Tag Archives | Russell 2000 Index

Meet Our Readers


This email is in response to 'Real Life Iron Condor Trade' and 'Meet Our Readers.' This series of trades leads to the least common multiple of my present position in RUT.

I am interested in your (and possibly your readers') thoughts.

Not certain which way to express IC and DD trades, but I think this will be intelligible:

The trades

12/16 +20 RUT FEB IC 700/710/830/840 @ 3.50 credit
[On Dec 16, I bought 20 iron condors, collecting $350 apiece]

Concern begins developing over RUT gains, so I bought some insurance.

12/21 +1 RUT FEB C 800 @ 19.40

The cost of this insurance was to be offset by the sale of some 830/840 or 840/850 call spreads.

The market continued to rise and disagreed with me about the value of those spreads.

Ready to put more at risk

1/07 +40 RUT MAR IC 700/710/850/860 @ 3.50 credit

1/14 +50 RUT MAR IC 730/740/860/870 @ 3.57 credit

But not so thrilled with being short that much vega: Thus,

1/14 -10 RUT MAR P 740 @ 10.90

1/14 +10 RUT JUN P 730 @ 27.55

1/14 -10 RUT MAR C 860 @ 6.80

1/14 +10 RUT JUN C 870 @ 20.60

My thinking is that vega largely protects me on the present collapse in RUT price and so I have done nothing. Even so, the 740 strike looks painful. The plan is to begin selling delta and buying gamma somewhere between the 740 and 760 strikes, if RUT reaches 770. I'll try to slough about 60 deltas and snag a gamma for about $3,000. Once the 750 level is breached I shall need to buy 20-30 of the 740/730 spreads.

Below 740 would the time to consider unwinding the diagonals, and I am always looking to unwind the rest at good prices. The remaining reward for FEB is starting to feel small.

The real money (i.e., paying a debit) diagonal is new for me, but felt necessary for continued premium collection.

On 2/1 I was able to buy in 20 RUT FEB 710/700 P for 0.30 and happy to do so. Shortly thereafter (2/3) I bought to close, 20 RUT FEB 830/840 C @ 0.70 and also sold 1 RUT FEB 800 @ 9.00

On 2/3 I put on the new position: +20 RUT APR 730/740/850/860 @ 4.40 which (afterward) I notice has my positions bunched more than I would prefer.

On 2/7 purchased protection in the form of 2 RUT MAR 830 C @ 12.90

On Friday (2/11) I removed risk by purchase of 40 RUT MAR 710/700 P @ 0.40, but there’s still plenty of risk at the 830 strike.


If you want to share a trade, personal incident, or relate how you became an options trader, please send e-mail to blog (at) mdwoptions (dot) com.

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Plunge Protection Team? Pump and Dump?

Hi Mark,

Recently I have been seeing a lot of the classical pump and dump
scheme in RUT. The futures usually went much lower compared to previous
day's close, then RUT opens by gapping down, and then rising back up
again, usually to previous level. And all this happens with a lot of
rhetorical delusions on the news, like 'futures down on euro woes',
'stocks up amid whatever nonsense'.

So my question is, do you see this as a concern? My opinion is 'I
do'. I think the zig-zag behavior is hurting people with stop losses.
That means the guys with proper risk management will be toast.

On the
side note, do you believe this is the undoing of plunge protection team?



Plunge Protection is a giant topic all by itself. I have no proof it
really exists. But plenty of people are convinced. From Wikipedia:

"The Working Group on Financial Markets (colloquially the Plunge Protection Team) was created by executive order on March 18, by Ronald Reagan.

The Group was established explicitly in response to events in the
financial markets surrounding October 19, 1987to give recommendations for
legislative and private sector solutions for "enhancing the integrity,
efficiency, orderliness, and competitiveness of [United States]
financial markets and maintaining investor confidence".

"Plunge Protection Team" was originally the headline for an article
in The Washington Post on February 23, 1997,
and has since become a colloquial term used by some mainstream
publications to refer to the Working Group.
Initially, the term was used to express the opinion that the Working
Group was being used to prop up the markets during downturns."

