A trader buys (or sells if you prefer that terminology) an iron condor, collecting a cash credit of $250. The market moves against the position and the trader decides that he/she is no longer satisfied with the trade. Something must be done. Keeping this discussion simple, let’s say there are two choices.
- Define adjustment: Change the position to reduce risk
- Necessary condition: The new position is ‘good.’ The trader wants to own it
- The adjustment is NOT made to avoid taking a loss. It is made to reduce risk
a) Close the trade, paying $400 per iron condor. Net loss $150 per
b) Adjust the trade
When the adjustment requires a cash outlay of $50 to perhaps $200, most traders are willing to protect their remaining assets by making the risk-reducing adjustment.
However, if the adjustment requires paying $300 – $350, there is resistance to the idea.
One of the Gold Members at Options for Rookies Premium made the following comment regarding such an adjustment:
I’m not sure I could spend more on my adjustment than I received; that might be tough.
A significant quantity of traders are predisposed to some ideas (mindsets or mental blocks) because they seem so obvious. The logic behind their reasoning appears to be so impeccable that it ‘s essentially inconceivable that the ‘obvious’ belief can be erroneous.
The quote above represents one such example.
Without an adjustment, the risk of losing too much money has become unacceptable for this trader.
These are the facts, although not everyone is willing to accept them:
- The iron condor is no longer priced at $250. The current market value is $400
- Making trade decisions based on the $250 price cannot be efficient because it is not a realistic price
Additional facts, based on the trader mindset:
- Trader is willing to spend $400 to exit the trade
- Trader is unwilling to spend $300 to make the trade, even though the new position would be:
- Safer to own, with risk of additional losses significantly reduced
- Less dangerous to own because amount that can be lost has also been reduced
- Good enough to own. That means the trader would be comfortable establishing it as a brand new trade
Trader is willing to exit, spending $400 because taking losses is sometimes necessary.
Trader prefers not to spend $300 to build a better position that offers a good return in exchange for the risk involved.
Why? Because spending $300 results in a owning a position when the bookkeeping says it can never be profitable (based on the original entry price). The excellent chance of earning money from today into the future is ignored.
When thinking about the cost of adjusting, that decision should be made between the current choices, and has nothing to do with the original price at which the trade was entered. The choice is: exit and pay today’s price; or adjust and pay today’s price. Make the better choice by making the better trade.
That’s the path to success.