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Finding the ideal trade strategy

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A follow-up question.

I guess the reason I was looking at this comparison (buying collars, buying call spreads and selling put spreads) this morning, is because I was looking at various limited risk bullish positions.

I concede that the following thoughts may not be well directed, nonetheless …

I noticed that in a typical bullish spread, the position has a break-even point that is roughly equivalent to the position’s extrinsic cost above the base strike. For example, to buy a 35/36 call spread (as of last Wed), with DBA at 34.90 would give a break-even around $35.50, which is about the same as the extrinsic cost of the position. So, to profit, the underlying has to move by more than .60 by expiration.

I also note that when one buys stock, there is no extrinsic cost and the break-even is the same as the price paid for stock. For example, if it goes up a penny by expiration, the buyer profits a penny.

Basically, the question I want to ask you is: Are there any option positions that can act like something in between these 2 examples?

For psychological comfort reason, I’m interested in a break-even trade – like buying stock – and limiting maximum loss to that of buying an OTM call spread. I’d trade-off something else in exchange for that.

One idea to accomplish this is with a collar. Instead of buying 100 shares only use 90,80,70,60,or 50 shares. I’d lose delta and compromise the upside protection, but I would meet my objectives. Plus, I could buy cheap FOTM put options as black swan insurance. Maybe this approach just makes sense for low $ stocks.

Crazy? Is there a better way to achieve objectives? Are objectives misguided?



Hello Dave,

The simple answer is no, there is no such animal. The reason is that you want the very low cost of an OTM option spread, but you want to buy it by paying no premium. That’s why the collar looks so attractive. You can buy puts and sell calls for little, if any cash out of pocket.

People choose to buy call options as a replacement for owning stock for two basic reasons. The first is leverage, allowing a small amount of money to be used to control stock and benefit if and when the stock moves in the right direction – before the option expires. The other, and more important reason in my mind, is to gain the benefits of reduced risk (after all, the stock may undergo a steep decline – even when you are bullish). The trader must pay for that protection (it’s the same as buying a put: long call is equivalent to long stock plus long put). You want it for no cost.

However, if you are willing to come along as we think outside the box, I believe I have a workable idea.

Thinking differently

It’s good that you are willing to trade something in return for what you seek. You want so much, that the only thing you have left to ‘trade’ is the sum you can earn.

To begin, consider selling an OTM put spread. We both recognize that it is the equivalent of a collar, but this time you are using lower strike prices than that of the ‘traditional’ collar (often both the put and call are OTM).

First, this trade can provide a profit, even if the stock declines (at expiration) down to the first OTM put strike price. So you are already better off than your first requirement that a profit be available if the stock moves higher.

Second, this trade limits losses. The problem is that the potential loss is greater than you could lose by buying an OTM call spread. However, here’s that trade-off you were willing to make:

  • Instead of selling (for example, 10-lots and collecting $1 for a 5-point spread)
  • Sell only 3 or 4
  • The maximum gain is reduced from $1,000 to $300 or $400
  • The probability of earning a profit is much higher than when buying stock
    • The stock does not have to move higher to earn money.
  • Loss is limited to $1,200 or $1,600
    • You control that maximum loss by the limiting size of the trade
    • You control that maximum loss by exercising sound risk management
    • Just as you would (I hope) sell the stock to limit losses at some point, so too do you limit losses by adjusting or closing the position, when necessary

You make that trade-off, which is reduced profits. Your losses are limited. You may earn money when the stock declines. What’s not to like for the bullish trader who is willing to accept limited profits in exchange for the specified benefits?

If you prefer, you can be more bullishly aggressive and sell a put spread that is ATM or even a point or two ITM. That reduces the chances of winning, but the maximum loss per spread is reduced and you can sell more than 3 or 4 of them.

No your objectives are not misguided – they suit the specific investor. However, not all objectives can be sought because it is not always possible to find a strategy that meets all of your requirements.


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Doesn’t making money mean it was a good trade?

