions. 

My compromise is to choose a position that its between distance neutral and delta neutral, but I do not dwell on this.  Whichever way you choose to initiate the trade, it should not be too far from 'neutral.'  I admit to fearing the puts and trade with the puts a bit farther OTM than the calls.  But this is truly a 'roll your own' decision.

This is a flexible situation.  I recognize that those who want to milk every last advantage out of options trading may want to keep careful records about neutrality and try to benefit from the data.  If you have the time and patience, it's a good idea.  If you have access to data and believe you can objectively select iron condors to trade – when you know the future, that's the best method for resolving this dilemma: How to be neutral.


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Limited Portfolio Protection; an Introduction

When discussing methods for protecting a portfolio from large losses, I've mentioned that I prefer a trade that allows me to own extra options – with the condition that those extra options are NOT father out of the money than my 'at risk' options.  Those extra options offer the possibility of earning a good-sized profit if and when a truly unexpected major market move occurs.

The problem with buying extras is that the cost is high.  When buying insurance, or adjusting a portfolio, one of the most difficult decisions is: How much should I pay? It's not the same situation as insuring a house against a destructive fire.  If you cannot afford to replace that house from petty cash (as most people cannot), then insurance is needed, and the cost is not the primary concern. [We all know that we pay too much for insurance, or else the insurance companies would not be profitable]

When we trade with negative gamma (credit spreads, covered calls, iron condors, etc), at some point we may be called upon to make a risk management decision, and that decision will often cost cash.  [Yes, we can always find a way to shift or roll a position for zero out of pocket cost, but that often increases risk, is not a good strategy for general use and is outside the scope of today's post].  There must be a spending limit when making a position safer to own.  At some point, the investment becomes too large, profit potential too small, and it's best to exit the trade – accepting the loss.

Spending less

Instead of buying extra options, an alternative is to buy spreads.  These are far less costly than individual options, and they offer limited protection.  I find that this is a winning trade-off under many market scenarios.  Consider this method and decide whether it has merit for your trading. 

When you buy a 10-point spread and pay $2, there is $8 worth of upside potential – if the market continues to move against your original position. That's a substantial amount of insurance at a very reasonable cost.

The problem is that these spreads are not available for $2.  By the time the market has moved far enough to convince you that risk must be reduced, these spreads may cost $5 or more.  In my opinion, paying half the maximum value of the spread is just too much to pay.

Here's an example:

You sold some call credit spreads: INDX Jan 920/930 when INDX was 840. 

figure 1

Now that INDX has moved to 890, the position is uncomfortable to hold (if it's not uncomfortable for you, at least assume it is for the basis of this discussion) and the experienced trader wants protection.

When buying debit spreads, the objective is to own spreads that are less far OTM than your current shorts because you must earn some good money from that 'protection' to partially offset the original position, which continues to lose money.  I don't know how long you would hold out before buying protection, but let's assume that no one would want to stay in this trade when the short strike (920) is breached.

Figure 2, shows an adjustment: we bought 2 INDX Jan 900/910 call spreads @ $4 each.


figure 2

The $800 paid for the trade comes right off the bottom line, if the market reverses direction. [Of course the trader always has the choice of selling out that protection when he/she feels it is no longer needed]

The $400 debit allows a gain of $600 for each spread, so the upside disaster is reduced by $1,200.

The good and bad news about buying call debit spreads for upside protection is that the expiration profit zone is much improved (red line vs blue line).  It's good news because there is a nice area of significant profits.  The bad news is that the trader may elect to hold this trade into settlement (Market opening for each stock in the index, on the 3rd Friday of the month), and that's a very risky situation.  With the market in the best possible spot (between 910 and 920) at the close of business on Thursday, the trader is set up to take a big hit if the market opens somewhat higher on settlement Friday.  A 10-point move is not that big for an index priced above 900 (it's a 1% move).

The protection looks good, but holding to expiration provides the same high theta (good) and large negative gamma (bad) threat – as always.



