Trading Iron Condors. The Opening Trade. Part II

Part I

Continuing my reply to Frank's questions:

We are discussing SPY iron condors and making choices about the options being traded.


2) The delta of the sold options is important to the probability of success and the probability of reaching a point that requires making adjustments.  It also plays a role in the cash collected.  Thus, it's a key element when constructing the iron condor.

You currently sell options with a 20 delta and one of your complaints is that you adjust too many times before being able to close the trade.

Do not even think about moving from 20 to a higher delta, unless you KNOW it will be comfortable.  You already 'make too many adjustments,' and thus I believe moving beyond 20 delta would be a big mistake at this point in your learning process.

When this experiment is over and you have drawn some conclusions, that's the time to think about (and hopefully discard) the idea of moving to 23 or 24 delta.  Moving to 30 is NOT going to work for someone who already believes he makes too many adjustments.


3) Spread Width plays an important role when choosing your iron condors.  From your questions I can see that you don't have any idea how to make a good strategic choice.  You allow time and premium to be the deciding factors when choosing the iron condor to trade.

You decided to trade 10-12 weeks spreads, chose to sell options with a 20 delta, and decided that the cash premium should be roughly $1.10.  Satisfying those parameters gives you no choice in choosing the iron condor.  Thus, for you, it's 4-point spreads.  That is not an efficient method for choosing trades.  It completely eliinates any judgment on your part.  It ignores your comfort zone (which is something you now realize). Let's see if I can help you make better decisions.

Here's a nuts and bolts idea of how to select your spread width, along with some commentary:

  • Did you know that the 4-point spread is equivalent to owning each of the adjacent 1-point spreads?  in other words, when you trade the 128/132 call spread 50 times, you really traded:
    • 50 of the 128/129 call spreads plus
    • 50 of the 129/130 call spreads plus
    • 50 of the 130/131 call spreads plus
    • 50 of the 131/132 call spreads
  • The only difference is that you save the commissions of trading each of these four spreads by trading them all at one time.  You MUST understand that this is true.  

You cannot trade options without grasping this basic concept:  Trading each of the four spreads is equivalent to trading the 4-point spread.  The risk/reward is identical. 

When you understand the truth of the above, then I hope it becomes clear that choosing the four-point spread is almost guaranteed to be a big mistake. Why?

I understand choosing a spread based on how much premium is collected.  However, people who do that (me) already know the desired spread width.  They do not allow the need to collect a certain premium define the spread width.

In relative importance, spread width comes in far ahead of premium. 

You are not thinking about the position. You made your 'line in the sand' requiements and tht's the end of the thought process.  Trading by rote or very strict rules is not viable – unless you already know that you will like the position forced upon you by the rules.  Clearly that is not the case here.

  • Look at each of the four spreads as an independent trade
    • Do you want to sell the 128/129 call spread?  I know you chose it because the 128C has a 20 delta.  But do you really want to sell this spread?
      • Is the premium sufficient for the risk?
      • Next, do you really want to sell the 129/130 spread?
      • Next, do you want to sell the 130/131 spread?  The premium is getting fairly small
      • Last, do you truly want to sell the 131/132 spread?

I cannot answer any of these questions.  My point is that it is highly unlikely that you want to sell each of these spreads.  If that's true, then sell only the spreads you WANT to sell. Do not sell any other spreads just to get the premium where you prefer it to be.  It forces you to make a BAD trade (BAD because you do not want to own it).

Instead of focusing on a 4-point spread to collect the 1.10 premium, concentrate on the spreads you want to have in your portfolio.  You may decide to stick with the 20-delta and sell only the 128/129 C spread.  Or you may prefer the 128/130.

You also seem to have latched onto the .20 delta option as if it were a requirement.  Perhaps you would feel more comfortable choosing only the 129/130 spread or the 129/131.  You would adjust less often, and that may solve your combination of problems.