Some days it's difficult to find a blog topic.  When that happens I spend some time reading other blogs, looking for ideas.  One, by the Stock Bandit, Jeff White, drew my immediate attention.  I've been saying the same thing for a long time, and it's always reassuring to see someone else with the same opinion.

In a post titled: Succeed by Not Failing, Jeff offers his opinion on a topic that many consider to be controversial:

"Too many traders think a winning trade is a good trade, and a losing trade is a bad trade…a failure.  I disagree."

The result of a trade is either a profit or a loss, but not a success or a failure.  Good trades can end up being losses, and poor trades can sometimes result in a profit. 

John gives an example and provides three common ways that traders fail.  It's worth reading.


If this is a topic that has not bothered you, consider the situation of someone learning to trade.  He/she dutifully opens a paper-trading account, chooses a strategy, but is not confident when choosing which options to trade. 

  • The covered call writer may be torn between selling ITM, ATM, or OTM options.  Then there's the problem of which expiration month to choose
  • The  butterfly trader may not know how far from the center strike to place the wings
  • The iron condor trader is told to find a comfort zone and begin from there

Comfort zone.  That sounds good.  We can tell when a position makes us nervous or whether we are entering into a trade with more confidence than usual.  But how do we do that?  It's based on experience.  We know what works and what doesn't work for us.  It's far better to have written trade records than to rely on what may be a faulty (biased) memory, but we have a feel for what to trade.

What is our beginner to do?  When initiating an iron condor position, the beginner has no idea what makes him/her comfortable.  With no experience, how far OTM is 'safe'?  Or how much premium does he/she have to collect?  Certainly there's no clue about an appropriate position size, and trading 1-lots is often the default choice.  But there's no 'comfort' there.  It's all uncertain territory.

The Winning Trade

 If this new trader is going to learn from making practice trades, There must be an understanding of how the trade was handled. 

Let's say our trader opens an iron condor position and the market moves.  The short put option goes well into the money and even the long put is ITM.  Doing nothing – out of fear and inexperience, our trader sees the market reverse, the iron condor expires worthless and here is a winning trade.  Not only a winner, but a maximum winner.

If the conclusion is drawn that this trade 'fits' into the trader's comfort zone and that the best way to handle iron condor trades is to wait for expiry, then this trader is already in trouble. 

This is a simple example of why it takes many trades before viable conclusions can be reached and why the result does not describe whether the trade was 'good.'

On the other hand, if the trader had felt queasy when the underlying declined and covered the entire position when the puts were 2% OTM (later than many would cover), he/she would have a losing trade and may conclude that this was a bad trade and that it was handled poorly.  Especially if the trader pays attention to what would have happened (I suggest not doing that).

In reality, it was the same trade and cannot be good part of the time and a poor choice at others.  Either it was suitable for this trader, done in the right size, had a reasonable risk/reward ratio – or it wasn't.  In this extreme example, it's risk management that made all the difference.  And to make matters worse as a learning example, it was poor risk management that led to the profitable trade.

Thus, profit or loss is not the deciding factor.  It's not to be ignored, but there are other things to consider.

Please use judgment when evaluating your initial positions.  Do not allow the final monetary result to enter into the decision-making process. Take your time.  Collect data and learn to read your own body.  Discover trades that make you comfortable and those which don't. Most traders sense when there is too much risk.  That could mean 'too likely to lose money' or 'too much money can be lost.'

That trader must also try to judge how well risk was managed because that's going to be an important factor in the trader's future profitability.  When first beginning to use options in a virtual account, it pays to take notes and try to gain something from every experience.  In reality, it's not easy to understand just what was done correctly (with the odds of success on your side) and where luck (good or bad) played a role.  However, the trader does accumulate knowledge as time passes. As he/she understand the trades better, the opportunity to ask questions accelerates the learning process.

Bottom line:  There's data to collect, experience to gain, and time before a new trader can know him/herself well enough to place money at risk.


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Adjusting a position: Using the underlying


I have maybe a naive question. Is it possible to make adjustments to already open positions, that might be 'in danger' of losing money, using stocks (or indexes if applicable) instead of options?