It's less expensive to buy the call spread with the highest strikes that are not already in your position (900/910 in this example).  The advantage to that play is that you can buy more spreads for the same money as buying fewer, more costly spreads.  I vote for the 900/910. 

One variation is to buy more (or fewer) such spreads.

However, it's reasonable to buy an 890/900 or an 890/910 call spread instead. 

Another choice is to pay even less and buy the 910/920 spread.  In genral, traders shy away from this trade because it involves selling more of the option they are already short. There is no reason not to make this trade, unless it's difficult for you to examine your position and figure out exactly what you own.  I recognize that this trade adds complexity to the position for less experienced traders.  Note:  I have no objection to this adjustment, but if you find it too strange to manage, then stay away.  You can decide whether this specific adjustment type appeals to you once you gain more experience.

The last variation to consider is buying the 920/930 spread.  Because that's the position sold earlier, this 'adjustment' is merely reducing position size.  This truly is an overlooked trade.  Those who refuse to take a loss, and feel they must adjust to allow an opportunity to escape a risky trade with a profit would never consider this trade.  In my opinion, a trader should buy the call spread that seems to best serve his/her purposes.  If that happens to be the trade sold earlier, then so be it.  Don't let that stand in your way.



The idea of picking up some positve delta (or negative delta, when trading puts) in the form of debit spreads works as a good compromise when making adjustments for negative gamma positions.  My philosophy remains the same on one important issue:  Do not buy farther OTM options.  When short the 920 call, as in our example, the adjustment (single option or spread) should involve purchasing a call with a strike of 920 or lower.

NOTE:  A trader may choose to buy some very far OTM extras as ultimate protection.  These are NOT satisfactory to protect a position such as a troubled iron condor, credit spread, or covered call.  Recognize that this is a waste of money most of the time.  But when the payoff comes, it's a dandy.  Owning these options is not for everyone, but Nassim Taleb claims that it worked wonders for him.



Ideal Christmas gift for your friend who wants to learn about options

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How I Choose my Trades


First and foremost I want to wish you a very Merry Christmas. I also wish to thank you for your gift to us of the Options for Rookies website. It's helped me learn a lot, along with your O.F.R book. Especially the "lose the pride, take the loss early" lessons.

I would like to ask you to consider a segment that would talk about your thought process in choosing your trades. If possible, I'm curious how you choose your spread widths, lot size, and strikes and what products you trade in overall.

I've noticed before your protocol of striving for a $3.00 premium for IC's. Is that a one-lot price or the total value for numerous contracts? I currently do only paper trading in Paper Money on Think or Swim (6 months now in verticals and IC's)and I see a lot of loss-risk vs. reward on the p/l graph when I try to reach those levels.

I thank you for any help in this area and again wish you and yours the best.



Thanks or the good wishes. I'm having a very happy Chanukkah right now, and hope to enjoy Christmas as well.  Your request is a good one, but my technique is pretty simple and thus, don't on't know how useful it will be to others.

The $3.00 is a one-lot price. I find it much easier to follow discussions when trades are broken down into the lowest common denominator, and so that's the way I write.


Market Bias

When making trades, the first thing to consider is whether you want to take a neutral, bullish or bearish bias.  This part is simple for me.  I never know what to expect, so I always choose a market neutral stance. 



There are always several strategies that suit a trader's market expectations and it's a good idea to experiment with several and maintain anything that works for you as part of your trading arsenal.  I've come to favor iron condors, and use them most of the time.  This is something for each trader to decide for himself – especially when in the paper trading stage.

I'll shift to double diagonals if and when I expect market volatility to be higher over the shorter-term, or when I believe IV is 'low enough' that I do not want to trade short vega positions.  It's important to have a suitable strategy when seeking profits from an option position.  You cannot just go out and'do something' and hope it works.


