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Zero Risk with Iron Condors: Can I Have my Cake and Eat it Too?

The following question is slightly edited.  The original question is elsewhere.

To provide a meaningful reply, I
requested more information.  Norm has been trading iron condors (with
real money) for five months.

Hi Mark,

"I am trying to come up with a strategy that involves zero risk of a
sudden downswing in the market because of a terrorist act or other
negative developments. You mention in previous blogs that one strategy
is to reduce your overall iron condor position size, but this would
still leave me with the possibility of losing the maximum for outstanding trades."

Hello Norm,

I'm sure you
understand that risk and reward go together.  If you truly want zero
risk for a specific market event, the best play is not to have any
position that loses in the unlikely event that your scenario comes to
pass. This means you will be out of the market (or part of the market)
with no potential losses, but that comes with zero reward potential.  Thus, this is not an easy decision – but
apparently you have made yours.

"Insurance for the downside is, as you have pointed out, too expensive
now, and it creates the risk of having to close a position at
unfavorable prices when the insurance expires."

Every trade you make has the possibility
of your being forced (prudently) to cover at unfavorable prices.

There are
trades that profit on a market collapse – the event you fear.  Those
plays are not iron condors, nor are they plays in which you have theta
(time decay) on your side.  As mentioned, IV is relatively high right
now, although it has been falling in recent days.

I don't know whether insurance is too expensive right now.  It's more than I want to pay, but my current positions are much less risky that they have been at other times.  For me, and the fact that I do not need insurance, I can state that it's too costly.

However, you are much more worried than I and perhaps insurance would be cheap with your mindset.  Let me clarify: I believe there is a realistic chance that the market may fall from its own weight.  It's the terrorist attack that I am forced to ignore.  Otherwise I would be unable to trade.

The very best play to
protect your portfolio is to buy some out of the money puts (yes, at what appears
to be exorbitant prices).

The most likely outcome is that the puts will
expire worthless (as does most insurance).  However, by investing
whatever amount of cash you are willing to place at risk, you can
prosper on a huge decline.  Is it worth it?  That's a personal decision.  Do you believe you can afford to own some puts and still earn a reasonable return?  If yes, go for it.  But it will be difficult, and you don't have enough of a track record to begin to make a reasonable (or otherwise) guess as to how well you would do.

"Consequently, I am considering limiting my trades to call credit spreads
which would have a bearish basis. My concern here is that if I try to
limit my losses to 1.5 times my average monthly earnings, this limit
could be reached fairly quickly with an upswing in the market because I
would not have the put spread income initially offsetting some of the
loss on the call spreads."

Also, my not having received the premium from
both the call and put side of the iron condor could limit my ability to
make a kite adjustment." 

Here is my
major problem with your questions/comments:  You jump form one example to another with no consistency.  You are worried about everything that occurs to you.  I understand that you want to be certain that major risk is covered, and you don't want to be trading in the blind.  Truly, the best way to cover your bases is to trade small while you are learning.  I understand that you do not want to trade small and that you want to earn money.  However, there are three truths that must be faced:

  • Trading with little risk is an excellent investing choice.  But accept the fact that it goes hand in hand with modest (at best) profits
  • You are moving too quickly.  You can learn and I can reply to questions.  However, there is just so much information that cannot be put into simple answers.  You want some experience trading and making decisions.  And that takes time.
  • You are trying to accumulate a large amount of data – and then base future trade decisions on those data. You must keep a detailed journal/diary of your trades, your thoughts, your decisions (even when the decision is to 'do nothing'), and the results.  Reread those journal entries often and see if they speak to you.  See if you can get some nuggets out of the data

I acknowledge that the more you can
understand the better trader you will be.  However, there is a limit as
to how quickly you can gain meaningful experience, but five months is not enough.  Not even close. Why? 

You must experience all kinds of trading decisions before you can know how well you handle them.  It's easy to trade an iron condor and then cover at a big profit.  It's easy to make a minor adjustment when a trade makes you slightly uncomfortable.  It's more difficult to see a big move in one direction – make a trade to account for that, and then have the market make another good-sized move.  That second move can be in either direction.  How well will you handle that?  Or are you willing to take your chances and make the discovery at the time it happens?

You write of average monthly earnings.  You have no idea what your average monthly earnings are going to look like over the longer term.  You don't yet know whether you can earn anything as an iron condor trader.  I am NOT being negative.  I am telling you that you are worrying about minute details when the big picture is an untouched canvas. 

Keep in mind that you plan to sell call credit spreads.  It may be similar, but it is not trading iron condors.  Thus, you have ZERO months of earnings from which to determine your 'average.'

Data from a
few months is worse than meaningless.  Yes, worse.  You have not
experienced enough different market types to know what that average is. 
Have you made enough adjustment/hold/exit decisions to have a good feel
for how skillful you are going to be in that area?

Norm – you are at the beginner stage
and no
amount of data that has been collected to date is any more than a hint
of what you can do.  You do not have any 'useful' average monthly

If you want to
establish a maximum monthly loss – and you should do so – then base it
on the size of your bankroll and the probability (as best you can guess
it) of taking the loss.  Don't base it on how much you earned when
trading iron condors – especially when you now plan to trade half iron condors.  the entire strategy is different – similar, yes – but
it's different.  You have different rules in place.  Rallies with
shrinking IV are less frightening than declines with expanding IV.  You
will have to use a different adjustment plan.  The point is your average
IC earnings are meaningless.