From "The Rookie's Guide to Options" I know that it is possible to create 'synthetic' positions and sometimes it makes sense to trade them.

One example: A put spread where short side is ATM (or very little out), probably too late, but at this point the put should be bought back.  Instead one might short the stock and buy a call to protect from a big upside move.

Could you please explain what are pros and cons of such adjustments.



Good question.  Let me reply by making some points

1) Yes, you can use stocks or futures or any underlying asset for adjustments.  Remember that these adjustments provide only delta (positive or negative), and do not reduce gamma, vega, or theta risk

2) Any trade that reduces risk and leaves the trader feeling comfortable with the adjusted position – is a satisfactory adjustment.  That is one of the goals of risk management.

3) Buying or selling shares is a very appealing adjustment method, but in my opinion, it's a poor idea.  Many traders use stock as their adjustment of choice, believing that 'fixing' delta is all that is needed to make a satisfactory adjustment.

Think about why the position is in trouble in the first place.  The ATM put contributes significant negative gamma to the position.  Buying, or in your example, selling, stock does nothing to reduce that gamma risk.  It does take the immediate delta risk out of play.  And that's good enough for some traders.

The advantage of using stock is that the trader doesn't have to pay for any gamma and does not have to sacrifice any theta (time decay).  After all, thinks the trader, I'm in this position to collect theta, so why would I want to make a trade that cuts my positive theta?

Answer: Because buying gamma comes with negative theta. And reducing both delta and gamma is going to make the position safer than only reducing delta.  If you – an individual decision – are comfortable with maintaining the negative gamma position, then by all means – adjust with stock.  However, I feel more comfortable reducing delta and gamma risk, rather than delta only.  There's no right or wrong here.  It's a personal choice.

There is also risk of getting whipsawed.  Although that possibility exists with any adjustment, it is especially painful when the adjustment was made with stock becasue it results in a buy high, sell low scenario.

My recommendation is that it's okay to adjust with stock when you cannot figure out what else to do – but the adjustment should be temporary.  As soon as you have the chance to unload the stock position and replace it with a positive gamma trade, that will give you a better position.  'Better' from the perspective of less risk in the future.

4) Consider your example.  You are long delta because of a short put spread.  Apparently you don't want to buy any puts, but you are considering selling stock short and buying calls to protect the upside.

Ask yourself: Why don't you want to buy puts?  Is it that if you buy the put you sold earlier that you would be locking in a loss?  Is it that puts seem to be too costly?  Is it that you hate paying the time decay present in the puts?  Is it that it feels more 'professional' to make an adjustment, rather than closing the position?

None of those is reasonable.

When you short stock and buy calls to protect the upside, you are buying synthetic puts.  Stock plus a call is the same as owing a put at the same strike as the call.  If you make the suggested trade, you are complicating a position (and raising margin requirements) for no good reason.  Buying the synthetic put is the same as buying the 'real put' – and if determined to make the stock plus call play, then I strongly recommend buying the appropriate put instead.

To answer, I cannot think of a single 'pro' for making that play , only 'cons'- unless the prices of the options are so far out of line that buying stock plus puts is a lot cheaper than buying the call (do not forget that it costs money to own stock).  The 'cons' have it.

Robert – just because you can trade a synthetic (or equivalent) position, it does not follow that it's always a good idea.  Here, buying protection in the form of puts makes the most sense (unless exiting makes you feel better).  As an aside:  DO NOT refuse to exit this trade to avoid locking in a loss.  If this position no longer feels right to hold, then please don't hold it.  On the other hand, if you like the adjusted trade and want it as part of your portfolio, then adjusting is the better choice.


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Trading Iron Condors. The Opening Trade. Part II

Part I

Continuing my reply to Frank's questions:

We are discussing SPY iron condors and making choices about the options being traded.


2) The delta of the sold options is important to the probability of success and the probability of reaching a point that requires making adjustments.  It also plays a role in the cash collected.  Thus, it's a key element when constructing the iron condor.

