The Fun Part of Risk Management. Taking Profits. Part I

Unidirectional markets are profitable when you are on the right side, but can be costly, when you are an iron condor trader.  I've encouraged readers to believe that the key to success is the ability to manage risk and to be certain that any losses do not exceed reasonable levels.

I've suggested several methods for adjusting risk, but the two that should have worked best during these one-way markets are

a) the idea of adjusting in stages helped minimize losses

b) the idea of buying extra calls and puts to gain positive gamma and vega may have turned losses into profits

If you own those extra call options right now, you may be wondering what to do with them.  Thus, today's blog is about how to handle those ITM calls that are now part of your portfolio:

Managing Your Protected Portfolio

There material below contains a lot of ideas and may seem to be too much to take in all at once.  Regular readers have already been exposed to some of these ideas.  But this time I'm attempting to gather the information, add substantially to that information, and make it a two-part post.  If this is too much to take in at one time, think of it as a book chapter and absorb it in steps.   And please remember, much of this is my opinion on what I believe is sound advice.  You are encouraged to use your own brain and decide if you agree or disagree with any, or all, of what follows.

Let's say you own a few RUT Aug 560 calls.  You probably bought them when they were pretty far out of the money, but we've come a long way and these options are now significantly ITM with RUT trading near 580 yesterday (7/12/2009).

That insurance policy turned out to be an excellent trade, and is currently working out well for you.  Most of the time insurance expires worthless, and as an iron condor trader, I prefer that result.

Here's a question that may not have occurred to you: Did owning those extra calls result in unnecessary losses?  True, you have a profit from the insurance you bought, but how did you handle the portfolio?  Assuming you bought these calls as a hedge against one or more iron condor positions (perhaps expiring in Aug or Sep), did you adjust those iron condors, as recommended, per your normal risk management tactics?  Or do you still own them, counting on profits from the insurance to mitigate losses?  In other words, did the fact that you bought insurance convince you it was  unnecessary to make adjustments to those iron condors?

I strongly suggest adjusting iron condors as usual.  There are two excellent reasons for doing so.  First, risky positions should be adjusted and not allowed to run even further against you.  Second, as the days go by, your calls lose time value and the call portion of the iron condors will move towards their maximum loss.  [This 2nd reason assumes you still own, as most traders do, Aug positions.]

If you failed to adjust those iron condors, I hope you came to the conclusion that you will not make that mistake again.  One of the ideas discussed earlier (see link above) is: when buying insurance, it remains important to manage iron condor positions as if you did not own protection. 

Once you make an adjustment to those iron condors – which type of adjustment is not relevant – then it's the time to decide what to do with the options you own as insurance.

to be continued


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