Yes, you can
avoid selling put spreads and sell only calls.  That does what you
seem to have established as your primary objective: No significant loss
if the rare event occurs.  My question to you is:  Which of the
following is going to produce more money in your account with an
acceptable risk level?

  • Sell a reduced number of put spreads,
    presumably earning a small sum, on average, on a continuing basis – but ever fearful
  • Avoiding puts altogether – until
    after the disaster.  Earning less, but without worry

This is a question, and you should take the time to figure out the answer: 
If you are that afraid of the loss, have you considered how much that
loss would be?  Have you taken an option calculator and determined the
value of a typical spread that you would sell – if the market gapped lower by
(perhaps) 25% one morning?  Assume IV triples, or make some other
assumption.  What would that spread be worth?  How much real cash would
you lose?

Do the same for the calls spreads and remember to subtract these gains (if any) from the put losses.

You may be surprised at just
how little of your portfolio is at risk.  What I am asking is: 
You are afraid of a specific scenario.  Do you know how much you would
lose in that scenario?  If you don't – and you clearly do not – how can you fear the scenario?  How can you make intelligent trade decisions when you don't know how much is at risk?  Your assumption that you could not exit the put spreads at any meaningful discount from their maximum value is incorrect.

Once you do the math (arithmetic), then if you decide that zero risk is the sweet spot
for you, then it will be an informed decision.  Right now it is a decision based on fear.  Do not misunderstand:  Fear is a great reason for avoiding a trade.  But don't you want a realistic estimate of how much would be at risk?

That brings us back to the question: Can you sell only call
spreads, and the answer is yes.  But to do that, you should not be a
bullish investor.  You don't want to wager against your
anticipated direction for the market.  So, do you prefer to sell only
call spreads?  The reply may be 'yes,' and if so, you are trading
reasonably.  If the answer is 'no' but you feel forced into doing it, I'd suggest you find an alternative strategy.

"Also, my not having received the
premium from
both the call and put side of the iron condor could limit my ability to
make a kite adjustment."

Regarding kite spreads;

a) You don't have to use kites.  There is
nothing magical about them.

b) Nothing hinders your
ability to use the kite strategy  If you want to use it, use it.  You
seem to have convinced yourself that if the credit collected when
opening your call spreads is too small, that kites are precluded. 
Nonsense.  If you decide not to sell credit spreads and pay too much for
insurance (any type), that's a decision.  It has nothing to do with
using kites.

Keep in mind
that kites are not a simple slap in on and forget it strategy, although
that's how it appears. 

Perhaps with only a few months experience, and
with IV remaining elevated, you ought to think about more useful
techniques than kites.  I also believe that you have far more to worry
about than kites.  You are new to this game.  Concentrate on learning
things that are important to your profitability – and one strategy for
managing risk is not at the top of that list (as long as you have some
plan in mind for reducing risk – when necessary).

"I realize that in the event of a sudden upswing
in the market due to some government action I would still have the
exposure of losing the maximum, but this scenario appears to be much less likely than a
similar scenario on the downside.
Given my concerns, is it reasonable for me to expect to be profitable if
I limit my trades to call credit spreads?"

Norm, I cannot answer this question.  Sure a meltup occurs less often and moves more slowly than a meltdown.  You want my opinion on how well you will do by trading short?   I don't know where the market is headed.  I don't know how far OTM you plan to sell the spreads.  I don't know how quickly (or slowly) you plan to adjust, nor do I know your adjustment plan.  I have absolutely no idea if it is reasonable to expect to make money based on what I know.

If you are bearish, then it's a very viable trading plan.  Go for it. 

If you are market neutral with a crash fear, it may be okay to trade this plan.  But I would not be happy camper if I were in your shoes and would choose to trade smaller size. 

If you are bullish, it's a death wish.

"Also, would it be too
personal a question to ask how you made out with your iron condor trades
during 911 and during the recent sudden drop in the market?"


Yes, it is far too personal.  I don't remember 2001.  I was not trading iron condors at that time.  I did much
better than average in 2008, with a small loss for the year and did
worse than average during all of 2009. 

The recent drop worked very well for me.  I had no problems for two reasons: My shorts were far enough OTM and I covered some put spreads on the rally.  Trading reduced size also made it easy.

I believe you have too much on your mind.  You must go after the more important stuff at this stage of your career.  I appreciate your need to understand the details, if you have the time to work on them.  But spend your energy on finding a suitable strategy and figuring out how to deal with your market fears.  There are inexpensive ways to play for a crash.


June 2010 Expiring Monthly.  Table of contents


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Iron Condors: Emotions, Psychology, and Risk Management

Andy made a very important comment, including questions. 

"I've been in the trenches the past month. Unfortunately, the experience has been costly. Started trading iron condors late
last year and  was losing money every month while everyone else was having fun riding the market higher.

You can probably guess where this story goes… I loaded up on MAY bull put spreads
and sold cash-covered puts (with the subliminal goal of
earning all the money I had lost with one fell
swoop). As everyone knows, a few weeks later, the market 'correction'
occurs, and I reluctantly closed some spreads early, but miserably
waited until the bitter end for many of my other contracts (I was in
shell-shock by that time). Indeed, I lost a lot of


It's appropriate that you commented on a post discussing trader psychology.  I know that you made trades that you considered to be reasonable at the time – at least when you began with iron condors.  However, I'm certain you recognize the 'one fell swoop' play was a high risk gamble.  Sure it could have worked, but alas, it didn't. 

I know the last thing you want to hear is a string of 'should haves.'  But let's get that part out in the open before going further.