You currently sell options with a 20 delta and one of your complaints is that you adjust too many times before being able to close the trade.

Do not even think about moving from 20 to a higher delta, unless you KNOW it will be comfortable.  You already 'make too many adjustments,' and thus I believe moving beyond 20 delta would be a big mistake at this point in your learning process.

When this experiment is over and you have drawn some conclusions, that's the time to think about (and hopefully discard) the idea of moving to 23 or 24 delta.  Moving to 30 is NOT going to work for someone who already believes he makes too many adjustments.


3) Spread Width plays an important role when choosing your iron condors.  From your questions I can see that you don't have any idea how to make a good strategic choice.  You allow time and premium to be the deciding factors when choosing the iron condor to trade.

You decided to trade 10-12 weeks spreads, chose to sell options with a 20 delta, and decided that the cash premium should be roughly $1.10.  Satisfying those parameters gives you no choice in choosing the iron condor.  Thus, for you, it's 4-point spreads.  That is not an efficient method for choosing trades.  It completely eliinates any judgment on your part.  It ignores your comfort zone (which is something you now realize). Let's see if I can help you make better decisions.

Here's a nuts and bolts idea of how to select your spread width, along with some commentary:

  • Did you know that the 4-point spread is equivalent to owning each of the adjacent 1-point spreads?  in other words, when you trade the 128/132 call spread 50 times, you really traded:
    • 50 of the 128/129 call spreads plus
    • 50 of the 129/130 call spreads plus
    • 50 of the 130/131 call spreads plus
    • 50 of the 131/132 call spreads
  • The only difference is that you save the commissions of trading each of these four spreads by trading them all at one time.  You MUST understand that this is true.  

You cannot trade options without grasping this basic concept:  Trading each of the four spreads is equivalent to trading the 4-point spread.  The risk/reward is identical. 

When you understand the truth of the above, then I hope it becomes clear that choosing the four-point spread is almost guaranteed to be a big mistake. Why?

I understand choosing a spread based on how much premium is collected.  However, people who do that (me) already know the desired spread width.  They do not allow the need to collect a certain premium define the spread width.

In relative importance, spread width comes in far ahead of premium. 

You are not thinking about the position. You made your 'line in the sand' requiements and tht's the end of the thought process.  Trading by rote or very strict rules is not viable – unless you already know that you will like the position forced upon you by the rules.  Clearly that is not the case here.

  • Look at each of the four spreads as an independent trade
    • Do you want to sell the 128/129 call spread?  I know you chose it because the 128C has a 20 delta.  But do you really want to sell this spread?
      • Is the premium sufficient for the risk?
      • Next, do you really want to sell the 129/130 spread?
      • Next, do you want to sell the 130/131 spread?  The premium is getting fairly small
      • Last, do you truly want to sell the 131/132 spread?

I cannot answer any of these questions.  My point is that it is highly unlikely that you want to sell each of these spreads.  If that's true, then sell only the spreads you WANT to sell. Do not sell any other spreads just to get the premium where you prefer it to be.  It forces you to make a BAD trade (BAD because you do not want to own it).

Instead of focusing on a 4-point spread to collect the 1.10 premium, concentrate on the spreads you want to have in your portfolio.  You may decide to stick with the 20-delta and sell only the 128/129 C spread.  Or you may prefer the 128/130.

You also seem to have latched onto the .20 delta option as if it were a requirement.  Perhaps you would feel more comfortable choosing only the 129/130 spread or the 129/131.  You would adjust less often, and that may solve your combination of problems.

Please give serious consideration to each spread that makes up the call and put portions of the iron condor and then choose to trade only the spreads you like.  For margin and risk purposes, it's best to keep the put and call spreads at equal width.  But it is not mandatory.

4) Multiple iron condors with same expiration

You must understand that you already have multiple iron condors in your account.  However, the fact that you don't 'see' the equivalent positions in your account leads you to believe that you own a single iron condor trade.

Nevertheless, I understand what you mean.  If you sell the 130/131 call spread and also sell the 132/133 call spread (and something similar on the put side), then you 'see' two different iron condors.