If you have some market expectations – regardless of direction – it's important to choose an underlying that you believe will participate in that directional move.  Other considerations are ease of entering trades, width of bid/ask spreads, satisfaction with fills, ability to adjust when necessary.  Once again, lacking predictive powers, I use a broad-based index, and always trade Russell 2000 options (RUT).  That may not be a good idea for you, but it's how I do it.


Specific Iron Condors

I know this is the heart of your question

1) Spread width.  I hope that you understand that this is far less of a big deal than it appears to be.  I choose 10-point iron condors because I find them comfortable to trade.  It's as simple as that.

If you want to trade 20-point spreads, there is one thing that must be understood.  A 2o-point spread is exactly the same as trading two consecutive 10-point spreads.  Here is what I mean:

Selling the 480/500 call spread is exactly the same as selling:

The 480/490 call spread and then selling the 490/500 call spread.  There is nothing 'special' about the 20-point spread.  I consider it to be a compromise and would choose that any time I was not sure which position I preferred to have in my portfolio: The 480/490 or the 490/500.  By choosing the 480/500, I get to sell an equal quantity of each spread.

One major point is obvious, but must be made:  NEVER sell the 480/490 and then immediately sell the 490/500.  That foolishly spends twice as much in commissions and increases slippage (the cash lost when trading due to the fact that we must deal with bid/ask spreads).  Just open the 480/500 spread in a single trade.

However, if you have a position in the 480/490 call spread, there is no reason why you cannot trade the 490/500 call spread at a later time.  Perhaps it would be adding a new trade to your portfolio. Or it may be part of an adjustment.

2) Lot size

If I am ready to be fully invested right now, then I decide how much margin money to have tied up in this trade, and enter an order for the maximum size.

When doing that, I always reserve some margin room for future adjustments, if needed.  If you never use anywhere near your maximum available margin, this is not a consideration.

At other times, I'll enter a portion of my preferred trade size, to get started, and then try to do more an a better price.  So, for example, if I decide to allocate $20,000 of margin to a new February RUT iron condor, I would enter an order to trade 20-lots of my preferred iron condor.  I'd keep the cash generated (let's call it roughly $6,000) available for future adjustments.

Alternatively, I would enter an order to trade two different iron condors, 10-lots each.

Most of the time, I enter an order to trade 4-lots.  Then trying to get $0.05 more for a 6-lot.  Then I try to add the final 10-lot for yet another 5 cents better.  If I cannot get my better prices, I have two choices.  I can go back to my original trade price, find another iron condor, or just play smaller size that month.

I do not take too long to get as invested as I want to be.  Perhaps Monday thru Wednesday after expiration (I'll open March RUT positions once the December option cycle is over)


3) Premium (price) and strikes

Each trader has a primary method.  Either the strikes are more important or the premium is moe important.  For me it's the premium.

One good way to choose strikes is by standard deviations.  The trader sells spreads in which the short option is 1.0, 1.5, or any other number of standard deviations out of the money.  This does not work for me, but it truly is a viable method for selecting strike prices.  It has the advantage of keeping the probability of seeing the options expire worthless at the same level (at least on the day the trade is made) each time you open new positions.

I prefer to take in a certain cash premium for my 10-point, 13-week iron condors.  Note:  I am not insistent.  If I find that the strikes chosen don't feel right – because of a market bias (I may not want to be bullish or bearish, but that does not mean I must ignore those thoughts.  If I feel my chosen strikes are just not far enough out of the money, then I'll take less premium and move out one additional strike price).

My preferred price is $3.00.  I always seek higher prices when implied volatility is high and the price of credit spreads is higher.  I could move further OTM, but prefer to collect $3.30/$3.40.  This is fairly flexible.  When concerned with risk, I'll go farther OTM and collect nly $3.00.  My point in offering this much detail is to explain that this is very flexible for me.

When IV is low, and it is lower than it has been in a long time right now, I'll just take $2.60 or $2.70. I'd rather feel safer going into the trade.