The life lessons to be learned are

  • It's very important to trade without emotions.  That said, I recognize that many people cannot do that.  I'm sure it's far too early in your trading career to know if you are in that group or whether this is a skill you can learn

If, for now, you cannot trade without making emotional decisions, the lesson is to avoid positions that are large enough to frighten you (when danger looms).  Trading when afraid leads to panic decisions.  Panic is not 100% bad – it will save you from going broke, but it usually leads to terrible results

  • Size kills.  It's important to properly size all trades as the first step in managing risk, and especially when emotions may come into play when making decisions
  • Getting even is never an appropriate trading goal.  Earning money is your goal, and maintaining risk at an appropriate level is the path to follow
  • Managing risk is a full time job.  I've been there.  I've held positions that I hated, just waiting for expiration to take them off my hands.  It's important to avoid losing a bunch of extra money, just hoping to recover.  Money not lost is every bit as valuable as money earned.  Conclusion: Don't hold onto hated positions.


"I haven't given up on trading… and, hopefully, will be able to
recoup a good portion of my losses over the next year (or two). In one
of your posts a while back, you mention how difficult it is to teach
risk management to a new trader, and that most people will go on to
learn their lessons from their own experiences.

Here are a few things that stuck with me:

1) If you get to the point where you have to adjust a condor, it's
hard to come out ahead. My condors were simple: close them whenever the
index came within 30 points of either leg. One major thing I learned
about this: the money you lose from the 'close' leg far outweighs the
money you gain from the 'far' leg. For a while, when the market was
moving singularly upwards, I simply tried selling fewer short legs (ie: 4
bull put spreads and 2 bear call spreads) and selling the short leg
further out of the money than the long legs. Eventually I just decided
to sell the long legs and scrap the short legs."

[Exiting when 30 points OTM is one choice.  But to tell the truth, '30 points' is not a term that tells me anything.  In RUT it's almost 5% OTM while in SPX it's only 3% OTM]

I don't agree with your premise. 
Obviously it's best if we never have to adjust an iron condor and get to
watch as it fades into the sunset.

Adjusting is not something to fear.  It's an opportunity to convert a risky trade into something better.  Not only do you reduce (not eliminate) the risk of further loss, but you improve the position.  If you cannot make the position good enough that you want to hold it – then it's best to take the loss and exit.  Then use your trading capital to own a position that you believe is good enough to hold.

The above paragraph is so important (in my opinion) that I want to shout it from the rooftops.  If you accept the premise that you are trading to earn money, then I ask: Don't you want to hold a portfolio of positions that you believe will be profitable?  Positions whose prospects (for whatever reason) you like?  Why devote your time and resources to defend a bad – or at least not good enough to hold – position?

The psychological need to defend a bad trade or to take extra risk to get back the lost money is based on emotion, not logic.  Mr. Spock would not approve.


I suggest that you make a change to your adjustment technique.  If you can comment with a SHORT description of which index you trade, when you tend to make the first adjustment (% OTM), and the strategy you use (i.e. reduce size, roll, buy extra options etc), perhaps I can help.  If it's a lengthy reply, send it by e-mail instead. For the options you sell, include either delta, or how far OTM they are.

In my experience, the adjustment gives the trade a good opportunity to do better that it would without the adjustment.  That's the reason I don't accept your premise.

Your next observation is disconcerting.  The losing side had a larger delta and a higher gamma.  Of course it moves more than the winning side.  But surely you already knew that.

Your plan of opening unbalanced iron condors is viable.  It demonstrates a market bias.  I'm surprised that even with those two modifications you still ran into trouble.

And even when you only sold the put spreads, if you kept to your standards and not increased size (selling naked puts is surely extra size) it would not have been so bad.  That was an emotional trade and I hope you have it out of your system.

Note:  It's fine to take a market stance and it's okay to increase size (modestly), but there must be a good trading reason to do it.  Seeking revenge is too emotional and not valid. 

No losing trade is a complete waste if you learn something useful.


2)  Sell your spreads for at least 1 dollar. Way out of the money for
25 cents seems nice, but then you have to hold onto your spread to near
expiration to make any profit. You'll probably find it much easier to
sell a spread for 1.25 and close it for a 1.00 if you're far from

I agree that selling spreads for small premium is not a good idea.  But each person has to set his/her own minimum.  There is nothing magical about $1.  You could just as easily have said $0.95 or $1.50.

I don't believe the risk/reward is justified if you plan to exit when a 10-point iron condor earns $0.25.


3)  For every trade you make, there is another person out there who
thinks otherwise (who do you think is buying/selling your spreads?). So,
what makes my judgment any better than his? By this reasoning, this
should be a 'zero sum game'. I've been pondering that the only reason
people generally make money from the stock market is that the influx of
new investors outweighs the outflux of retiring investors, thus the
market generally floats upwards (like a pyramid scheme). Thus, doesn't
it only make sense for the non-prognosticator to invest long, and never

You do not always get filled by another person who thinks as you suggest.  Sometimes you get filled on each leg by trading with an individual investor.  Also, a market maker makes a two-sided market.  He/she does not have an opinion on the small trade made with your order.  Bid enough and the MM sells; offer low enough and the same MM buys.  The MM does not have an opinion on your iron condor, nor does that MM hold the trade as an iron condor.  It is hedged in a flash and then forgotten.

No.  It does not make sense to always invest long.  That's what the masses do.  They buy mutual funds, getting screwed by the management team who charge far too much for doing far too little. 

Markets do not always rise.  Invest as you see fit.  If that's 'always long,' then go for it.  But don't do it based on the rationale given here.  If your picture of the market holds true and if you believe in that pyramid scheme,
then what is going to happen when baby boomers withdraw their savings to
cover living expenses?