There is nothing wrong with doing that.  I do that all the time.  However, I initiate the preferred iron condor.  Then if I want to add to my portfolio, I'll choose a spread that is appropriate at the point of entry.  Many times that's an iron condor with different strike prices.  If you plan to open them simultaneously, be absolutely certain that you WANT to own each position and that you are not making the trades because you like the idea of owning a variety of spreads with the same expiration.


Bottom line: I cannot overemphasize that it is bad policy to choose spreads that fit some preconceived notions. 

As a rookie trader, you have to observe more trades as you gain the needed experience.  But you can, and I strongly recommend that you do, trade positions with the risk/reward that places each trade squarely within your comfort zone.  When you are more experienced, you can try to expand that zone.  But not now.  Now you are learning to trade options and your primary goal is to survive.  It's great to be earning money on a steady basis.  But this game is not quite that easy and I'm pleased that you are not getting overconfident.

Thanks for the excellent questions.



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Trading Iron Condors. The opening trade Part I

Today's post covers an important and popular topic. Choosing the parameters of the original iron condor is a complex issue.  There are strikes and expirationn dates to choose.  Then there's the right underlying and  spread width.  For some traders, there's the timing element.  A fascinating topic and I have much to say.

Here's a recent series of questions:

Hi Mark,

Thank you for maintaining this blog.  your comments have been very helpful to me.

I have been trading condors since April by using SPY at 10 to 12 weeks from expiration, selling the short strike at a delta of .2, I target collecting a premium of $1.10+.  This results in long position at 4 points from the sold position (i.e. sell a 128 call buy a 132 call).

I make partial adjustments if delta reaches .35 by reducing the spread to two positions [MDW: I have no idea what 'two positions' means], reducing the position or converting to a calendar or even a vertical. I have been making money, but at times I feel as if I maybe making too many adjustments (two to four before closing).

I try to exit the positions at 4 weeks to expiration. I found that the $1 premium collected allows me to make adjustments yet still have a profit. My usual position size is 50 to 100 contracts per leg, but at this time, I believe [emphasis added, MDW] the 4 point spread range maybe too risky.

I am considering reducing my exposure from a spread of 4 to one or two. I am using the thinkorswim site and found that if I stay with a .20 delta for the short strike and choose a two-point spread, then premium would be about 70 cents.

To go to a .30 delta and a one-point spread, I would collect about 50 cents; or at a .4 delta the premium is 70 cents.

I am also considering multiple condors with same expiration month such as selling SPY 130/131 and 132/133 call spreads. [MDW: Frank then goes on to offer adjustment ideas, but that's off topic] 

I am most comfortable trading SPY.  I tried using SPX once and got burned by waiting to long to close the trade, and its not as liquid as SPY.

Mark any suggestions you can provide or other factors I should consider would be appreciated.


Happy new year Frank,

I like the questions and the fact that you are seriously considering several alternatives. By the way, you got burned with SPX because you waited too long.  That has nothiing to do with preferring SPY.

There are two problems for me.  The answer you seek requires a great amount of detail, and could easily fill a couple of one-hour webinars.  I simply don't have the time to provide that much detail.

But more importantly, I would be responding from my personal perspective and you must truly trade something that fits within your comfort zone.

In responding to the questions, I'll take the path of offering advice – that I trust will help you find the answers. The comments go directly to your questions.



Let me begin with some comments:

