Trading Iron Condors. The opening trade Part I

Today's post covers an important and popular topic. Choosing the parameters of the original iron condor is a complex issue.  There are strikes and expirationn dates to choose.  Then there's the right underlying and  spread width.  For some traders, there's the timing element.  A fascinating topic and I have much to say.


Here's a recent series of questions:

Hi Mark,

Thank you for maintaining this blog.  your comments have been very helpful to me.

I have been trading condors since April by using SPY at 10 to 12 weeks from expiration, selling the short strike at a delta of .2, I target collecting a premium of $1.10+.  This results in long position at 4 points from the sold position (i.e. sell a 128 call buy a 132 call).

I make partial adjustments if delta reaches .35 by reducing the spread to two positions [MDW: I have no idea what 'two positions' means], reducing the position or converting to a calendar or even a vertical. I have been making money, but at times I feel as if I maybe making too many adjustments (two to four before closing).

I try to exit the positions at 4 weeks to expiration. I found that the $1 premium collected allows me to make adjustments yet still have a profit. My usual position size is 50 to 100 contracts per leg, but at this time, I believe [emphasis added, MDW] the 4 point spread range maybe too risky.

I am considering reducing my exposure from a spread of 4 to one or two. I am using the thinkorswim site and found that if I stay with a .20 delta for the short strike and choose a two-point spread, then premium would be about 70 cents.

To go to a .30 delta and a one-point spread, I would collect about 50 cents; or at a .4 delta the premium is 70 cents.

I am also considering multiple condors with same expiration month such as selling SPY 130/131 and 132/133 call spreads. [MDW: Frank then goes on to offer adjustment ideas, but that's off topic] 

I am most comfortable trading SPY.  I tried using SPX once and got burned by waiting to long to close the trade, and its not as liquid as SPY.

Mark any suggestions you can provide or other factors I should consider would be appreciated.
Regards,
Frank

***

Happy new year Frank,

I like the questions and the fact that you are seriously considering several alternatives. By the way, you got burned with SPX because you waited too long.  That has nothiing to do with preferring SPY.

There are two problems for me.  The answer you seek requires a great amount of detail, and could easily fill a couple of one-hour webinars.  I simply don't have the time to provide that much detail.

But more importantly, I would be responding from my personal perspective and you must truly trade something that fits within your comfort zone.

In responding to the questions, I'll take the path of offering advice – that I trust will help you find the answers. The comments go directly to your questions.

 

Experience

Let me begin with some comments:

  • If you believe it is too risky, that's the end of the discussion.  In this matter, do not let anyone try to convince you that your decision is foolish.  'Too risky' is not a fact.  It is an opinion, and yours is the only opinion that counts.  It so happens that I don't like your 4-point spreads, but more on that later
  • You have too little experience to be rock-solid with a single trading idea.  I don't care how much money you have been making or whether you have been a winner in each of these months.  You have not seen enough to understand how the markets truly behave over an extended period of time
  • Experiment now, as you plan to do.  If some of the experiments feel uncomfortable, then you have only two choices.  Don't trade them due to the discomfort, or use a paper-trading account for those trades
  • The fact that you have been trading 50 to 100 condors per month is irrelevant.  For most newcomers, that's far too much size.  if you are trading an account with $10,000 to $12,000 – then your size is egregiously large and you are in way over your head with risk.  On the other hand, if your account has one half million dollars in it, then your size is truly peanuts and you are indeed learning to trade on a small scale. What's more important than contract size is the percentage of your account value that is being tied up in margin for these trades.  I'm not asking you to disclose that, just trying to tell you that contract size says nothing
  • The item that I like best about your inquiry is that you show some fear, despite profits.  That's excellent.  One of the best ways to go broke in a hurry is to become overconfident.  I'm pleased to see that you seem to be avoiding that
  • While making these experimental trades, make it easier on yourself by cutting position size.  Maybe 20 to 30% fewer spreads.  Why? Less pressure while playing with alternatives.  Yes, less profit potential, but the learning experience should prove to be beneficial for a long time, and it pays to do it correctly.  With less pressure to succeed and more time to make observations, you get to study the alternatives in a calmer atmosphere

to be continued…

869

 


 

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7 Responses to Trading Iron Condors. The opening trade Part I

  1. Gus 01/06/2011 at 2:42 PM #

    Currently for a SPY 4 point spread, example 120-116 March 11 put you can get a mid price of .61, 4k of margin on a 10 lot for a total collected of $ 610. On the other hand for the 120-119 1 point spread you can get .17, 4k of margin on a 40 lot you can get $ 680. Of course on a 10 lot you save some $$ in commissions.
    My suggestion would be to go back to SPX and trade the 1200-1190 10 point spread, mid-priced at 1.7, 4k of margin on a 4 point lot is $ 680 and you save a ton in commissions.
    Additionally, if the S&P goes down and gets close to your short, the 1200-1190 spread will have less value, as your long 1190 will have a better proportional value than the 1160, especially close to expiration, when the 1160 will be so far OTM that it will be worthless.

