Trading iron condors with negative gamma

I'll be giving a webinar for TradeKing on Tuesday Feb 16, 2010.  Covered Call Writing from a Different Perspective.


For space considerations, I've cut some of the wording that's not directly a question.  Here's the entire comment.


I came across your blog as I was looking for ideas about hedging iron condors. I have to admit, you have a lot of great info, but I do have a few

1. Obviously, maintaining a delta neutral portfolio is a challenge
since the delta changes as the underlying changes, and maintaining a
delta neutral profile can result in a lot of trades. Is there any sort
of guideline about what is an acceptable delta or what may be
considered excessive delta? I realize that if you have many IC
positions, you can't view the delta on a per position basis, but rather
the portfolio as a whole.

2. Can you provide some 'layman' examples of how negative gamma can
impact a position(s)? Is it possible for negative gamma to impact a
portfolio of ICs in both a positive and negative trending market?

3. In
your posting called "Iron condors: Diversification and VIX options as
hedges", I understand why VIX options should not be used…  Have you ever considered, or ever heard of
someone, using something like the Proshares Index ETFs options as a
hedge?  Specifically, since I almost exclusively trade SPX, I was
looking at buying options or debit spreads on UPRO and/or SPXU – which
are directly correlated (in theory, at least) to SPX.

Thanks again.


1) Simple answer: No guideline that's universal.  But, you can discover your own as you gain more experience.  Keep a daily diary that contains the portfolio Greeks.  Enter comments about your comfort level, whether you considered adjusting, and whether you did adjust.  Track daily P/L.  It's going to take a bunch of days before anything meaningful can be learned, but merely examining the Greek levels every morning is beneficial.  Over time you will build a record of where your discomfort level lies.  Track any statistics that you believe are important.

With negative gamma, you cannot (as you say) adjust all the time.  You must pick your spots.  There are many methods for trying to keep delta in line.

  • Adjust every time SPX moves one (or 1.5 or two) standard deviations from the last time you adjusted
  • Adjust when you are 100 (or 500 or 1000) delta from neutral.  Your own comfort zone and portfolio value help you decide
  • Adjust when you will lose 1% (or 2% or X%) of your portfolio value if SPX moves an additional X% from its current value.  Note this is percentage of total portfolio, so don't allow the number to be too large.  Your comfort zone will be a guide

Delta is not the only Greek to adjust.  When making an adjustment resulting from negative gamma, give serious consideration to picking up some positive gamma when adjusting.

Most iron condor traders disapprove of spending money on option premium, but it's often best to buy some positive gamma to reduce the ongoing problem.  I am not referring to options that are farther OTM than your iron condor.  The gamma must come from options that are closer to the money than your short option (or it's okay to buy in a small number of your shorts). Why? Because your plan is to hold the IC, and when time passes you know those OTM options will lose much of their protective value.

The best way to handle negative gamma is to find a reasonable solution that allows you to sleep at night and not worry about losing too much money.

Any time your delta total seems too large, then it is too large.  I know this is not the specific reply you had hoped to receive, but there is no 'number' or 'percentage of portfolio delta' that suits each trader.

There is no doubt that a single iron condor position is easier to manage, but you and I carry multiple positions and it's best to manage the portfolio as a whole.

WARNING: That last paragraph does not relieve you of the responsibility of seeing that no iron condor ever approaches its maximum loss.  Sometimes you must exit a single iron condor position and find another.

2. Yes. Negative gamma hurts regardless of which direction the market is trending.  When your position has negative gamma, your portfolio accumulates positive delta as the market falls.  It also loses delta as the market rallies.  That's why time decay is good and volatile markets are bad.  That's as near as I can get to describing this is the simplest (layman) terms.  You get longer when you don't want to do so (falling markets) and you get shorter when you don't want to do that (rising markets).

3. Whatever else you do, please do not hedge with leveraged ETFs.  Unless you plan to get out of the hedged position the same day, you will be very disappointed in how they perform.  You do not want to own these vehicles.  Ever. Trading a spread is not as bad, but these are items you do not want to trade.

You can use SPY instead.  Yes, you must trade a few more shares and that may cost commissions, but you must avoid these leveraged devils.

