I am a daily reader of your blog since last year and you provide a lot
of good information here about these income generation strategies.
I did not know exactly how to send you this message, but as the topic
is iron condor, I am sending here as a comment.
It is about an adjustment/insurance strategy that I heard in a
webinar for Iron condors. The "Mouse Ear" strategy.
For Example on RUT
650/660 Calls 4 Contracts
550/540 Puts 4 Contracts.
To protect you sell 1 660 Call and Buy 1 640 Call
To protect you sell 1 540 Put and Buy 1 560 Put
It is cheaper than the extra calls but is this protection good enough?
My idea is adapted from the "Mouse Ear" using the 2-3 months Iron
Condors you use, buying short term options.
On the Above Example :
FEB 650/660 Calls 4 Contracts
FEB 550/540 Puts 4 Contracts
To protect you sell 1 FEB 660 Call and Buy 1 JAN or DEC 640 Call
To protect you sell 1 FEB 540 Put and Buy 1 JAN or DEC 560 Put
The idea is not to use it as a pre-insurance, but to make this adjustment
only when RUT reach the midpoint between my Enter point and my Short
On the Above Example buying the JAN options you can make the adjustment
for free or by paying very little.
So the Adjustment will reduce my loss if RUT reach my short option and
get stopped out.
I hope you understand the explanation.
Thank you for being a loyal reader. Yes, I understand your question, and commenting here is the best way to ask that question.
answers are a bit complicated – because there are several alternatives
to consider. Thus, this is a lengthy reply and will require more than
one post to complete.
the analysis below, I've ignored the possibility that you would exit
the trade if and when RUT reaches 650. Obviously any investor can
close the position at any time. The more complete discussion is for
anyone who would continue to own the position.
1) As you know, there are many methods you can use to adjust, or reduce the risk of holding, iron condors.
2) The 'mouse ear' is a method used by Dan Sheridan. It's a good idea.
I agree that the cash required to make this trade (the sale of a call,
or put, diagonal spread) is small – and many times you collect a cash
credit. The market value of the spread depends on how much time
remains in the lifetime of the Jan option, and more importantly, on the
implied volatility of the Feb option (because you sell the call with
more vega, higher IV means the chances of earning a cash credit
not a good idea refer to this as buying something 'for free.' You do
sacrifice something when buying insurance. It's nice to avoid paying
cash, but it's not free.
4) I agree that this is NOT a good candidate for pre-insurance.
IS IT ENOUGH? Does it offer sufficient protection? And if the
protection is adequate, how does the profit and loss picture look?
are the important questions. I don't believe there is a simple reply,
but let's take a detailed look to see what we can learn. I'll offer my
opinion, but you must decide if the mouse ear makes the position
comfortable for YOU to hold.
There is something special about the iron condor you chose. It's a CTM
position, meaning that the options you sold are CTM (close to the
money). The options have deltas of 31 and -24. [Although I have made no specific
recommendation, my guess is that most index iron condor traders begin
by selling options with a delta between 7 and 15. ]
For many iron condor traders, not only are those deltas too high for an
opening trade, but they are well past the original adjustment point.
And some traders would feel so uncomfortable that the position would be
this is not a popular iron condor to trade. But, that does not make it
a poor trade. Some very successful traders prefer CTM iron condors.
Tomorrow [ADDENDUM: Monday] we'll continue the discussion using your example.