When you get over the shock of what happened, you will recognize that you can only earn money at the rate that is available to you.  That rate is dictated by the size of your bankroll and the risk you are willing to take.  I urge you to trade with risk you can afford – especially until you have proven than you can control emotions when trading.

I wish you good trading.



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Trading Iron Condors as a Source of Income


Earlier question by Joe:

I'm reflecting on the question asked by GW and your response.
If ICs are deemed income trades then how would one generate a
reasonable income on only 10 ICs a month? 
So would you say trading much larger whilst carefully managing risk with
added protection unwise?

Joe: I amended the reply to include this:  Apparently I missed the point.  I do NOT believe that traders should limit their position size to trading 10 IC at one time.  I hope I never said that.  I believe that's a large position size for a beginner, but not for the experienced trader.

My question (which may have been phrased incorrectly) was pertaining to
trading ICs to generate regular income on a consistent basis.

I think I
may have taken your response out of context as I assumed you were
advocating to trade no more than 10 ICs. So to be clear I don't disagree
with your overall thoughts on ICs as income trades but would still like
to know your view on trading ICs in much greater size with good risk management, in order to generate a greater income.

I ask as I have read
and heard from varied sources that there are traders who do this each
month and therefore would like to know if you think it's a feasible way
of trading?

Yes, it's feasible.

But that's not the same as saying that it's a good idea for most traders. in my opinion, to trade on a scale large enough to generate a steady (not every month, but on average) income that is large enough to replace working elsewhere to earn a living, translates into being a
professional trader.

Why did I jump to trading for a living
when all you asked about is making extra income?  If you plan to trade
size, and if you plan to manage positions carefully, you cannot be
working at a full time job.  At least not when the markets are open.

I don't have real statistics, but I am told by sources I believe to be reliable that 'the average trader never makes any money.'
If that's true, then trading is similar to other professions. Only a
few play sports well enough to become professionals and earn a living. But many play as a hobby, on weekends.

It's easier to make a living as a trader than it is to play in
the NFL – but it's still difficult. 
First prove to yourself you can consistently be profitable. If you
believe you have already proven your skills as a risk manager, and
if you believe you have the discipline, then yes, it's feasible to earn a
living. (Or extra income).

Just remember that earning 20%/year doesn't seem to be a great achievement when you see all those Internet ads telling us how easy it is to earn 5 to 10% per month – guaranteed. [Notice to all readers: Those claims are false]  But you know that 20% is an excellent return, especially over a multi-year span.

And yes, you can earn 50% per year and more.  However, the risk required to earn those returns makes it highly likely that you would eventually lose every penny of your trading capital – if you sought such returns.

The key to earning a living as a trader – in my opinion – is to decide how much income you need, remembering that a significant portion must be saved to pay taxes.  Next, come up with an annual return that you believe is realistic for your trading style and current skills.  Keep in mind that your original plan is to manage risk well.  That must include trading fairly conservatively because you cannot afford a large drawdown.  Then calculate how much capital is needed to generate the cash required, assuming your rate of return is realized.  Then get some extra capital for safety.

Conclusion:  If you have a track record of profitability, if you can raise the capital, if you maintain your discipline and not get flustered when you are suddenly trading more size than ever before, then yes -you can earn a living as an iron condor (or other) trader.  

One caution:  Increase size gradually. Do not move from 10 to 50-lots overnight.  Do not then jump from 50 to 100-lots (or whatever your size turns out to be).  Always keep cash in reserve – because you may need that cash for adjustments at a moment's notice.

Joe, the most difficult part to remember is that being a successful professional anything requires skills and practice.  It is feasible.  That is not the same as 'anyone can do it.'

The one warning that I want to mention is:  Do not make any attempt to do this if you are under-capitalized.  It adds too much pressure. If you start to lose – even a little, then you are going to have to try to earn money at a higher return to compensate for having a smaller account.  And Joe, you know that means increased risk.  That in turn increases the risk of ruin.


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Learning to use Insurance to Protect Iron Condors


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Position: From a Different Perspective

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The following (condensed version) question provides an opportunity to discuss the idea of owning extra options as insurance
against a catastrophe – when trading iron condors.

Hi Mark,

I made the following paper trade after studying Chapter 20 of your book (The Rookie's Guide to Options):

Sold 10 RUT Aug 720/730 C spreads and  BOT 1 RUT Jul 700 call as insurance.  Collected $1,391 for the spread and paid $611 for insurance;  net credit: $780.

Had I not been paper trading and able to pick up some of the bid-ask spread, I would likely have received a $1,430 credit. 

I am puzzled by the current negative theta (-2) for the position.  If RUT remains unchanged, theta would be zero on June 22 and increase to 37 by July 13, when my long call expires.

Insurance provides protection on the upside, and enables a profit on the downside, but eliminates profits from theta for 11 days.  Then theta profits are low until near the Jul expiry date. 

Is this what you would expect, or should I have increased theta on the overall transaction by selling about 13 credit spreads, rather than 10?

Do you think that this transaction represents a reasonable risk/reward if I had been able to receive that $1,430 credit? 



1) If
your paper trading account requires that you pay offers and sell bids,
it's not worthless, but it's pretty bad.  Ask the broker how are
you supposed to gain any useful experience trading when you cannot get
realistic prices for the trades.  I assume you enter spread orders and do not trade the options separately.

It's a good
question to ask.  If they cannot help you, find a free online site to practice.  I have no idea whether the CBOE paper trading is any good. 

