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Adjustments: Selling Puts in a Rising Market

Mark,

I wanted to get your thoughts on a RUT put spread I sold yesterday [Jan 11].

A few weeks ago I sold a RUT call spread with the intention of selling
a put spread to complete the iron condor at a later date. Shortly after,
though, RUT jumped more than 20 points in less than 2 weeks and I never
got around to selling the put spread.

Monday afternoon, I became concerned that good earnings
reports could skyrocket the indices and I'd have to take a loss on my
call spread and roll it. To hedge myself, I desperately sold a put
spread for much less than I felt it was worth in the closing minutes (I
had to lower my ask price several times before it finally sold).

Do you feel it was worth selling that put spread for less than I
felt it was worth in order to balance my call spread before earnings?

Andy

***

This is not an unusual story.  Even traders with the best plans can have trouble sticking with those plans when a small (hopefully it's small) sense of panic is felt.

1) My biggest concern with your question is not the dilemma you state, but the phrase: 'I'd have to take a loss on my
call spread and roll it.'

a) You do NOT have to roll it.

b) Exiting with a loss is a perfectly acceptable risk management technique.  I hope you believe that this is true.

c) Rolling is a fine alternative when one condition is met.  It's a simple condition, but important.  DO NOT ROLL unless you like the new position and prefer to have the position in your portfolio.  If that condition is not met, simply exit (or otherwise adjust) and wait until you find a position you do want to own before making the trade.  As a constant roller (over a period of years) I finally woke up one day and recognized the serious errors I was making by rolling a position in an attempt to prevent a loss. 

The loss cannot be 'prevented.'  It has already occurred.  It is not essential to get back to even on this trade.  Take the loss and make money on a good trade when you find it.

2) Ask yourself this question:  If your fear is a rapidly rising index, how much extra protection did you get when selling the put spread?  Not very much, was it?  If you had been able to get a better price – perhaps even the price you thought it was worth, would those extra dimes have made a meaningful difference?

I understand that you had not yet sold any put spreads, so this was not a trade that doubled your downside risk.  But it gave you downside risk when you had none.

My answer to your question is: No.  It was worth neither the risk nor the potential reward (of course, if you collected $4 for a 10-point spread, that makes a difference.  I'm assuming you sold a spread for not too many bucks.)

3) From my perspective, it's not that you sold the spread for less than fair value that's the problem.  If the sale is a good idea, those extra dimes do not matter that much. 

But this was not a trade you needed.  It was a trade you felt you wanted.

That raises these questions:  Are you truly comfortable legging into iron condors?  Would you be better off selling the second leg as soon as you are filled on the first leg?  Or better yet, why not just trade the whole iron condor in a single order?  You may miss out on some good legs, but please ask yourself – the only person who knows the answer – whether you make enough on the good legs to make up for all those times you never get to sell the second leg – or even worse, sell it at a poor time.

My guess is that you will be better off if you forget the legs. Especially call legs.  If you are wrong and the market rises, the IV decrease makes selling a put spread much more difficult.

4) There are many adjustment methods available to a trader.  As usual, I'm not trying to tell you which is best, but I have a strong belief that the worst possible adjustment is the sale of more options to collect some cash.  I know this is a popular strategy and that some traders love it.  But perhaps there is more to their methodology than I am aware.

The cash collected is seldom enough to  provide the needed protection.  Thus, if that 'adjustment' trade works, you gain little.  And if the market reverses, you did not receive sufficient compensation for the additional risk.

5) Sometimes it's necessary to take the loss and move on.  It may not be easy to know when that time has arrived, but your upset stomach, queasiness, and general discomfort, along with a possible inability to sleep will tell you when your position sucks.

580

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