I don't always open three-month iron condors.  If I believe IV is just too low to sell extra vega (3-months options have more vega than 2-month optioons), I'll sell those 8- or 9-week options instead.  I prefer to collect just over $2.20 for these trades.  Hwever, as you may anticipate, it's a flexible number.

If you trade a different underlying, they these prices would be meaningless to you because the implied volatility of the options would be very different.

4)  Products.  i do believe diversification is important when selling premium.  Thus, if trading individual stocks, I'd want to have about five positions open simultaneously.  Trading indexes, I feel that supplies sufficient diversification and there is no advantage (for me) in trading more than one product.  This is the main reason:  If trouble looms, if the markets get violent, I want to have the fewest possible posiitions to adjust.  One product ismuch easier to handle than two.  I may lose a bit to diversification safety, but I make up for than in having half as many troubled positions to handle when important decisions must be made.  True my trade plan helps with those decisions, but I prefer to depend on being able to 'see' what's available at the time when others may be in a panic.

5) Expiration months

I'm happiest with 13week iron condors.  But when IV is especially low, or I don't like the premium available from 3-month trades, I'dd choose 2-month positions instead.

I do not trade front-month options,except to exit any front-month positions that I still own.  I do this to avoid positions with so much negative gamma.  yes, I give up the rapid time decay, ut it's safer and I'm happier with less overall risk.  You may feel differently.  that's ok.  Most traders prefer to trade front-month options and love trading the Weeklys. (RUT has no Weeklys as of this writing).

Bob, I hope that gives you enough insight to allow you to find methods that are suitable for you.





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Front Month Iron Condors: Challenging to Trade?

Interesting trading points raised by Brian:


I have been trading front month ICs (opening 4-6 weeks out), but at times am finding it too challenging to manage. So in Sept I experimented by opening a Dec position (3 months out). One thing I noticed is that the theta decay was almost non-existent the first 30 or so days. I could have opened the position 30 days later for almost the same credit. Not sure if this is a usual occurrence or not.

Also am curious as to why you say that SPX is difficult to trade. I would think that RUT would be more volatile and hence more difficult. (it seems to rise & fall more, %-wise, than SPX)



Hello Brian,

1) 3-month options have time decay.  And I know that you know that to be true.  It is not anywhere near zero, nor should it appear to be near zero.

Here's one way to see that for yourself. When you look at a 3-month trade (even if it is not a trade you make in real life), also look at the 2-month trade with the same strikes. Then you can compare just how much more time premium is built into options with a 4- or 5-week longer lifetime. That should provide a reasonable estimate for how much time decay to anticipate over the next month or so.

Be careful to keep an eye on the implied volatility (IV) for the underlying: VIX (for SPX options) or RVX (for RUT options). Longer-term options are more vega dependent, and if IV rises, you may see what appears to be zero time decay. It's not. It's just what can happen when vega affects the option price by more than theta.

IV (hearts)  trumps theta (spades)

We have all seen examples in =  which a sudden market decline, accompanied by a surge in IV .  The result is a huge increase in the value of put options and even an increase in the price of call options as the market falls.  That's vega trumping theta, delta, and gamma simultaneously.

2) It's the negative gamma that makes spreads challenging to manage efficiently. Longer-term options have less gamma.  This may seem simplistic, but the truth is that when trading those 3-month options, you earn your profits more slowly (less theta).  In return, larger market moves result in less change in the price of individual options and option spreads – and less money is lost. 

If you want maximum risk and maximum reward, then you found it with front-month options.  If you prefer less risk and less reward, you can move out in time and initiate trades using 3-month options.  Then if you also plan to exit early – two to four weeks before the options expire – you avoid the period of maximum time decay and maximum effect of negative gamma. 

I know it's difficult to leave money on the table, but you are not really doing that.  From my perspective, early exit means taking a decent profit  – or perhaps a loss if you made an unfortunate adjustment or two earlier) – but the main benefit is eliminating all risk and being able to sell new, longer-term options with less risk. 