  • If you believe it is too risky, that's the end of the discussion.  In this matter, do not let anyone try to convince you that your decision is foolish.  'Too risky' is not a fact.  It is an opinion, and yours is the only opinion that counts.  It so happens that I don't like your 4-point spreads, but more on that later
  • You have too little experience to be rock-solid with a single trading idea.  I don't care how much money you have been making or whether you have been a winner in each of these months.  You have not seen enough to understand how the markets truly behave over an extended period of time
  • Experiment now, as you plan to do.  If some of the experiments feel uncomfortable, then you have only two choices.  Don't trade them due to the discomfort, or use a paper-trading account for those trades
  • The fact that you have been trading 50 to 100 condors per month is irrelevant.  For most newcomers, that's far too much size.  if you are trading an account with $10,000 to $12,000 – then your size is egregiously large and you are in way over your head with risk.  On the other hand, if your account has one half million dollars in it, then your size is truly peanuts and you are indeed learning to trade on a small scale. What's more important than contract size is the percentage of your account value that is being tied up in margin for these trades.  I'm not asking you to disclose that, just trying to tell you that contract size says nothing
  • The item that I like best about your inquiry is that you show some fear, despite profits.  That's excellent.  One of the best ways to go broke in a hurry is to become overconfident.  I'm pleased to see that you seem to be avoiding that
  • While making these experimental trades, make it easier on yourself by cutting position size.  Maybe 20 to 30% fewer spreads.  Why? Less pressure while playing with alternatives.  Yes, less profit potential, but the learning experience should prove to be beneficial for a long time, and it pays to do it correctly.  With less pressure to succeed and more time to make observations, you get to study the alternatives in a calmer atmosphere

to be continued…




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Trader’s Mindset Series II. Always Collect Cash

In the first part of this series, I wrote about beginners who ask the wrong questions, such as: 'How much can I expect to earn when trading options?'

This time I'd like to continue on a theme that began yesterday. That theme can be simply stated:

There is a subset of option traders who seldom, if ever, are willing to pay cash.  All  initial trades, all adjustments, all rolls – must be made at a net cost of zero or less.  The only exception occurs when exiting a trade and collecting a profit.

Opening the trade

When selling premium, it's natural to begin by collecting more cash for options sold than you pay for options bought.  And those who sell naked options never think about buying protection or limiting losses – because it cannot be done for free.  The following discussion of this specific trader mindset refers to trading spreads rather than naked options, although the principles are the same.

The opening trade is easy.  The traders wants to collect a cash premium and choose one of a bunch of strategies that enable him/her to do that.

Managing the trade

This part is more difficult.  If all goes well and time passes, then the option values decrease and may eventually reach a point that our trader is willing to spend a small sum to exit the trade.  However, it's likely that the position will be held, hoping all options expire worthless.  Paying a few nickels to exit a trade and eliminate all future risk is not a popular idea.

One of the problems with this mindset occurs when the market does not behave in a manner that is friendly towards our trader's position.  Premium selling and negative gamma are close relatives.  When the market goes against  a position, further moves increase the rate at which losses increase and the position becomes more dangerous.

Traders with a more normal mindset: "This position requires an adjustment because my current risk is too high and I must avoid a large loss" have no trouble making good trades that reduce risk.  Most of the time these trade involve spending cash.

  • Reduce size and buy back some of the position
  • Buy single options for protection
  • Buy debit spreads for protection
  • Buy…

The strategy tends to be to buy something and spend cash.

However, the trader with the mindset under discussion: "I don't want to pay cash for any option trades.  I do want to prevent large losses, but I will find a way to protect myself with no cash out of pocket" has a more difficult time managing the trade.

Clarification: It's may not seem to be a more difficult time for the trader.  He/she is happy to sell extra premium because it affords an opportunity to make even more money.  However, these traders increase overall risk and do almost nothing to take care of the current problem.

When the market rallies and the position is short too many delta, this trader does recognize the need for making an adjustment.  At those times, the most obvious first choice (for the 'take in cash' traders) is to sell some puts.  That not only adds cash to the coffers, but it adds positive delta.  That's a feel good trade.  However, it's very short-sighted. 

What's wrong with getting some useful positive deltas by selling puts?  Two things.  First, it does almost nothing to reduce the current upside risk. The only upside benefit is to keep most or all of the put premium collected.  However, that cash is not enough to offset the losses that accrue as the market marches higher and negative gamma soon makes the position lose money more quickly that it did before the adjustment.  Second, the position now has risk where none existed – downside risk.  And for what?  For the cash collected to 'protect' the upside.  Selling those puts is not a good idea.