From my perspective hedging with the equivalent of stock is a poor idea.  I know many people adopt such a technique, but to me you are setting yourself up for getting whipsawed (buy high, sell low) when you have negative gamma.  Buying stock or an ETF is equivalent to buying delta and zero gamma.  Yes, it has no negative time decay.  So if that's what you want to do – then that's your decision.  BUT DO NOT buy those despicable leveraged ETFs.


13 Responses to Trading iron condors with negative gamma

  1. Bill 01/28/2010 at 8:38 PM #

    My concerns about the strangle options play is that it just seems too simple, and that I may be missing something important. My gut feeling right now is that my constant vigilance and a plan to modify or exit the strangle in the case of an extreme move will provide me with adequate safety in my efforts. I’m also selecting very high-quality stocks which have a history of slow and narrow moving ranges, and which will not be reporting earnings during my holding period. Also, my strangle positions individually will represent not more than 5-6% of the portfolio total value, so any one position is not going to destroy things on its own if it turns bad and out of control.
    Here’s my short list of questions:
    1. I had assumed that an option which reached its strike price and would be subject to assignment would be from the “in the money” direction; if this is true then does it mean that my “out of the money” strangle positions are automatically subject to possible assignment, from the outset?
    2. I don’t feel any particular fear from being assigned; my brokerage just shorts my account (I don’t have to actually hold the underlying) and then I would manage it as a short position of a common stock–it could actually yield additional gains if this happens in a down day of course–but even if it’s moving up in price a quick “buy to cover” removes the issue with minimal losses. I understand the issue of potentially disastrous losses if some unusual event were to occur which would move the underlying price at an accelerated rate–and this is why my position size is intentionally small as stated above.
    3. The issue of actual selection of expiration and strike price is a little mysterious to me–in the way that it seems so simple. I’m using the nearest expiration date (Feb 20 right now) as my expiration of choice because it allows me to roll the funds over into the next expiration with the highest frequency; the reduction in premium compared to a longer expiration date is minimal and I also like being able to count on a probable smaller move in the underlying during the shorter period. Regarding the strike price selection I’m simply using the furthest strike price available from the current price of the underlying; this yields the highest premium and minimizes the possibility of the underlying striking my holdings.
    Currently I’ve sold 3 Feb HAL 36 puts and 3 Feb HAL 25 calls; price of the underlying at this writing is 29.53 and the 90-day highs and lows are 34.87 and 25.50.
    The first question to be answered is, am I making some kind of gross error in my assumptions?
    Please feel free to fire both barrels at me if I’m in over my head here!
    Thanks in advance for taking the time to help me out.

  2. Sina 01/28/2010 at 9:24 PM #

    Hi Mark,
    I’m trying to do iron condors, and I used a kite spread that you suggested. The risk graph looks good right now, but when I move forward in time, I see the graph changing so that there becomes much bigger risk as time goes by (if market keeps going down), even tho the hedge is closer to the money than the short puts.
    Also, for some reason I’m seeing that my theta is negative now, after putting on the kite spread. Does this make sense to you?

  3. Mark Wolfinger 01/28/2010 at 9:30 PM #

    Please have patience. I’ll get to this next week.
    There’s more to discuss than just the reply.