This philosophy is not for everyone, as short-term options constantly get the most play. If not convinced that this is true, the high volume of Weeklys ought to make it obvious that short-term options (when do the Dailys start trading?) are the favorite tools of most traders (and all gamblers).

3) I used 'difficult' to trade SPX in the context that it is more difficult to buy/sell the options at favorable prices.  The markets are wider, there are no exchanges making competitive quotes, and the last time I tried to trade these (a few years ago), they did not even have electronic trading.

I was not referring to managing the position. Yes, RUT is a more volatile index, presenting more management challenges.  However, option premium is higher, and that means the trader is compensated for taking additional risk.


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A reader’s concern: Did I manage this iron condor well?



May I ask you to have a look at this "real" life (paper trading portfolio) situation?

In late September (SPY @ 114) I bought the following IC (40 lots): Dec SPY 124/126 C, Dec SPY 101/99 P @0.51 (no commissions included).

In early November (SPY @119), not feeling very comfortable with the rapid rise in SPY, I decided to roll  124/126 to 127/129 at a cost of 0.24. By doing so, my original premium of $2040 was reduced to $1080 (OK it is not important, I just want to mention it.)

Yesterday, I closed the puts 101/99 at a cost of 0.04.

So, I am left with #40 127/129 C. (max possible gain is now $920). Today (SPY @ 119.8), the greeks for my position are: Delta= -133, Gamma= -51, theta= 17, vega= -78 Delta for Dec 127C is 0.06 (very low) I feel comfortable looking at the greeks. But, at the same time, I have no idea where the market is going. SPY has only to rise by 6% (quite probable), in the next 30 days, to reach my short call (127).

If I want to close my position it will cost 0.07. Then, my final profit becomes $640. This is not what I had in mind when I planned the trade. My objective is to close the position once I can achieve 70-80% of the original premium (approx $1450). So, here I am, feeling comfortable on one hand but not feeling "safe" enough on the other hand.

What shall I do? OK, I do not pay attention to profit and I decide to close the position (I think I will sleep better). I will open a new one expiring in February. Obviously, I do not expect you to tell me if I made the right decision or not. But maybe you can comment on my thinking process. My feeling is that I did not manage this trade in the best possible way.



I'm very disappointed in how disappointed you are in what you have done with your position.  I believe you are dissatisfied because you did not achieve the maximum possible result.  You faced some trouble, chose to spend cash to temporarily get out of trouble, and you earned a substantial profit.

Why are you disappointed?   Your trading goal should be to make good risk management decisions at the time that such decisions must be made.  That represents the long-term path to success.

In my opinion, you handled this very well.  I have minor quibbles, but they are minor:

a) You must look at commissionsI think that 40 lots of SPY is too many to trade.  Why not trade 4 SPX spreads and cut trading expenses?

You traded 160 contracts to open; 160 more to roll, 80 more to close and will trade an additional 80 to exit the calls.  How much profit disappears through costs?  You cannot ignore commissions, especially when trading 480 contracts.  With some brokers, that would eat up all the profits – and then some.

Try SPX next time.  Do a 4-lot, 20-point, SPX spread and see how it feels to manage that position.  That's one purpose of paper trading.  It allows you to experiment.


b) You were uncomfortable and reduced risk.  That's good.  You paid a lot for this call roll – approximately half the original cash – but if that's what it takes to get comfortable, then that's what it takes.  Holding positions that you want to own comes first.  Nothing wrong with this trade.

Minor quibble: paying 24 cents is a big cost.  But don't let that prevent you from doing the same thing next time.  The real decision for you was: roll or exit (or reduce size).  You chose the roll.  Very reasonable.

Your short options were still 4% OTM, and for most traders that is too early for rolling.  However, you are not most traders.  You are Dimitris and must satisfy his comfort zone.  It's ok to be conservative.  However, there is a limit.  If you adjust every time the underlying moves 2%, then this is not a good strategy for you.  However, another purpose of paper trading is to get a feel for making adjustments and when to make them. 