What about rolling?  Surely that's a good risk-reducing technique, says our trader.  Well, 'yes and no' says I.

Rolling works when you move to a good position and exit the risky trade.  However, with cash as the driving force behind the roll, the trader often rolls to a position that is already too risky for an initial trade.  It feels good because it includes extra cash and moves the short options farther out of the money.  As I said that feels comforting.

But it shouldn't.  The new trade is probably so far from neutral that it already requires an adjustment.  That sets up even more risk.  And if the call spread was rolled because of a market rally, and if new puts are sold to balance the new position (turn it into an iron condor), then what about those now FOTM puts from the original iron condor? Prudence dictates paying some price to get those puppies off the street, but our intrepid cash collecting trader does not think that way.  In fact, in his/her mind those have already expired worthless and that, in an of itself, reduces the bath being taken on the call side of the trade.

Then there's the situation when rolling isn't good enough.  It's necessary to pay $6 to buy back the (now ITM) call spread and the most reasonable place to roll (to collect lots of cash) is a spread that trades near $4.  Most credit spread traders do not sell 10-point spreads for $4 when the idea is to watch the options expire worthless.  They are far too close to the money.  But the trader with the cash is king mindset will sell 3 spreads for each two bought.  That allows him/her to roll the position at even money (buy 2 at $6; sell 3 @ $4). 

Immediate risk is gone and the shorts are no longer ITM.  However, this is a very short delta position, had a potential loss that is 50% greater than the original, and is likely to create additional problems.  Rolling for a cash credit may feel nice, it may make the trader falsely believes that no loss has been taken and that there is still a good chance to collect the entire premium – but it's a hollow belief.  The truth is that risk has increased.  That is not the path to survival as a trader.


This is the easy part for most traders.  Take the profit and move on.  To the cash is king trader, buying in cheap options is a waste of money and the trader believes that options were made to expire worthless.  Another misconception and dangerous belief.

If the mindset described fits you, please at least think about modifying the way you think about trading options – to something more reasonable.



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Premium Selling in Low IV Environments

I've received a few questions about selling option premium when IV is low.  This is one example:


For approximately 1 month stocks have gone up without the volatility that we had become accustomed to in the fall.  At the same time the vix has gone down to approximately 16.

It pays to look at the multi-year picture to get a better feel for what can happen to implied volatility.  We are indeed below long-term averages at this level, but as recently as Jan 2007, VIX was 10.  The point is that we may look back at these IV levels and think of them as being relatively high. I have no idea which way IV will be trending in the coming months.

I usually sell option premium and with such low implied volatility on individual stocks, it has become very difficult to sell premium without being exposed to higher touching or expiring risk to get the same premium.

Those last four words describe the problem.  Whether you are trading credit spreads, iron condors, or even selling naked options, the decision on which options to trade MUST be based on something other than option premium.  Premium is one of the important consideations, but allowing that to be the one and only factor is a big mistake, in my opinion.

I urge you to think seriously about collecting the same premium when that involves taking greater risk.

When IV is low, it's low.  You must accept that fact and adapt your trading habits.  If you want approximately the same level of risk as your previous trading, then there is no alternative: you must accept a reduced premium.

Taking on more risk is always wrong – unless the extra reward more than compensates.  If you must take more risk, trade smaller size.  You are dealing with statistics. Unlikely events will occur at random times.  If you do not trade as if that fact were the gospel, then you must get rich quickly (and then retire from trading) because you have almost no chance of surviving over the longer term.

Positions that originate when already outside your comfort zone have too much probability of not working.  You may not like my answers, but I implore you: 'Please' do not take more risk just because the markets have not been volatile. 

This is a different market, and perhaps a different strategy should be used during these times.  Positive gamma can be added to your premium selling portfolio, but that would cost some cash, and your note tells me that spending money for any options is not something you are anxious to do.

In your webinar (at Trade King, on debit spreads) you discussed how the debit spread was very similar to the credit spread with a small advantage to the credit spread as you can do whatever you want with the cash.