Please give serious consideration to each spread that makes up the call and put portions of the iron condor and then choose to trade only the spreads you like.  For margin and risk purposes, it's best to keep the put and call spreads at equal width.  But it is not mandatory.

4) Multiple iron condors with same expiration

You must understand that you already have multiple iron condors in your account.  However, the fact that you don't 'see' the equivalent positions in your account leads you to believe that you own a single iron condor trade.

Nevertheless, I understand what you mean.  If you sell the 130/131 call spread and also sell the 132/133 call spread (and something similar on the put side), then you 'see' two different iron condors.

There is nothing wrong with doing that.  I do that all the time.  However, I initiate the preferred iron condor.  Then if I want to add to my portfolio, I'll choose a spread that is appropriate at the point of entry.  Many times that's an iron condor with different strike prices.  If you plan to open them simultaneously, be absolutely certain that you WANT to own each position and that you are not making the trades because you like the idea of owning a variety of spreads with the same expiration.


Bottom line: I cannot overemphasize that it is bad policy to choose spreads that fit some preconceived notions. 

As a rookie trader, you have to observe more trades as you gain the needed experience.  But you can, and I strongly recommend that you do, trade positions with the risk/reward that places each trade squarely within your comfort zone.  When you are more experienced, you can try to expand that zone.  But not now.  Now you are learning to trade options and your primary goal is to survive.  It's great to be earning money on a steady basis.  But this game is not quite that easy and I'm pleased that you are not getting overconfident.

Thanks for the excellent questions.



, , , , ,

10 Responses to Trading Iron Condors. The Opening Trade. Part II

  1. Tyler's Trading 01/07/2011 at 10:45 AM #

    Loved the explanation of how a 4 point spread is the same as selling four 1 pt. spreads. Understanding that concepts REALLY helps in deciding whether it’s worth widening a 2 pt. spread to 3 pts.; or 3 pts. to 4 pts.

  2. Mark Wolfinger 01/07/2011 at 11:06 AM #

    Thanks Tyler,
    For some reason, this is one of those points seldom mentioned.
    I remember not knowing how to choose between 10- and 20-point spreads when it dawned on me that the big deal is not whether its 10 or 20. The important decision is: do I want to own both 10-point spreads, or just one of them

  3. JP 01/07/2011 at 6:12 PM #

    I don’t entirely agree that the decision is if you want to open each individual spread. I think there is a point of efficiency that matters. I generaly choose my sold strike by some % OOM (It varies by the implied volitality) and then pick the bought strike by determining the return on margin. Once I decide which spread is the most efficient I’ll determine how many spreads to open based on total margin I want to risk.
    BTW, I find most of my IWM spreads are 2-points
    (I’m sure this table isn’t going to look good, I hope you get the idea…)
    IWM March 2011
    Strike Last Spread Commission Max Profit Margin ROM
    85 0.68
    86 0.53 0.15 $2.50 $12.50 $100.00 13%
    87 0.34 0.34 $2.50 $31.50 $200.00 16%
    88 0.25 0.43 $2.50 $40.50 $300.00 14%

  4. Mark Wolfinger 01/07/2011 at 7:27 PM #

    Hello JP,
    I agree that choosing the option to sell comes first, and is based on specific criteria.
    I’m not certain whether you seek a specific, minimum return on margin, or whether you choose the highest ROM.
    I’m sure we agree that different traders do, and should, own different positions.
    You are allowing ROM to determine the position you own. I prefer to take less ROM and own the position that makes me more comfortable initially. That’s the position I deem has the better chance to return a sufficient profit.
    There is a difference in approach, but I don’t believe it’s serious. We each attempt to trade the position we want to own. We don’t have identical criteria for making the choice. I am not convinced that best ROM is the best choice for me. I accept that it the best choice for you. That suggests that we are both being efficient.
    I agree 100% that the number of spreads (position size) cannot remain a constant and depends on margin requirement. In our situations, that’s the width of the spread.
    Thanks for sharing

