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Q & A. Insurance, Risk, and Uncomplicated Positions

Hello
Mark and thanks for your excellent blog! I have been considering your
thoughts on trading 2nd and 3rd month Iron Condors and did a successful
test last month, closing out the position 1 month early. I have been
trading front month RUT iron condors for an average credit of 1.00,
however I tend to leg into my trades. For example, I will first sell
the call spread as the market is rising for around 0.50 (based on some
technical analysis) and then wait for an opportunity to sell the put
spread for again around 0.50, or vice versa. On some months I do not
open up both sides of the iron condor because I don't like the risk of
one particular side and can't get enough of a credit that would give me
sufficient "breathing room" in the trade.


I had a question about your method of buying insurance. You tend to
look for higher credits in your condors and then buy extra insurance.
Would this not be similar to just opening up a wider iron condor for a
smaller credit? It would seem to make things less complicated and have
less commissions as well. I tend to think of these extra puts/call as
complicating the overall portfolio, especially in relation to your
recent posts on when you would then exit these positions (i.e. would
you exit your long puts at the same time you adjust your put spread
early?) I find the idea of opening up longer dated iron condors
intriguing but the concept of purchasing extra insurance seems to
really complicate the portfolio for me.

Tom

***

Tom,

NOTE: Overall 'risk' is a combination of how much you can lose and
the probability of losing it. Thus, 'reduced risk' can occasionally be
a confusing term. 

In today's context, I'm referring to 'dollars that can be lost' rather than the 'chances of losing those dollars.'

1) Any trading ideas I offer are meant to be something for readers
to consider. I would never tell you that you must (or even 'should')
adopt them.


What I am trying to do with this blog is to explain how options work
and how the average investor can use them. Obviously some readers are
far more experienced than others and already have ideas of their own.
That's good. If those readers think about what I have to say, they may accept
those ideas, or discard them. That's an educational process because it
gets those readers to consider alternatives and make a choice.


For the rookie, such as yourself, I'm offering ideas that you may
want to consider. But, if you are making your first few trades, we can
agree that you should take it slowly and not do anything that feels
complicated.


2) If it makes you uncomfortable, or if you don't fully understand,
please don't use such ideas. Not until you understand them well enough
to decide if they seem right for you and your trading style,
philosophy, and bankroll.


3) There is nothing wrong with legging into trades, if you believe
you have the market timing skills to do that profitably. Just
remember when you sell inexpensive spreads, it takes a decent-sized
move for the spread to widen by ten cents. That makes it tough to get
your price, even after the market moves your way.


4) Regarding selling wider spreads: NO. That INCREASES risk (larger
possible loss) with little extra to gain. That is not a good idea, and
is NOT anything similar to owning insurance. The whole idea behind any
type of insurance is to reduce the amount than may be lost.


Wider iron condors have a larger credit, not a smaller credit. Thus
I ask: Did you mean: open a wider iron condor that is FARTHER out of
the money?


If that is what you mean, that reduces 'risk' from the perspective
of: 'it reduces the probability of losing money on the trade.'


When I refer to 'reducing risk' I don't mean it that way. I use that phrase to mean: 'less money can be lost' on the trade.


5) Yes. If I am adjusting a losing put spread, I would sell out all,
or part of my extra puts. I would buy new insurance puts that are
appropriate for any new put spread that I sold.


But, if I buy in a put spread early because it became very cheap,
I'd still be tempted to hang onto my insurance. It truly depends on how
much I can get when selling those extras. If it's very few dollars, I
do not sell. Black swan events do happen. I may not want to bet on
them, but if I already own a cheap option, there is no point in giving
it away.

6) Commissions are not to be ignored.  But in today's world you can find a broker who charges less than $1.00 per option contract, with no additional 'per ticket' cost.  If you find commissions are hindering your ability to trade (and I get it, because I used to feel that way before the deep discounters arrived on the scene), you have the option to change brokers.  It's very difficult to avoid a trade just because the commissions are excessive.  If you feel that way occasionally, you must think about a new broker.  You don't have to change, but it is worth considering.


I hope this was helpful. Trading in an uncomplicated fashion is NECESSARY in order for you to remain within your comfort zone.

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