2) If the Jul calls expire and if you cannot close the Aug position at favorable
prices, then you are left with a one-month iron condor and no
insurance.  Not the ideal situation.  That is the worst case scenario when using insurance.

You must decide – and yes, I know experience
makes these decisions easier – if the insurance is worth the cost.  Or
if this is the right insurance to own.  Or if this is the right iron
condor (or call spread) to own. 

Consider this scenario: It's expiration week for July and the market takes a big tumble.  Do you own enough insurance? 

Norm, insurance can be helpful.  But it is expensive and not everyone likes paying top dollar and still not being completely protected.  Remember that the least expensive insurance is to cut position size.

3) You
have two ways to make money with iron condors.  Theta.  IV decrease.  

Theta is not the end-all be-all of trading.  If theta is that important
to you, I strongly suggest you avoid buying extra
options.  There are alternatives. 

To learn to handle risk better, you want to experience a number of situations in which you incur problems.  This is my suggestion:

a bunch of trades over several months and see how they play out.  It's best if you have access to a realistic paper-trading account. 

By 'play out,' I am not suggesting that only the P/L results are important.  You want to pay attention to the positions on a daily basis. 

Decisions: Are you
comfortable with (pretend) owning these positions?  Does the long option (bought as insurance) lose time value too
quickly?  Do you feel the insurance is worth the cost? 

To do
this effectively, keep a trade diary.  Write down your thoughts every
trading day. You may like the idea of owning insurance now, but change your opinion later.  Insurance is expensive when IV is elevated.

Track positions with and without insurance.  Discover your comfort zone.  Take your time and collect useful data.


will have many data points and observations.  Record when insurance seems to be worthwhile due to protection.  Record when insurance feels
too costly.  Write in detail.  When you have worked through a bunch of
trades, you will have a valuable book to read.  With YOUR thoughts and
ideas that suit YOUR comfort zone. 

Manage risk – owning insurance does not suggest that you can ignore risk.  Record all thoughts
about your trades.  I can give opinions, but they will not help you in
the long run.  Develop your own.

Does this require an effort?  Yes indeed it is.  I
believe it's very worthwhile.  You gain a lot of good experience
you have good data and the ability to come to reasonable conclusion
about what you are seeing happen on a daily basis. Please avoid the trap of believing that winning every month means you have discovered the ideal.  When profitable, recognize if it was good fortune, or whether you did something to earn the profit.  Same with losses – truly unlucky, or did you neglect to take prudent action?

4) Iron condors have positive theta and negative gamma.  Insurance
comes with just the opposite – positive gamma and negative theta.  At
various times and RUT prices, you can expect to see theta and gamma
change.  That's because the nearer-term option are more theta and gamma
sensitive.  A change in stock price or time – affects these options more
than those in the iron condor (or half of an iron condor). Don't forget that with elevated IV, option prices are higher.  That means your naked long calls erodes much faster than it would if the premium were lower.

If owning positive theta is an essential part of
the strategy for you, then take that into consideration when choosing which option to buy as insurance. 

'Insurance' is just one idea.  Buying it when IV is
elevated, as it is now, makes that idea costly.  I don't own any
insurance at today's prices.  With high IV, I prefer to either trade
fewer iron condors, or move a bit farther OTM – reducing my need for

5) Do I think this trade has reasonable risk/reward prospects?

is not the right question to ask, although I do understand why you do ask.

I don't know if you will exit
at a specific profit (or loss) level.  I don't know how aggressive you
will be when making adjustments.  I don't know how you will treat this
trade if the market moves lower. 

Thus, I  have no idea what the
risk/reward is.  The position looks reasonable.  Personally, I'd prefer
to be short (a little) more vega at these levels.  Thus,to maintain risk at a reasonable level, I'd not buy insurance and I
would trade fewer than 10 iron condors.  But that's my comfort

To answer an earlier question: no I would not sell extra call spreads just to gain positive theta.  Theta is not a good reason to accept extra risk.



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Quandary: The Logic of Trading Iron Condors

This post originally appeared at The Options Zone


I'm an iron condor (sell call spread and put spread with
same expiration date
on same
underlying asset
) trader.  I understand the risk and reward potential for these positions and recognize that skillful risk management is crucial to my success when trading these negative gamma positions.

The best part of trading iron condors occurs when the markets are calm and no adjustments have to be be made.  In those rare situations, I eventually cover my shorts and bank the profits. 

In the current volatile market, there is little peace.  Depending on the strike prices chosen, iron condor traders are making frequent adjustments to their positions.  That thought took me down a strange path.  Looking ahead by a few days, it occurred to me:

  • It's very likely the underlying asset will move sufficiently so that the iron condor is no longer delta neutral (due to negative gamma)
  • If that happens, the position will have lost an unknown number of dollars

That leads to this quandary:  Why should I trade the iron condor today, when it is very likely to trade at a higher price soon?  Why not simply wait for that higher price to enter the trade?

If I were to follow that unusual line of thought, I would proceed as follows:

1) Choose a specific iron condor and estimate the premium I can collect now

2) Do not enter the order.

3) Wait until that trade is losing money: i.e., I can collect a higher premium 

How much higher?  How long to wait?  I don't have answers to those questions.

4) Open the trade and collect that higher premium.

Obviously this trade is no longer delta neutral, nor is it likely to be the trade i would select at the future date.  But it's the position I would normally open today.  By waiting I get to make the same trade at a better price.  Doesn't that have to be better than owning it at a worse price?

