Tag Archives | kite spreads

Recent Iron Condor Trading Activity

Iron condor traders have faced some interesting decisions as the market continues to rally.  Those who adopted very bullish stances have fared well.  Those who trade market neutral iron condors have faced adjustment decisions.

I understand that my personal trading results differ from yours, however we may have faced similar decisions.  This is how I'm currently situated.

I own RUT iron condor positions with Nov and Dec expirations.  I own a very small January position because I decided to save my free margin for position adjustment, rather than for making new trades.

Each trade was initiated with a minimum premium of $300.

a) I bought all of my Nov put spreads when they became available at $0.15 and $0.20 per spread

b) I've already covered some Dec put spreads at the same prices

c) Not predicting, but fearing a large market selloff, I did not open fresh put spreads when covering those cheapies.  In retrospect, that has cost real cash, but it's not my style to sell new spreads when covering the original trades.

This (idiosyncrasy?) violates the principle of remaining delta neutral.  Thus, I have been trading with short delta as the market has been rising.  To avoid large losses in the rising market, it's necessary to stay ahead of the game and adjust positions.  In some situations, it pays to exit the trade and take the loss as the adjustment.

d) Thus, the bulk of my activity has been concentrated on protecting my call spreads.

Here are two sample (the volume mentioned below represents the lowest common denominator, not the actual trade volume) trades:

i.  Kite spreads. Here is one example

Buy one Nov 710 call; sell three 740/750 call spreads

This provides a much better upside, if the market surges.  It adds current + delta and gamma.  That's all good.  However, if the whole position is held into expiration week, the negative gamma becomes worse near RUT 740. 

This type of kite allows for the sale of four 740/750 spreads, but I'm selling only three to reduce risk

This trade was made when RUT was near 690

ii. Buy one Dec 730/740 call spread;  Sell two Dec 760/770 call spreads.  Traded when RUT was near 710

This type of trade is not appropriate for all.  It works under two conditions.  The first condition is that your account is not already exposed to major risk.  By that I mean that current risk – before and after the above trade is made – is within your comfort zone.

It is a poor risk management technique to convince yourself that although the 730 strike appears to be vulnerable – that 'surely the 760's are safe.'   When the market moves as it has been moving, you never know how far the move may extend.  There is no sense making predictions. 

Because I have extra room (by choosing not to open January positions), I'm using some of that extra margin (and risk) availability to make this trade.

Iron condor traders may choose among many types of trades to reduce risk,  Tomorrow I'll discuss some possibilities.

820


 

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Is Owning Straddles Overnight Viable?

Mark,


I think the kite spread is a good idea, but a big gap, like the one I
highlighted, is still very damaging despite having the kite spread.

Of
course trading smaller size will help, but that will result in smaller
profit too.

I have another idea, not sure about its feasibility, but maybe you can
share some insights. How about buying a straddle at the end of the
session, then sell it back next day when market opens. Transaction fee
may be an issue here if I do this everyday, but let’s assume I only do
this when I think something big might happen, like earnings report.


Thanks.

John,

***


1) Smaller size:  The primary purpose of trading smaller size is to reduce risk.  And it’s the easiest, most convenient risk management tool.  too bad it’s used so infrequently.

In my opinion, ‘size’ is a crucial, risk-related decision that must be made for each trade.  Of course, we already ‘know’ our preferred size, so unless some change is being considered, this decision is already known at the time the trade is initiated.

2) A ‘big gap’ is usually very profitable when you are the owner of naked long options.  The only reason you may have a problem with it is that you are using one kite per 10 call spreads.  That’s not really enough to provide a gap profit. 

But is that your true goal?  A profit from an unexpected, unlikely event?  Wouldn’t it be more prudent to own a single kite as partial insurance?

These two figures show a 10-lot of call spreads protected by one, and then two kite spreads.

10_IC_+_one_kite

2_kites

Two kite spreads yields a profit on a 10% gap.  That is so unlikely that I cannot see how it’s worth the cost of buying two kites.


3) There are multiple problems with this play:

a) Daily commissions

b) Daily time decay:  Yes, holding a trade overnight results in time decay for the options.  See Adam Warner’s post for more on this.

c) Slippage.  You may not have to pay offers and sell bids, but every time you trade, you give up some value to the mid-point of the bid/ask spreads.

d) If you think you have any idea when ‘something big’ will happen, then all you have to do is quit trading, take advantage of your ability to predict such an occurrence, and position yourself for an occasional windfall.  That’s much easier than trading every day.