  5. Fran 01/08/2011 at 2:40 AM #

    Hi Mark and friends.
    My approach is different.
    I understand a vertical spread like a financial instrument itself, different from naked options. Like a binary option is different from a naked option, a vertical spread is different from both. Its sensitivity over time decay, changes in volatility or changes in the underlying asset is very different from other financial products.
    A narrower vertical spread works more like a binary option and is less volatile just after open the position but it can easily stay alive until close to expiration.
    Sensivity in a wider vertical spread is more like a naked option: a very nervious position just after the position is opened, but very sensitive to time decay too.
    Between binary and naked, vertical spreads offers a lot of choices for options trader. This trader must choose what type of vertical to operate according to which one is best suited to their market vision in order to capitalize her edge.

  6. Sally 01/08/2011 at 10:24 AM #

    Hi Mark:
    I have a question when it comes to buying a call option do you make more money buying in the money, at the money or out of the money?
    Thanks, Sally

  7. Mark Wolfinger 01/08/2011 at 2:53 PM #

    I completely agree that trader must own positions that suit market vision, comfort zone etc.
    The bottom line is that a wider spread is not really a wider spread. It appears to be a wider spread and acts like a wider spread.
    But it is a combination of each of the consecutive spreads within that wider spread. It’s okay to open that 40-point spread, but it’s also okay to trade each of the four different 10-point spreads independently. Each of those behaves just as you want it to behave: Like a spread. It’s only similar to the naked option (with a cap on losses) when managed that way.
    It’s a matter of perspective.

  8. Mark Wolfinger 01/08/2011 at 2:58 PM #

    That’s an impossible question (for me) to answer.
    What do you mean ‘make more money’? Per option bought or per $1,000 invested?
    You can buy a bunch of OTM options for the same cost as one ITM option, and there’s a chance for a big payoff. But it’s a very foolish move. The likley result is losing the entire investment.
    If you buy ITM, you make the most money per point that the stock rises. But I’m sure you already know that.
    How good are you are predicting stock movement? If you are excellent, then ATM should work best for you. But if you are like >99.9% of the investing public, you cannot pick market direction. And the majority certainly cannot time the move.
    In that case, if you must play, at least play by paying the least time premium. To me that means always buying ITM options.
    I hope that helps.