I hope you are keeping a journal of your trades – and more importantly – of your thoughts when you make those trades.  Don't forget to include your thoughts when you decide NOT to make an adjustment.

Once you pay this much for the roll, there is no possibility of meeting your original profit objective.  You must come to recognize that this is ok.  Your primary goal is not to incur a large loss.  Your secondary goal is to earn a profit.  Your tertiary goal is to meet your profit objectives – over the longer term.

You are overlooking one substantial point.  Your profit objective, to be kind, is unrealistic.  Surely you do not anticipate earning that profit on a consistent basis.  Your margin requirement was $200 per spread.  And if your broker allows, it was only $149 because you can use the cash from the trade to meet part of that requirement.

If you had been able to earn a 70% profit, that would have been $35 per spread (70% of $51).  That's a profit of more than 23%  (35/151) on your investment in less than two months.  Please tell me that this is not your normal expectation. 23% for a year is a good result, one that is met by very few investors and traders.  To anticipate that result every couple of months, and to be disappointed when you don't earn that much – is… Well, I have no kind words for that.

As it is, a profit of $640 represents more than a 10% profit, or better than 5% per month.  How can you not be happy with that result? Yes, the true gain is much less due to commissions.

When markets are dull, you may earn something near that 20% return for some of your trades. But you will not earn that consistently.  No way.  When the market makes an unfavorable move and your comfort zone (and prudence) dictate making a change to the original position, there is not going to be enough credit remaining to meet your current lofty goals.  And believe it or not, you are going to lose money some months.  If you get overconfident, you may lose a bundle. And quickly.

c) You covered an inexpensive OTM spread.  That's also good.  You paid the equivalent of $0.20 for a 10-point spread.  For December options, I see nothing wrong with that.

What to do now?  That's easy.  Do you want to hold this trade when you can exit at 7 cents?  If yes, hold it and the next decision is just how much to bid.  Then enter the bid.  If you do not want to trade front month options, then look to exit now, on weakness, or on time passage.  Perhaps Monday.

One more quibble:  If the delta is 6, then it is not 'quite probable' that SPY will rise 6%.  It is unlikely, based on statistical analysis. If your gut tells you differently, then go buy that call spread.



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Expiration and iron condors

This question arrived Friday 11/5/2010 and because it was time sensitive, was answered immediately via e-mail. 


I sold [I prefer the term 'buy' – but this is not the time to quibble. MDW] a Nov IC in early Oct which included a RUT 750/770 call spread.

Delta is climbing every day, and with 2 weeks left and 16 points between current and short strike, I'm trying to decide the best route to save this with the least amount of red.

On the potential reversal side, volume is dropping on RUT, A/D line is over 200, and RSI is through the roof. So some professional feedback would be great.

Here are my current thoughts. 1) Close down shop and possibly roll up to higher strikes next week for less credit. 2) Close half the position now, and open additional contracts next week farther out. 3) Roll all 750 shorts up to 760 which is 10 points above April high. 4) Wait it out and pray. Least likely scenario. 5) Move half shorts to 760 and the other half to 780 and keep longs open. 6) Buying back a few shorts. 7) ??????????

Thanks for your feedback.



I can provide feedback on trade ideas, but I have no clue on market direction and have nothing to say about A/D or RSI.  I believe risk must be managed by what we see and how we feel about it. 

A trader who is confident that the market will decline, may feel comfortable with your position.  But lacking a crystal ball, WYSIWYG.  And risk is what we see. 

1) Closing is often, but not always the best choice.  Howeve, it is seldom a poor choice. By closing, you avoid making a poor trade in an attempt to 'keep hope alive.'  And do not ignore the emotional benefits of getting out of, and no longer having to manage, an uncomfortable high-risk position.