Earnings report?  Are you kidding me?  That’s when all the amateurs pay inflated prices for options.  That’s the time you don’t want to be buying options. See this post.

e) If you don’t do it every day, you will surely miss the terrorist attack, or the assassination, or the massive earthquake and tsunami that has a huge economic effect.  You will miss the out-of-the-blue discovery of a cancer cure.  In short, you know you cannot time the market, and more than that, the gap producing events are unexpected.  By definition you have no clue when one may occur.

654


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How Kite Spreads can Become Embedded Back Spreads

James and I have had a back and forth discussion regarding whether certain positions are back spreads.  The discussion began here and there's an interesting aspect that's worth consideration:

How can a kite spread – in which you own a limited number of long options (on top) turn into a position with back spread properties?

First, some definitions:

a) A kite spread is generally purchased as insurance when an iron condor or credit spread threatens to move into the money.  It's either a bullish position using calls, or a bearish position using puts.  It's constructed by buying one option (the kite string) and selling (usually) 3 or 4 farther OTM vertical spreads (the kite sail).  A more detailed description is available.

b) 'On top' means closer to the money.  It's a call option with a lower strike  than the options being protected.  Or it's a put option with a higher strike than the options it is protecting.

Example:  Please note:  These are randomly selected fictional trades, generated today, with RUT @ 675.  I don't have prices for these 'old' trades. The discussion involves the appearance of the portfolio, how it came to be constructed and says nothing about profitability.

Assume you sold 20 call spreads:  RUT Apr 650/660 when RUT was trading below 600. 

As RUT moved above 620, you became concerned about the position and decided to make an early adjustment (a Stage I adjustment). The trade you chose was to buy 2 RUT Apr 640; 670/680 kites [This is the C4 variety]

Adjustment I:

Buy 2 Apr 640 calls

Sell 8 Apr 670 calls

Buy 8 Apr 680 calls

You now own 2 Apr 640 calls and are short a total of 28 call spreads

The market continues to move higher, and when RUT passes 635, you are very uncomfortable with your position.  It's time (you decide) to get out of some of those 650 calls.  The simplest trade is to buy back a few of the Apr 650/660 [typo corrected] call spreads, but you decide to buy kite spreads instead.

You buy 5 Apr 650; 670/680 C3 kites.

Adjustment II:

Buy 5 Apr 650 calls (to close)

Sell 15 Apr 670 calls

Buy 15 Apr 680 calls

Comment:  Increasing position size is usually a poor choice.  The reason it's acceptable with a kite spread is that the adjustment trade (as a stand-alone position) adds no additional risk to the upside, other than the debit incurred when placing the trade.  It does provide plenty of upside profit potential when RUT is not near 680 at expiration.

When RUT moves past 640, one reasonable trade is to sell the 640/650 C spread.  This feels counterintuitive, especially when the upside is where risk lies and making the upside worse doesn't feel right.  But if you sell this spread between $6 and $6.50, the maximum loss is only $350 to $400 per spread and it does make the down side better.

The true rationale for selling the call spread is to use the proceeds to buy more kites, reducing my short position on the 650 line.

Adjustment III

Sell Apr 640/650 spread 2 times

Buy 3 more Apr 650; 670/680 kite spreads


The position now looks like this: [with errors corrected]

– 10 Apr 650 calls

+20 Apr 660 calls

-32 Apr 670 calls

+32 Apr 680 calls

James calls this a back spread and I'd prefer to describe this position as one that contains a back spread within.  The characteristic that gives this backspread-like properties is the fact that the extra long options are no longer 'on top.'  The long option is the April 660 call.

To completely eliminate backspread characteristics, there are alternatives:

a) Buy 5 Apr 650; 670/680 C3 kite spreads.  My preferred choice

c) Buy 5 Apr 650/660 C spreads. Perhaps sell one extra Apr 660 call to offset the cost cost, but only if the risk graph and your comfort zone allow that trade.  I see no good reason to make this trade

c) There is no necessity to make these trades, but if looking at the 'backspread' portion of the position is uncomfortable (too much negative theta), you can take steps to alter the position

That's how kite spreads can turn into positions that resemble back spreads.  And the process continues.  With RUT currently trading near 675, it's likely that anyone holding this position would have repurchased many of the 670 calls as part of a kite that sold more 690/700 spreads.

637


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