By the time I enter the trade, the position may require a minor adjustment. No problem.  Open the slightly adjusted position in place of the original. 

To adopt this idea, I cannot allow much time to pass or I may miss a profitable trade opportunity.

Thus, the quandary:  Why trade now?

5) By collecting that better price: 

I have more risk than I prefer when making a new trade, but to compensate, I collect additional premium.  The bottom line is: I would be facing this extra risk had I already owned the position, so why not own it several days later – with the same problem, but at a better price?

Another point to ponder:  Is this truly taking on more risk?  By not opening the position sooner, I had zero risk of loss (or profit) during the time that I had no position.  The easiest method for avoiding a disaster is to be out of the market.   Is the benefit of a few days on the sidelines enough to offset a bit of extra risk when the non-neutral position is opened late?   I believe it is.

6) And if that quandary is not sufficient, why not take an additional step?  Instead of waiting, open an unbalanced iron condor right now.

I would be forced to make the trade with a choice of extra upside or downside risk, rather than allowing the market to force that decision upon me. 

I can go even farther by opening half the trade with an upside bias and half with a downside bias.

The real question is:  does it make sense to open an iron condor position at the time I am ready to trade, or is it better to either:

  • Wait for a better price
  • Open two unbalanced IC now, in place of a single, neutral IC


Opening positions that are not neutral when lacking a market opinion feels wrong.  Yet, the probability is very high that I'm going to have that position anyway. And soon.

Why not take advantage of that by opening those two non-neutral iron condors at a better price now?  (I do that by choosing an iron condor that is already unbalanced.  Because it is no longer neutral suggests that it is losing money.)

Bottom line:  It appears that I can take advantage of the fact that whichever iron condor I choose is likely to be a (hopefully temporary) loser at some point in time.  By waiting for it to become a loser and delay initiating the position until that time, a better premium is collected.

Logic tells me this is not sound reasoning.  Yet, I cannot find the flaw(s) in my argument.   A quandary.



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Short Course in Risk Management: Introduction

In my opinion, there is only one hard and fast rule about managing risk:  You must get it right.  Most beginners accept the fact that it's important to trade very small size and/or use paper trading accounts to gain experience. Few jump into trading with large trades.  There's no denying that sizing trades is the most efficient and easiest method of managing risk.  But that's where risk management ends for beginners.

When a rookie gains confidence because of his/her ability to earn money, it's natural for that trader to want to increase position size.  And making a gradual change is justified. 

However, it's not a string of profitable trades that should be the determining factor.  The best approach is to demonstrate the ability to profit by making good decisions before considering the possibility of increasing size.  This does not mean three consecutive winners. 

It means several months of success – both in dollars earned and in terms of holding positions that do not involve more risk than you should be taking.  It may be difficult for the rookie to tell the difference between good luck and good trade management, but it's necessary to make that distinction.

If I'm making money, isn't that all there is?

Risk management is never considered from the same perspective as profits. Most traders who are able to earn profits – especially when they earn profits as soon as they begin trading – make the unwarranted assumption that they are talented traders.  They don't consider that the market may have behaved perfectly for their chosen strategy.

It's very important to understand the difference between trades that are well-managed and those that luckily end well.  This is a subtlety lost on too many.  The 'obvious' but inaccurate conclusion is often: 'If I made a profit then it was a good trade and I must have handled it well.'

To understand the risk of any given position (or portfolio), it's essential to know

  • How much can be lost, if the worst case scenario occurs
  • How much can be lost today, under unusual market conditions
  • What you have to gain by holding the position; i.e., potential profits
  • The probability of earning a profit from the position as it exists now
  • How theta (the passage of time) affects the position
  • The effect of a large change in implied volatility (vega risk)

To manage risk successfully, you must know

  • What is your first line of defense?
  • When will you take that defensive action?
  •     At some specific number of delta away from neutral?
        When your short option reaches a certain delta?
        When your position loses a specific sum?
        When you get nervous?
        When the risk graph tells you something specific
            Lose $X if the market moves another 2 or 3%?
            Lose X$X if one week passes or if IV drops by 10%?

  • What is your general plan when trouble looms?
  • Will you exit the entire trade?
  • Will you buy back a portion of the losing side?
  • Will you trade shares of the underlying asset to get delta neutral?
  • Will you buy extra options?  Which strike price?
  • Will you roll the position to farther OTM strikes?
  • If rolling, to which month do you plan to roll?  Same?  Next?
  • Do you plan to adjust in stages, or all at once?

As a rookie, you cannot be expected to have the knowledge or experience to prepare a plan with all this information.  But, you can pick a small number of items. 

I'd suggest that you know your first line of defense.  To me that means whether you plan to get out of the whole trade or plan to find a suitable adjustment.

The other important topic is when you will implement that line of defense.

That's a good start.  When you find it's time to make a position adjustment, the decisions you make may help you find another couple of items to add to your trading plan.

Over time, you will develop a sense of what you want to know in advance.  The better the plan, the better you can manage risk.

It's not essential to know these items in advance, but if you do, you will be in much better shape.  You can make decisions, when necessary, even when conditions are stressful.  Having a well thought out plan makes a big difference, especially when you lack the experience or discipline to make good decisions under pressure.  If you have never been short a bunch of puts in a rapidly falling market (with exploding implied volatility), then you cannot know how you will react.  It's far better to have a plan in place and then act on that plan when necessary.

As you gain more experience over the years, as you gain more confidence in your ability to react well under pressure, then these plans will be easier to compile.  If you prefer to make decisions on the fly, and are confident you can do that well (without emotions getting in the way), you can continue making trade plans with rough guidelines rather than specific trade ideas.