I agree with your attitude: looking to minimize losses.  Refusing to acknowledge that you are uncomfortable with this position is not a winning philosophy, in my opinion.

Rolling should be a separate decision.  If you find a Dec (or Jan) trade that suits, then sure – open it after taking care of the Nov trade.  RVX is rather low right now (25), and you may not like the premium available for new iron condors, but there is no reason why IV cannot move much lower. 

2) Reducing position size is very similar to exiting the entire trade. If you cannot quite get yourself to exit, then this is a good compromise.  However, there is one condition: Is holding half (or any other portion) of the position 'comfortable'?  The answer may be 'yes' when half the risk has been removed.  However, if you hate holding this, then don't.  The potential reward is obvious when expiration is near.  However, recent trading tells us that this call spread can be ATM in a single day.  Only you know how queasy that makes you.

This is not 'better' than shutting down the trade.  It is making the same trade in half the size.  In other words, I don't recommend worrying about the difference between these two choices.

If you decide to buy back the Nov call spread, then the next decision is 'how many to buy.'

3) Buying the 750/760 call spread is viable.  If you prefer to hold a position in the front-month options, then this is a good compromise choice.  It reduces risk, and that's the primary objective when making an adjustment.  The problem is that 10 points is not much protection.

How to decide on this alternative:  Cost.  Are you willing to pay the price required to gain 10 points of protection, when you may be forced to close the trade in a few days?  This is a difficult decision. However, it's one that you want to learn to make in a matter that suits your needs – because this situation is going to happen again

4) NO.  There is no praying in options trading. 


One of the problems with exiting when 'pray and hold' was considered and dismissed is deciding how much worse you will feel if this spread moves to it's maximum value. Compare that with how much worse you will feel if you exit and the market reverses.  It may seem foolish to be concerned with this comparison, but psychological factors are important to a trader.  You do not want to destroy your confidence, but neither should you be willing to take more risk than is appropriate.

It's best when you can make your choice and then ignore what might have been.  Not everyone can do that.

I am NOT telling you to exit, but do not shut your eyes.  Make a reasoned decision.  If that decision is to hold, then that is never a final decision.  You will be facing the hold/close decision several times every day – for as long as you hold this position.

5) Once again, if you cover the 750 calls and keep the 770s, you have a choice as to which options to sell.  And how many to sell.  There is nothing special about 'half' other than it's a middle of the road decision.

The specific trade mentioned leaves you short the Nov butterfly. 

6) I like this idea as a general method for reducing risk.  It provides major protection. 

There are two problems. 

  • The first is cost.  Are you willing to pay the cost?  That's why most traders who buy the 750's prefer to sell something against it to reduce cost.  (And if you choose to sell the 770s then you are closing some spreads)
  • Second: Analyze the remaining position.  It's a front-month back spread.  You own more calls than you are short and thus, cannot be hurt with a gigantic upside move.  However, a rising market can kill you when time passes and the value of your 770s disappears.  As 'good' as this trade (buying some 750s) looks, it's vital that you examine the new position and be certain you are happy to hold it.  I prefer making this trade when dealing with options with a longer lifetime.

Right now the 750s don't cost a bundle, and covering some of them makes the risk graph look much better.  But it does give you that back spread.

Future consideration:  Consider a kite spread.  Buy one (or more) 740s or 750s and sell 2 or 3 of a farther OTM call spread.  Perhaps 780/790 – although that is probably too low priced to consider when time is so short.

7) You covered the major possibilities.  Almost any position that picks up positive delta and some gamma is a good idea here.  However, if you plan to hold this position into expiration week (or to the bitter end) be absolutely clear about the fact that the 770s will most likely cease to serve any purpsoe other than to limit losses.  And those losses can be substantial. 


The big decisions remain: 

  • How much are you willing to spend to 'defend' this trade? 
  • Is it worth defending? 

It's a personal decision and I cannot tell you how to play it.  Honest I can't.  I don't know enough about you, your investment goals or how much risk you are willing to take.  I don't know if you are 65, using your retirement money or 25 using extra cash.

