Tag Archives | profit and loss

Establishing a Maximim Loss for a Trade

Hi Mark

I know you always refer to the comfort zone to decide when to exit a losing trade, but to me, that concept is too vague.

If possible, I'd like to know if there is some ratio that allows the approximate calculation of the maximum price you can repurchase a spread (considering the other half of the iron condor is cheap) when the market is attacking the strike price.

Sorry to be insistent, but I have the idea that to be successful in long term, your losses   shouldn't be too big.   The underlying price usually touches one of the short strikes of the iron condor when you open a new position every month.

Anyway I'd like to know what is the amount you consider as the limit to repurchase one spread – if threatened out of your comfort zone -  to compensate with good trades.   I don't need you to say a particular number, I'm asking about the way of calculating the maximum losses to benefit in long term.

Yours, Antonio



I re-worded a portion of your question for clarity.  I hope you don't mind.

I truly have no good reply, but will offer the following advice:

Let's assume I make an almost identical iron condor trade every month.

There is no easily calculated set number that represents my maximum loss.  Here are some reasons:

1) If I trade one 10-point iron condor and collect $100, I can lose as much as $900.

If my plan is to make $100 most of the time, I cannot afford to take a loss of $900, even if it occurrs only once per year.  The remaining profit would be too small.  So far I know you agree.


I must set my maximum loss at a price that takes into consideration the following:

  • If I exit when the price reaches $300, I will never lose more than $200 per trade
  • If I exit at $300, I will not collect my $100 profit as frequently
    • I cannot know in advance how often my spread will reach that $300 exit price
    • I cannot know, in advance, how often to expect to earn my $100
  • I must gather data by paper trading and make this trade many times before I know the best exit price to choose.

    • This can be done, but it takes time and patience
    • Simultaneously, I would experiment with different exit prices
    • One year's worth of data may be enough to begin trading with real money, but I would want to continue the paper trading experiment to collect more data.  I may discover that $300 is not a good exit price.

2) If I collect $350 for my monthly iron condor, I will earn the maximum $350 less often than I would earn the $100 above. I still must know how often this trade will be successful.  I cannot use probability statistics because I don't know how often the iron condor will reach my exit price. 

If I decide to cap losses at the same $200, that means I would not allow the position to move beyond $550. Without a bunch of trades as history, I don't know how often to expect to exit, nor do I know how many times per year I would earn my $350 (or less if I decide to exit early at a low price)

3) Next consider this additional problem that must be considered to get the reply you want.  How much of the exit price do I reserve for the call and how much for the put spread?  When paying $550, clearly the spread in trouble is going to eat up most of that premium , but if I don't reserve enough for the spread that is not in trouble, I'm going to be forced to pay more or else remain short that spread – with little to gain and lots to lose.

4) Next consider this.  What hapepens when the market gets very volatile.  Say -3% one day, up 4% the next and then down 5% again.  The iron condor is not in any trouble.  It has probably moved only 2% (especially if it is a broad based index).  It is far from both strike prices and you feel calm (for the moment).

However, no one else is calm and the implied volatility of the options that comprise your iron condor has increased by 15 to 20 points.  That spread you traded for $100 is now priced at $300.  You are forced to exit by your methods at a time when you are not really in trouble.

It is true that it may be wise to exit an iron condor in a volatile market.  But if you prefer to hold, what can be your excuse?  What would your new exit price be?

5) Here's another situation for which it is difficult to use a formula. If you collect $400 for an iron condor, then the maximum loss is established at $600.  Would you really want to exit any lower than that?  You surely don't want to pay $8 for that iron condor when the risk is only $200 and the potential reward is up to $800.  So how can you make an intelligent stop loss decision?  Perhaps setting it at $200 would work, but I'd be afraid of reaching that point fairly often when collecting as much as $400.  As you know, when the premium is that high, the options cannot be very far out of the money.

Rule vs. Judgment

6) If you use a rule to make these decisions, you don't have much room to exercise your judgment as a trader.  If you want such a rule, I'd suggest the following – but please understand that this is my guess. 

Exit when your loss is between $150 and $200 if you trade iron condors at approximately $1 for a 10-point spread.  If you trade near $2, I suggest a maximum loss equal to the premium or perhaps $50 higher.  If you collect $300, my guess is that $250 – $300 should be the maximum loss.

However, market conditions affect my decisions.  I don't know about yours.

A different strategy

7) How about another strategy.  Let's say you buy a butterfly or an out of the money debit spread and pay $0.50.  Isn't that 50 cent maximum loss good enough?  Or would you feel forced to exit if it drops to 10 cents?  For that last 10 cents (you would have to pay commissions, so you would collect even less), doesn't it pay to take a chance and just hold the position?  There's almost nothing to lose, and every once in awhile a miracle happens.

My point is, there is no reason to establish a maximum loss when the cost is very low.  And yes, it's a very good idea to establish a maximum loss when potential losses are too high for you. Think about that: the loss is too large for you.  What does that mean?