  9. Chris 01/08/2011 at 9:15 PM #

    Hi Mark,
    I’ve been reading your blog extensively the past several months. Your approach to education has helped me analyze my trader psyche in a much appreciated way. I must say that as basic and elementary as the advice is, your “does this position make you comfortable” approach is a great way to simplify the decision making process before committing capital.
    I have had varying levels of success in the different stages of my trading over the years (10+ years, not full-time). I am not quite sure where I am in the journey of a trader, but I have gone through classic newbie mistakes, account blow-ups (futures), revenge trading, “newsletter guru” following, and several other approaches. During this time, I have learned a lot, and over the past several years my options education has been parabolic. More recently, I have been able to break away from needing guidance for trade decisions and been having promising success on a _consistent_ basis. I still make mistakes, but they are either less damaging (not as much leverage) or my experience has allowed me to identify them earlier. I make these statements with crossed fingers that I’m not overlooking some gross error in my trading.
    The reason I am giving this background is that I want you to understand where I am coming from. With this relative success has come a uncharacteristic fear that I am missing something. My losses in the past have taught me that complacency is usually the best indication of a major fault somewhere in the trading. I am not complacent now, per se, but I am searching to resolve an unsettled scenario in my mind.
    My current options trading is basically a mixed bag of calendars and verticals. Much of those verticals are Iron Condors, but I also bolster the portfolio with directional verticals based on limited technical analysis and/or fundamental analysis. I allocate more to calendars in relative low IV environments, such as now, but ICs/verticals actually always make up at least 50-60% of the in-play capital as I like the low-maintenance aspect of them (from a monitoring point of view). The verticals I put on tend to be bearish due to this next reason:
    I am very afraid of the black swan. I realize that markets move significantly faster and more relentless to the downside than any upside move. When it comes to ICs, an upwards probe of the short strike is usually assisted by falling Vega, however the IC shows no mercy to the downside. For this reason, I tend to put on significantly more bearish verticals in my directional trading.
    However, in trading my RUT ICs, I cannot deny that not putting on the BPS side limits my reward. In fact, my ICs have been my most profitable trades last year. Because of this, I am searching for an acceptable way to trade ICs and have protection in the face of a Black Swan event. I have read your suggestions about buying an extra OTM put per X amount of spreads. However, this approach seems to limit the profit potential quite significantly, especially if the underlying is rising into the short Call. From my analysis and stress-testing, the trade-off to this downside protection is having to allow for several additional weeks of Theta to reach the profit target, which increases the Gamma risk significantly, all the while losing the effectiveness of the hedge.
    I am not going into detail about how I trade ICs because I know in your general advice columns that its strictly how I feel about them that matters, but I would be happy to expand if it would be helpful. The bottom line is that I’m looking for a Black Swan hedge to offset IC losses. Basically, the thought of another Flash Crash hitting the tape or a couple Lock-Limit down openings terrifies me as there is no chance to adjust the ICs in time. Outside of your suggestion to trade an extra OTM put per X spreads, do you have any recommendations on a correlated hedge such as VIX or Volatility futures or options that might help accomplish this job? If my target is 7-10% return on an IC trade, I would be willing to give up 2-4% of that for a hedge that would limit my losses. Any direction would be greatly appreciated.

  10. Mark Wolfinger 01/09/2011 at 10:42 AM #

    Excellent contribution. Thank you.
    1) Crossed fingers may help, but the real killer for many traders – becoming too overconfident – is not going to be a problem for you. You are careful and thoughtful in your approach and recognize that you are not invincible. That tells me that your trading career will be very successful (unless my innocent comment moves you into that ‘I can’t ever lose money’ mentality).
    2) It’s true that any outright play to take advantage of a possible Black Swan scenario is going to cost money when the market rallies. Whether it’s buying puts outright, or using the kite spread (buy one put per batch of put spreads sold), cash is spent. That reduces position theta and hurts on the upside, but I don’t see any way out.
    You are not the only one who wants this protection and there is a price to be paid to own it.
    3) There is a difference (as you know) between BS protection and trying to earn a profit on a market decline.
    The best BS protection is owning naked puts. In addition to the delta gain, the exploding IV generates extra profits immediately. And it’s easy to exit the trade. You can just sell a long put with no worries about getting a decent price – there will be buyers everywhere.
    However, it may be more difficult to unwind a spread position when the bid/ask spreads become enormous. That’s why I prefer the naked put as BLACK SWAN protection. If you merely want to be bearish, there are better choices.
    4) To keep costs low, I recommend a trade that I would never recommend to anyone. And that is to buy front-month, OTM puts. A few lots can provide a huge return, despite the fact that they are going to expire worthless almost every time. It’s a cheap-dollar way to play.
    You can apply that 2% you are willing to spend to buy those puts, and perhaps use another 2% on an alternative (further OTM puts in the next expiration month?)
    5) As to the idea of finding a good hedge with other investments, such as any of the many volatility products recently introduced into the market, I’m certain there are good methods you can use.
    My friend Bill Luby writes abut this topic often and believes that the serious student can find a way to develop a good hedge. However, for some products the data is scarce and for others, there are special issues (i.e., VIX options use futures as the underlying, not the spot VIX).
    I must admit that I have not taken the time to study this special investment opportunity – I am just too busy and I spend less time trading than writing. I suggest getting in touch with Bill for some better answers related to using volatility products as a hedge. He also recommends a new blog that covers this area.
    Thank you