But don't give up making those trade plans.  It's good risk management to prepare for contingencies.

to be continued


Kindle edition

Lessons of a Lifetime


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The Importance of Having a Trading Plan


In my last post I explained how I am in my second month of trading
spreads. I also explained that for this month I entered the call side
first and entered the put side last Friday. As you continue to point out,
the key to being successful in these spreads is how you adjust (or NOT
adjust) not just whether you make or lose money.

At this point, I could
exit my call side (these are May index options) for about a 60% of
max profit. If I exited my put side I would probably lose most of that
profit, and have a slight gain from the whole transaction. the delta on
my puts are about .06 so I am not at risk at this point.

How would
you normally handle this situation? There are many "options" I see, but
most likely are:

1. Close all positions, take a small gain

2. Close the Calls for a 60% of maximum profit and either

a) sell a new call
spread to try and bring in more premium; or

b) do not sell a new call
spread and wait and watch the put spread

3. Do Nothing



I've previously explained my personal methods.  They suit me but may not suit you.

1) The point of adjusting is to prevent loss and to give yourself an increased chance to earn profits going forward

2) When you opened this trade, did you have a plan?  Did you have some idea of WHEN you hoped to exit or HOW MUCH you hoped to earn?

Having such a plan makes these decisions so much easier.  The fact that you lack a plan is why you are asking questions now.

The plan is not the absolute final word.  You can be flexible.

Would your plan call for exiting now at a small profit?  If not, why are you considering doing that?  Are you afraid?  Are you outside your comfort zone?  Do you fear a rally – is that why you want to repurchase the calls?  You cannot expect to be able to continue trading when you don't know he answers to these questions.

3) I always exit my 'winning side' regardless of whether the 'losing side' is in serious trouble.  The problem is when to exit and how much to pay.  I trade my iron condors, collecting about $3 credit.  I close almost any spread at $0.15, and will bid as much as $0.25, depending on circumstances.  That's my plan.  Decide what your plan is.

I don't care about 60%. That's not enough information.  For example, if you sold @ 10 cents, would you pay 4 cents to cover?  You'd lose money after commissions. 

How much would it cost to cover?  That's the key issue.  Are you willing to take the risk of remaining short this call spread at its current price?  If yes, then do nothing.  If you are a bit concerned, then consider covering a few of your short call spreads.  Enough to move you back withing your comfort zone.

If you are covering because you are bullish – that's okay, if you want to trade with a market bias.  There is nothing wrong with doing that.  It's your money.  But be certain that's what you want to do.  There is no shame is risk avoidance.

Selling another call spread is a legitimate way to play this.  But I dislike that idea.  I prefer to establish a plan and not increase risk at any time.  Selling a new call spread brings the position back near delta neutral and that is desirable for many traders. 

I prefer to be satisfied with my target profit – if I can get it – and not be greedy.  To me, selling new call spreads just sets up the possibility of a huge whipsaw.  You are too new to do this.   One major decision you must make:  how much extra cash must you take in to make this trade worth the added risk?  You are too inexperienced to have a good idea.  I recommend saving this idea until you have proven that you can manage risk well enough to take the chance of increasing it.  That does not mean six months.  Take your time.

Keep in mind:  Some extra cash from call spreads provides very little protection if those put spreads get into trouble.  That's why I don't like selling replacement spreads.  Too little to gain, too much chance of losing.

When I cover a call spread, I almost never sell other call spreads as a replacement.

4) If you have no plan write one right now.  Look at your position as it exists right now and make some decisions:

  • When do you hope to be able to exit?
  • How much would you like to pay when that time comes?
  • How flexible do you want to be in the above goals?
  • How much are you willing to pay to exit the call (put) spread?  How much is cheap enough?
  • Does time remaining prior to expiration affect that low price you are willing to pay?
  • When do you plan to take a good look at risk?
  • How high must the delta of your short option be before you plan to adjust; or
  • How much money must you be losing before planning to adjust; or
  • How much time must pass before you would consider exiting the whole thing at a small profit?
  • Anything else that occurs to you

The trading plan offers guidance in making a difficult decision under stress.  If you already have a plan in place, you can execute that plan. 

As a beginner, the more guidance you can provide for yourself – in advance – the easier it becomes.  A good exercise is to look at that plan daily and decide if it's still good, or whether you should revise it.  The point is for you to THINK about your positions frequently and make a plan often.  It is NOT to change the plan.

The plan gives you more confidence because you have already thought about what's important.

It truly helps manage risk.  It makes decision-making easier.


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Adjustment Headaches II

To Mark,

Hi John (Addendum: MDW response in blue)

Here's what I do when trading iron condors (IC)

  1. I initiate positions
    without any market bias, which means I do not know whether the stock is
    going to rise or fall or remain in a narrow range.
  2. When the
    stock swings to one direction, not a lot, probably a few points, then I
    will rollover the spread on that side to further strikes.

    How far OTM are your current strikes when you 'rollover'?  Are you adjusting too late or too early?  Most important of all:  Are you rolling just because that's what you always do?  That is not a good idea.  Please be certain
    that the new position is a 'good' one.

    Another thought:  If trading stocks, perhaps the strike prices are simply not very far OTM.  You may be more comfortable with higher priced stocks or index options.  You find rollovers to be unprofitable, yet you do them when the stock moves 'a few points.'  If you are rolling when the stock moves only 5%, perhaps your options are too near the stock price.  Can you move more OTM and still get a reasonable premium?