That means the loss is outside your comfort zone.  If that remains too vague, by all means, establish a maximum dollar amount.  Perhaps that maximum will be based on a ratio that depends on the premium collected.  Perhaps it will be based on a specific dollar amount.

I do believe this is something you must work out for yourself. 

Unless some readers have ideas or experiences to share.  I'd love to hear from you.



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Exercising at Expiration Follow-up: A real world example

Hi Mark,

Thanks for your suggestions on my DFS trade. In fact I should have mentioned that a majority of my option positions are OTM credit spreads and iron condors.  This is the one or two speculative positions I have at a certain point. I entered the trade back in December anticipating DFS to go up, and it did. I do admit that I committed the sin of being emotional with my position and want to make even, but in this case, I also believe in the company and I do own the stock in another account with a higher cost basis. I was in a similar situation late last year, took a loss but slept well.

1) When you opened the position, and the price you paid are immaterial

2) Your position may have been born short a put spread, but now it's a naked short put

3) You 'believe in the company'?  What does that have to do with the price of tea in China?  Is owning naked long stock (or a covered call) the way you want to play this company going forward?

4) The fact that you own more stock in another account is immaterial.  Although the fact that you are already long with downside risk ought to encourage you to take less risk in this account

The cost basis of your stock is immaterial.  Only the IRS will care about that – if you ever sell the shares.

5) It is not a 'sin' to get emotionally involved with your decisions.  That's a trait that is difficult to overcome, but it is necessary if you want to be a successful trader or investor

It is not a 'sin' to try to get back to even.  However, it is an exercise in bad judgment. You obviously plan to continue to trade.  It should not matter which stock, or which specific position, provides profits.  Your goal is to earn maximum profits with minimal risk.  You are not doing that with this position.

6) One way to break that 'get back to even' mentality is to ignore your entry price for a trade.  Write it in your journal, but do not pay any attention to that price.  Pay attention to current risk and reward.

I recognize that my stance on 'forget about break-even' is the minority view, but I stand by my belief that it's the only view that makes sense.  Consider this:  You hang onto a trade to get one more dime out of it.  You need that one more dime to break even.  While waiting for the dime, the stock moves and you lose two bucks.  Nice risk/reward.  Maximum gain is a dime, maximum loss is ???

On the questions you raised, this is what I think:

Writing covered calls the best play? By the middle of expiration week, I have a couple plans in place:

Plan A: Close the spread with nice profit.   That did not happen 

This an example of you making a trade decision based on profit or loss and not on risk/reward.  It's your money, but this is not a good idea – in my opinion.

Plan B: Short DFS stock so I am completely out of the position by Monday.   I was going to do it on Friday if Plan A didn’t work, but DFS dropped further, so I decided that was not the best time to lock in an exit price 

Again, a decision based on the fact that it would lock in a loss to exit.  This is not a good decision based on risk/reward.  You are free to trade that way, but my recommendation is to learn to think differently.

Plan C: Exercise the $15 call and let the $17.5 call expire; then exit in the near future.  I chose to write covered calls.

A viable plan.  A reasonable strategy.  However, if you chose this backup to a backup plan just to avoid taking a loss, it's no longer a viable plan. 

There is one thing that I did not think about, and that is to roll the position to a later month.  I usually view different expiration dates independently, and I did not have the work done the night before. I guess I should start looking into this possibility. 

Sure, be aware of the possibility. Plan ahead.  If you can get a price you would be happy to get to roll, then this is a good plan.  But rolling just to do something – which is what you did this time, albeit with a weekend long leg – is a bad idea. 

Rolling is not some magical trade that turns losers into winners.  It's a decision to exit one trade and enter another.

Less risky plays? This position as I explained earlier, is one of the speculative positions I have, so by design if I lose 100%, I will be fine with it (on this one, I see that with a little more time I can turn that to a profitable position). I used to speculate with vanilla long calls but I do not feel comfortable with that any more.

When this trade was made, losing 100% meant a loss of $88.  Now it represents a potential loss of more than $1,400.  Are you still willing to lose 100%?  Is this a good speculation?  Are there no other bullish plays that satisfy you?  Must you own stock?

Let me see if I have this right:  You do not feel comfortable with the risk of owning calls, but you are ok with the risk of owning stock? That's not how I measure risk.  But the nice thing about options is that there are so many alternatives that we can each take the risk we are willing to hold.

Naked long over the weekend a good idea? Acceptable, I’m comfortable with it.

Covered calls ONLY because I refuse to take loss? Part of the reason why I exercised, but I also believe in the stock itself.

Gibberish.  If you believe the stock is moving higher  – can't you find a less risky way to be long?

Once again, thanks very much.

Thanks for the question and follow-up.



"I thoroughly enjoyed your book “The Rookies
Guide to Options
”.  The book has paid for itself many times
over.  Thank you." VR


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