In my heart, I believe the Obama administration wants to do the right thing.
However, I think in our horrible financial condition, there is just no
money available to support the markets. Thus, I don't believe the PP team would be doing much, if their mandate is to actively support the markets.


Pump and dump works for the stock of small companies. I don't see how
it can work for a gigantic index. Perhaps I am merely being naive.


I do believe, as you obviously do, that the stock markets are no longer a
safe place to invest. Trading is still viable.  But investing for a
decades-in-the-future retirement account: That's just a gamble.

I believe the quants have demonstrated the ability to take much of the
inefficiency out of the markets, and if they had not been over-leveraged
and greedy, they would still be doing so.

My point is that the
individual investor, as well as the professional money manager, has
virtually zero chance to win.

And the thieves still run the place. Allowing the banks to survive, and
now prosper with zero remorse and zero appreciation for being saved –
that's just too outrageous for words.

Sure investors can profit, but the game has changed. Careful research no
longer matters. Things we cannot comprehend rule the markets.  It's a
brave new world in which trading with open-ended risk (such as being
naked longs stocks) is unacceptable.


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Risk Management: Are Rules of Thumb Applicable?

Don asked:

I recently ran into trouble with some high probability iron condors on
RUT. I know this has been a difficult month but would like to know
“rules of thumb” to apply to these type of trades.



I don't believe there is a generic set of rules or generalizations that works for everyone. 

I know this rule of thumb is important:

Don't allow the position to move outside your comfort zone.

However, that's not a useful rule. To begin, there's no way for anyone to understand where your comfort zone lies.  It's even difficult for you to know. You'll know when the position upsets you or makes you nervous – but by that time you are already beyond your boundaries.  Thus, you must have a way to 'do something' before that happens.  Not so easy when you cannot recognize when the zone boundaries are about to be breached.

One way to make that 'stay withing the zone' rule easier to achieve is to adjust trades early, rather than late.  What will that do for you?  It makes the position less risky, making it less likely the position will reach the point of making you uncomfortable.  The problem with that idea is that many adjustments result in a loss – possible through a poor choice of which adjustment to make – but why spend money on insurance – unless that's your preferred approach?

But, there are side effects.  It makes you adjust more frequently.  Is that a good thing for your situation?  How can anyone know?  Why should you take a more conservative view just because it's not easy to determine when it's the proper time to make that adjustment?  

The point is that there is no suitable rule of thumb.  By definition, that's supposed to be a general rule, or one that applies to almost everyone.

How about this as a rule of thumb?

High probability iron condors are not your friends

That doesn't seem right, does it.  More than that, what is high probability?  Is it 95% or 90% or 80%?  The way you define the term is probably nothing similar to the way others define it. 

If you choose 98% probability iron condors (that means there's a 2% chance, if held to expiration, that one of the options will finish in the money), the low premium makes this methodology unsuitable for the majority .  The delta for each short option in the iron condor is 0.01 – and that means a low premium.

Why unsuitable for most?  Because undisciplined traders cannot bring themselves to adjust, or exit, a position to lock in a loss.  When you trade 98% iron condors, any adjustment is likely to lock in a loss.  That makes trading them a losing strategy for most investors.

The problem is, can that rule of thumb be used?  I don't think so.  Especially for anyone who considers a 75% to 80% chance of success to be a high probability.

You can use this rule of thumb.  I know it will help with the problem.

Trade smaller size

The easiest method for managing money (and thus, managing risk) is to be certain the size of the position is not too large.  Imagine a gap opening that makes one side of the iron condor completely ITM.  If the amount lost would hurt, then the position is too large.  Trade smaller.

Don, if you manage money properly, the position will not be too risky.  That already helps when the markets don't behave.  Outside of that rule, I'd suggest that you look into becoming a bit less aggressive and consider making small adjustments earlier than you do now.  Even an early one-lot can make a difference.


Unsolicited comment from Don: "the author is an experienced floor trader who replied to all questions asked. If you are inclined to purchase $2000+ in software and another
$2000-5000+ in so called "training" or "education", please save your
money and seed your options trading account with it instead. But before
making ANY trades, nail down what this book teaches. It is all you need."


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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.


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