  3. Doing so allows me to have a good position, but only for the
    I still do not know whether the stock will continue in that direction,
    stay there, or retrace.

    That's true for most traders.  If a trader had a market opinion when opening the trade, that opinion has been proven to be incorrect – when the adjustment was made.

  4. This adjustment gives me an unrealized
    loss. My observation is this happens in every adjustment, and the
    reason for this is fairly straightforward. Calling it deferred loss is
    only a matter of opinion. Regardless of how I call it, the unrealized
    loss is real. 

    Yes, it is real.  But it seems to be a 'realized' loss to me. What is your method for the
    'rollover'?  Farther OTM strikes in same month?  Next month? 'Rollover' is
    not the only type of adjustment available.  This is obviously not working for
    you.  Have you considered alternatives?  a) buy back 20% of the short
    spreads and hold the remainder until you feel it's time to repurchase
    more.  This is adjusting in stages, rather than all at once.  b) Buy one
    or two of your short calls.  c) etc.  There are other alternatives.

  5. Since I do not have market bias, I will never know whether my
    new positions will be profitable going forward.

    True.  But if you don't expect them to be profitable; if
    you don't 'feel' good about owning these positions, then don't own them.  Perhaps
    there is a different strategy that you can adopt?  

    The new position is
    just less risky compared to the old one, again, for the moment. Less risky is good, but it's not good enough.  The risk/reward potential must be acceptable. 

  6. On
    the other hand, if I exit the trade, then it will result in an
    immediate loss.

    To me that is not
    important.  If you don't want to own the current position and if the
    rollover doesn't appeal to you, then exiting is a good idea.  Holding onto a trade just to avoid taking a loss means you are going to own bad positions frequently.  When you do that, you are gambling.

    look like a good choice to me because of 3
    reasons: i) if I adjust immediately, theta decay can still come to my

    I don't like this rationale.  If
    you open a brand new position, theta is also on your side 

    gives no benefit because without market bias, I do not
    know when to initiate a new IC;

    I see
    your point, but without a market bias, isn't it safer to own a new,
    market-neutral, IC than the current position?  Don't forget that 'neutral' is a market bias.

    iii) if
    i exit and stay around hoping
    to roll with better strikes, then I am just guessing the stock will
    continue in the same direction, but I may be wrong.

    The basic decision remains:  Do you feel comfortable
    with the current trade, or would you prefer another?   Maybe you should consider an alternative strategy:  Less volatile stocks; selling options
    that are farther OTM and have a lower delta.  I don't have a specific suggestion, but I sense the
    frustration. I understand that you feel helpless doing what you believe is
    'right' and losing money.  Keep in mind that IC are not suitable for
    all markets.  They only work part of the time.

  7. My opinion is when I adjust, one side of the spread has
    already gone bad. Adjustment prevents it from getting worse. I don't
    see why I would adjust if the stock price stays at the middle of the
    range enclosed by IC.

    When you do that 'unnecessary' trade, it's the purchase of insurance. 

    In other words, I adjust to prevent the bad side
    from getting worse

    Yes, that's one reason.

    As a
    consequence, there will also be deferred

  8. Here lies the problem of deferred losses. If the stock
    heads in
    direction suddenly and quickly, the deferred losses are quite big. If
    that stock do this for few days in a row…well you get the idea.
    Although still unrealized, that unrealized loss gives you the shivers.

    I look at risk.  If it's too risky, I get out of the
    trade – either by adjusting or exiting.  Perhaps you don't look at
    adjusting the way I do.  It is not just a risk-reducing trade.  It is
    not just a 'reduce the position size' trade.  It is a trade that gives
    you a good position – a position you want to own.  It does not give you
    a position you are forced to own.  Adjusting is voluntary.  If you don't
    like the trade, don't make the trade.  As mentioned in yesterday's response, adjusting affords profit opportunities.  If you don't find that to be true, then you are not making the best adjustments.

  9. I believe this is the nightmare of IC, apart from a big gap
    that put the trader ITM without a chance for adjustment.

    Yes.  That is one argument for owning insurance in the
    form of extra options.  It doesn't always help enough, but it helps. 
    The problem is that the extra options must be closer to the money than
    your short options, and that makes them expensive.

  10. I
    do not have any solution for this, and market making seems like the
    only valid strategy to me. Everything else has a market bias built in.

    There is nothing wrong with a market bias – if your
    track record shows you have good judgment.  You and I trade with a neutral bias.

The points you mentioned seem to suggest that you know the
will stay range-bound after adjustment.

know nothing about the future market.  What I do with an adjustment is
reduce risk, and maintain a position I like.  I suspect your options are
very near to being ITM when you adjust, and that means it's probably
too late to salvage the position.  

Judging from this
'believe the position will be profitable going forward'. That is having
a market bias in my opinion.

understand how you feel.  When I open an IC position, I feel the
position will be profitable going forward.  If I didn't, I would not
make the trade.  Sure, that assumes a market bias.   IC assumes a
range-bound market.  Every trade has some bias – bullish, bearish, or
neutral.  Not knowing which to choose, I choose neutral.  But that's not
'better' than bullish, it just more comfortable for me  – and 'neutral' has been drummed into my head by risk managers for more than 25 years.  Now I'm the risk manager.

from a technical analysis
background, I find that market bias is only guessing and consistency
can never be measured.

Well, thanks for reading my rather long details. If you have
something to add, correct, or alternative theory… please

I sense your frustration.  I'm  offering advice based on my opinion as to what I believe is
sound.  In the final analysis, it's up to you.


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