  2. Frank 01/06/2011 at 3:03 PM #

    Hi Mark, thank you for the addditional input.
    You are correct I did wait to long on SPX and had purchased position 4 weeks from expiration,something I no longer do. Six months ago attended ThinkorSwim seminar which the instructor said SPX is paper traded on an open exchange which is why a wider bid/ask than compared to SPY. I was initially attracted to SPX because of the larger premium that can be collectd relative to the number of contracts bought/sold(lower commissions). Instuctor suggested to stay away from SPX and stay with SPY. I have learned more so perhaps I will reexamine using SPX.
    Also what I meant by adjusting to “two positions” is the spread between the short and long strikes so if SPY 128 is the short and 132 is the long, then move from 128 to 130 or 132 to 130(hope that clarifies).
    Your comments regarding total portfolio risk is understood and look forward to any further postings.
    Regards,
    Frank

  3. Mark Wolfinger 01/06/2011 at 3:14 PM #

    Gus,
    1) I did not verify. Does the March 116 put have a delta near 20?
    2) I don’t know if Frank would choose to sell four 119/120P spreads or find another way to use 4k in margin.
    I don’t like the numbers. I’d rather go for the $610 than the $680 in this specific scenario. The extra $70 (12% ‘bonus’) in potential earnings is just not enough for my comfort zone to sell four 119/120P spreads. I cannot speak for Frank.
    3) Selling 4-lots of the SPX 1190/1200 put spread seems to be a good, commission-saving alternative. However, Frank is unwilling to trade SPX – at least now now.
    However, Your analysis that the long SPX 1190 would retain much more of its value than the SPY 1160 is true as far as it goes, but it is immaterial.
    You must remember that if he sells the 116/120 spread, he is ‘synthetically’ long that 119 put because he owns 10 lots of each of the four spreads that comprise the 4-point spread.
    You may not see the 119P in his account, and he does not have the right to exercise that option, but he owns it (synthetically) nonetheless.
    There’s more: If the index is below the 120 or 1200 strike, then it’s not so much the value retained by your long option that matters. It’s ‘how far OTM is it’ and ‘how much downside risk do you have?’ He collected less premium for selling the 116/120 spread and has less downside risk than you do. Risk vs. reward is a trade-off.
    This is a good discussion and tells me that more on this topic is needed.
    Frank – do you have any comments?

  4. Frank 01/06/2011 at 3:21 PM #

    Gus, thanks for your comment. I understand what you are suggesting and I am going to do some studying of trading SPX. I just took a quick look at march short call 1310 buy 1315 and short put 1170 long 1165 and can collect a mid point of 2.40, with 5k of margin on 10 contracts.
    Regards,
    Frank

  5. Mark Wolfinger 01/06/2011 at 3:23 PM #

    Frank,
    Collecting $240 out of $500 is a huge credit. It tells you that the options are not very are OTM.
    Great reward potential, but it does come with a higher probability of loss.

  6. Mark Wolfinger 01/06/2011 at 3:26 PM #

    Frank,
    SPX is not for everyone. If it makes you unhappy, if you don’t like the fills, emotional considerations come into play. Sure, it’s better to keep emotions in check, but don’t trade SPX if it makes you uncomfortable. Do your research.
    Yes it clarifies. You reduce your spread width by buying one of the 2-point spreads.
    Thanks Frank. You replied while I was responding to Gus!

  7. Gus 01/06/2011 at 4:37 PM #

    The march’11 120 put has a delta of 24, the 118 has a delta of 20. I just used 120-119 as an example as how you can always collect more premium by selling more lots on a smaller short-long spread than less lots on a bigger spread with equal margin.
    When I trade SPX, I always look at the SPY chain for a fair mid price. SPX has pretty wide price spreads and sometimes is hard to figure a fair price. I also open and close legging the spreads, it’s easier to get better fills than trying to the open and close the entire IC together.