In times of low volatility such as this holiday season how does it impact the strategies?  Selling credit spreads with such low volatility is very likely to result in problems with vega increasing faster than theta decay making it an unattractive strategy.  

More than similar, it's equivalent when the trades are initiated at equivalent prices, using the same strike prices and expiration dates.

You have drawn incorrect conclusions: It's not 'low volatility' that is 'very' likely to result in problems.  It's your personal need to collect the same premium.  You are increasing substantially the probability that those 'problems' will arise.  It is not mandatory to do that.

Remember that premiums are smaller for a good reason.  The market has not been volatile and thus, the expectation is that low volatility will continue. In fact, the market has been less volatile than predicted by VIX, and that's one reason VIX is still trending lower. 

You could be happy with a non-volatile market.  You could look at it as a less-risky situation.  Yes, it offers less profit potential per spread, but it also increases the probability of earning a profit.  What's so wrong with that?  You may prefer the higher risk/higher reward scenario, but that is not what this market is offering.  You have chosen the higher risk/SAME reward strategy.  Surely you must understand that this may work for you, but it is not wise and it fights those statistics mentioned earlier.

One reasonable solution is to alter your methods.  My solution to these 'IV is too low' situations may not suit you, but I try to own positions with less negative vega.  Thus, if I trade iron condors (I do), then I may add some OTM call and put spreads – just to add positive vega and gamma.  That reduces risk. But be sure to add positions that reduce risk, and do not add to it.

Or I may add diagonal or double diagonal spreads to an iron condor portfolio, making it more vega neutral.  You may decide to go long vega – if you expect that IV will increase quickly.  There are alternatives to your chosen methods.

More often I do not sell credit spreads but sell uncovered options further out of the money and this too is very unattractive with low volatility.

This is a strategy with higher risk.  I have nothing extra to say about this except that moving strikes nearer to the stock price is not the way to go. 

Another possibility for careful traders is to sit on the sidelines until finding something comfortable to trade.  You are not forced to trade right now.  As a compromise, trade one half as many contracts as you do now.

We must be prepared to modify our strategies when market conditions make those strategies less comfortable to use.  Flexibility – not increased risk – is the way to prosper.

Please explain your spread strategy preferences pro and con for very low volatility. 

This is more of a 'lesson' than a quesion, and I respond to questions such as this in the comments area (nor via e-mail.

Answer: I trade iron condors in smaller size – i.e., I trade fewer spreads and just accept that I'll try to make less money.  If you are successful, if you are making money, then it has to be okay to earn less when you feel risk is too high.   I also consider owning a portfolio that is far less vega negative.  I also consider buying insurance (naked strangle)

And please explain your spread strategy preferences pro and con for very high volatility.

Again, this reply required a book chapter, and I cannot go into detail here.

Answer: As an iron condor trader, or credit spread seller, I go farther OTM when IV is high.  I do not go after the higher premium.  I anticipate more volatility and move farther OTM to accept the same, or even less credit.  I like being farther OTM and will take 10% less premium to move another strike OTM.  I trade negative vega strategies and  recognize that some months afford larger profit opportunities than others.

For spreads one is always buying and selling volatility.  For deep in the money there is little impact for volatility as there is no time premium, but in most other circumstances one option is being sold and one is being bought and it seems to me that a change in volatility will have in general a similar impact on spreads of nearby strikes.

Similar, yes.  Nearby strikes and DITM strikes, yes.  But when selling OTM spreads, there is enough difference that the spread widens as IV increases.  This is more obvious with put spreads, where the skew curve plays a larger role.

There is no best answer to this situation and there is no set of rules to follow.  There is only good judgment and risk management. 

There is a lot of hit and miss when trading – it is not an exact science.  I suggest avoiding extra risk, even when that means trading less size.  I advise accepting smaller premiums, and maybe taking a trading break.  However, there are appropriate alternative strategies when you believe IV is moving higher. When it is low and you don't know where it is headed, it seems to me that vega neutral trading is the safest path. I know safety is not your current concern.  It's not too late to reconsider.


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