I recommend closing if you are seriously considering that possibility. 2nd choice, buy 750/760 spread – but not if price is above $5.  If these were Dec options, I'd recommend buying some 750 calls.

If you choose to hold, monitor closely.

Remember your goal:  You are seeking to earn money over the longer term, not only in the Nov 2010 expiration cycle.



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Adjustments and trading costs

A recent comment from Fran (from Spain), who writes an options blog in Spanish, raises an important point.  The obvious goal for traders is to make money and one sure-fire method for increasing profits is to reduce expenses. [This assumes that using a less expensive broker does not result in losing money via poor trade execution].

Some time ago I penned an article (free registration required) supporting the idea of reducing trading costs as a 'sure-thing investment.'

Fran's comments:

1) What about transaction costs with all these adjustments? The best adjustment strategy (in my opinion :-)) is to  reduce position size, because in the long run, transaction costs are another risk to manage and make a big difference in your trading performance.

2) if you have a verified trading edge, how does your adjustment bias affect this advantage? Have you tested it?

Hard questions to answer for a lot of options traders, but that trader must be sure that when cutting costs, edge is not being eroded. You must manage risk with low cost trades. Here, less is more



I never object to size reduction as an adjustment. In fact, it is a method that should be used more frequently.  I believe there exists a trader mindset that equates exiting a trade, or even reducing position size, with doing something unacceptable: giving up and accepting a loss.  This is a loser's mindset because every successful trader understands the importance of limiting losses and exercising sound money management.

I know that winning traders recognize that it's impossible for each trade to be profitable. But more than that, they understand the importance of not fighting when the odds are not on their side.  Taking losses when necessary is an important aspect of the trading game.

On the other hand, I don't believe that size reduction should be an automatic decision.  It is often advisable (i.e., profitable) to adjust a position, rather than cut its size. 

Most traders consider 'being forced' to make an adjustment to be an unfortunate situation.  They miss the fact that adjustments can increase both the likelihood of earning a profit and the size of that profit. That is not something to be ignored.

Yes, transaction costs are important – and that's especially true for those who trade one and two-lots with a broker who tacks a 'per trade' fee onto the regular commissions. I have no idea how costly commissions are in Spain, but US traders can find good brokers with very low commissions.  Low enough to make them a very small consideration when making trade decisions.



I don't worry about 'edge' when making an adjustment.   I have only two concerns:

  • Does this adjusted trade give me a position I want to own? [I'm not likely to want to own it if I had to give up much edge to create it.]  Do I like the profit potential? 
  • Does this adjusted trade truly make the position less risky? Have I reduced the probability of losing money (from today into the future)? Is the amount at risk (both short-term and worst case scenario) acceptable?

If both sets of conditions are met, I pay the commissions and make the trade.

As to 'edge': I do not make a trade that I believe adds negative edge. I will not accept a position that is worse that it is right now (when an adjustment is needed). I prefer to take the loss and find a new, better position to own than to add negative edge to my current position.  However, 'edge' is not easy to measure because it depends on making an accurate forecast for future volatility of the underlying. In other words, our volatility forecast must be accurate before we can determine the value of the options, and the edge, we own in our posiitons.

Fran, Much of this is art vs. science. It's also a matter of personal comfort. Not every trader has yet learned the importance of being willing to accept a loss on a given trade.

Avoiding that loss can result in poor adjustment decisions.  Why?  The mindset that requires the trader to hold a position, also forces the trader into making almost any adjustment.  This is especially true when  rolling the position to a later expiration date,  with the hope of eventually earning a profit.  I have a friend who makes 'ugly' adjustments in preference to exiting the trade. 

Traders with that "I must do something to my position – but will not lock in a loss" mindset are not on the success path.  These traders would do much better to consider reducing or exiting a trade that has run into trouble

Thanks for the discussion



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