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The Difficult Trade Decision: Take the Loss or Hope for the Best

I appreciate the excellent question that have been arriving as comments to individual blog posts.  Many are worth their own separate posts.  Here's a timely example.


Hi Mark,

I've been having some trouble in deciding how I should be exiting and/or adjusting my Iron Condor trades.

(1) I like your idea of exiting once x% of the potential profit
from the trade has been achieved. How should this be executed? Should I
just leave a limit sell order with my broker the moment I put on the trade?

(2) I bought a RUT Iron Condor 650/640 C and 540/530 P about 1 month
from expiry (Jan). I've received $200 credit a piece. When I entered
this trade, RUT was trading around 609. Seeing as how RUT is trading
around 640 (it breached my sold strike for a few days), have I left it
too late to adjust?

It will be a loss if I exit it at market (roughly $80-90 each
spread) now but I also don't really want to face settlement risk with
RUT that near to my sold strike.

I would like to find out what more I could have done to save
my position. The "when to adjust" question seems to be difficult to
answer, but leaving it until the underlying breaches the sold strike
doesn't appear to be viable.

It might be too late to salvage this position, unless the market
heads south. I did actually open 3 more Iron Condor FEB positions on
RUT, in effect "rolling" it to another month, without closing the
initial. My plan was to close these at the same time as my Jan
positions – in the hopes that the credit I receive can offset any loss
from the Jan options

What is your opinion?

NK

***

When to exit is the true dilemma.  And it has no simple answer.

Psychology plays a huge role.  Look at it this way:  Assume you pick a spot where you recognize the risk, don't like that risk, and exit the trade.  You know it's the right decision for you. 

Once the exit trade has been made, would you

a) forget about it?
b) watch closely to see what would have happened?

If you chose b) that is not to your advantage.  If you learn to make a good decision and move on, you will be less emotionally tied to your trades.  That's a good thing.  You can never make the winning decision every time.  Your job is to keep your positions out of trouble.

In my opinion, the simplest method for doing that is to avoid holding into expiration.  Yes, pulling the trigger is difficult, but over the longer term, you will be a happier, less stressed trader if you can do that.

If you cannot make up your mind to pull the trigger, then consider this question: Which would make you feel worse

a) not exiting when you know you should, and losing more money?
b) exiting and seeing the market reverse?

If you know which would make you feel worse, even when the amount of cash at stake is identical, then for peace of mind, you should minimize the chances of 'feeling worse.' 

This is where the psychology of trading comes into play.  The worse your decisions (that turn out to lose money) make you feel, the more you must do these things: 

  • Avoid placing yourself into situations in which the decision that makes you feel worse may be your best choice
  • Avoid the choice which makes you more upset.  If this is going to cost you money, then obey the suggestion in the above bullet point
  • This is a decision-making process.  Do the best you can (sure, try to develop skills that allow you to make even better decisions), but learn to live with those decisions

Now, your specific questions/comments

1) I do not recommend exiting at a specific percentage gain.  I was merely commenting that such a method was appropriate for some traders, including the person to whose comment I was replying.  I believe it's better to make the decision to hold or exit on an ongoing basis

2) Placing the order with the broker is a good 'set it and forget it' routine, but I don't like it.  You truly may forget that the order has been entered and that can be a problem. If you work full time and cannot watch the position closely, that's a different story and a GTC order may work.  Just don't forget you entered it.

3) If you watched RUT trade about 4 points above your short strike price, in my opinion you waited too long to adjust.  But this time it worked for you.  Don't assume it will always work well.

You got a reprieve and could have exited yesterday at $2.  Did you do that?  If not, how greedy do you want to be, after getting a reprieve?  Note:  This is a question; it is not a reprimand.  You should be asking yourself:  What are you waiting for?  The position to expire worthless?  

4) I agree that you do not want to take settlement risk.  That's important

5) Do not exit at 'market.'  Use limit orders

6) You have a loss?  So what difference does that make?  Here is something I believe very strongly that is difficult to convince others:  It makes no difference what premium you collected when you opened the trade.  The only things that need concern you now are:

  • You own the position right now at the current price
  • Do you want to continue to own this position at this price
  • Do you accept the risk/reward of the position as it stands NOW
  • If you want it, hold.  If you don't want it exit.  Whether it is a profit or loss is 100% immaterial

7) You did not 'roll' the position.  You ignored the Jan position and opened a new one in Feb

8) I have discussed many times – ideas for adjusting an iron condor position.  It's not the strategy that is the most important part of the decision.  It's your need to recognize that iron condor trading involves losses.  You cannot win every month.  You must also recognize that an adjustment reduces risk and often results in even higher profits than when not making the adjustment.

Your problem is an apparent unwillingness to pull the trigger because it may cost you money.  You already have a trade that may cost you money.  Your job is to manage the risk, not worry about profits.  If you ignore risk, I can almost guarantee that you will fail as an iron condor trader.  You cannot simply hold each position until expiration arrives and anticipate that this is a winning strategy.  It is great over certain periods of time, but at other times, it will bankrupt you quickly.

I suggest you have a serious talk with the portion of your persona that represents your risk manager.  The trader persona has taken over and the risk manager must be given more authority.

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