  4. Mark Wolfinger 01/28/2010 at 9:57 PM #

    Hi Sina,
    Readers unfamiliar with the kite should click on the link in categories in the right hand column above.
    Comments first
    1) The kite spread is recommended as an insurance policy – if you choose to buy insurance. I know it’s costly.
    2) The kite is not recommended in the sense that anyone might think I suggested “do this and make money”
    3) The kite spread appears to work more efficiently that it’s nearest alternative method – and that’s buying a single call or put as insurance.
    That’s why I like the kite spread.
    If you agree with using it for that purpose, then let’s proceed.
    Replies next
    1) True. The kite spread has negative theta. So it loses some of it’s usefulness as time passes.
    2) The main purpose of any insurance policy is to protect you from huge losses. Owning that extra one lot (per kite spread) of puts provides excellent protection if the market falls out of bed. That’s a bonus.
    3) The kite spread can also become profitable when expiration approaches when the underlying is priced right. I am NOT telling you to hold on to the position to see if that happens, but if it works out that the underlying moves lower (towards the option you bought as part of the kite) as expiration is approaching, you should be able to get out of the iron condor at a good profit and take an additional profit out of the kite spread. Another possible bonus.
    4) Compare those two bonuses with paying an equal premium to buy a single put. You would own an option that’s some strike prices farther OTM than the option you buy with the kite. In a Black Swan event, that would be less profitable, but still ‘good enough.’
    In the drift down, per #4, this put would not offer much of a profit opportunity when compared with the kite.
    Plus, the time decay for the single put option is even more rapid than that of the kite.
    This is the rationale for choosing the kite instead of buying a single call or put option for protection.
    the kite is better, but not perfect.
    5) Owning the kite does not eliminate the desirability of managing the risk of your iron condor as if it were held without any insurance. If it moves into the money, losses can mount very quickly. You can hold and hope the market continues its move in the same direction so that the kite can work its magic. But that is not the best approach.
    If you make an adjustment to that iron condor (or credit spread) that’s in trouble, you should have some profit from the kite to ease that loss.
    In other words, it provided some protection. it cannot provide complete protection against loss unless you buy a bunch of kites – and just as buying a bunch of single puts – that would be far too costly to be an attractive play.
    6) I would not expect theta to turn negative, unless the iron condor were deep in the money – reducing its theta – or unless you own ‘too many’ kite spreads. That would result in negative theta.
    It’s difficult to know how many to buy when you decide to buy that insurance. I find that one kite per 10 iron condors is often sufficient, although I have bought 2 per 10 on occasion.
    I have no ratio to suggest. I’m sure you made a trade that looked satisfactory on the risk graph. And if so, then you bought an appropriate quantity.
    I believe this play is better than not owning insurance, but not everyone would agree. If you don’t ignore the IC, believing that you have done all you must do (or hoping for a market collapse), that could be the problem.
    7) Bonus time: If you choose to take on a very small additional downside risk, I find it a good idea to roll down your long put by one or two strike prices. As long as the option you own is still closer to the money than your short options, taking cash out of the kite can lead to a great result if the market reverses. And if it doesn’t, the loss is small. For example, you may elect to sell a 20-point spread in the index for some number near $14, or even less. Iv’e done this. Sometimes I make that $1,400 and sometimes I give up $600.

  5. Sina 01/28/2010 at 10:28 PM #

    Thanks for the length reply Mark.
    I have RUT MAR 550P/540P spread as part of my iron condor, and I bought the 570/550/540 (1x3x3) in a ratio of about 1:12 to the number of credit spreads. I know the kite spread has negative theta, but I didn’t expect the entire position to have a negative theta. When I step through day by day risk graph, if the RUT doesn’t change price from current, it shows that I continue to lose money for the first 17 days (50 days left to expiration), and then it begins to rise afterwards (positive theta). I’m using ThinkorSwim.
    As I’ve said, as time goes by the risk graph starts to sink dramatically in the way out of the money down side, so I’m thinking maybe it is a good idea to remove some of the position before it starts to sag alot.
    Thanks Mark.

  6. Mark Wolfinger 01/28/2010 at 10:35 PM #

    Too many kites. I suggest you sell some of them until you have the position you want to have.
    I’d suggest selling more put spreads – perhaps 520/530 – but increasing position size is seldom a good idea.

  7. Sina 01/28/2010 at 10:44 PM #

    what about selling some of the kites, or maybe just selling a small amount of the 570P? That way I do get more of the 550/540 ratio-wise.

  8. Mark Wolfinger 01/28/2010 at 11:37 PM #

    I did suggest reducing the number of kites.
    Yes, you can sell 570 P instead. If the position is comfortable to hold.

  9. Sina 01/29/2010 at 2:58 AM #

    Thanks Mark.

  10. Bill 01/29/2010 at 6:24 AM #

    Okay, I will. Thanks.

  11. Roger 01/29/2010 at 10:48 AM #

    Excellent discussion, Mark. Thanks.

  12. soemardi 01/30/2010 at 6:35 PM #

    “From my perspective hedging with the equivalent of stock is a poor idea. I know many people adopt such a technique, but to me you are setting yourself up for getting whipsawed (buy high, sell low) when you have negative gamma. Buying stock or an ETF is equivalent to buying delta and zero gamma.”
    mark do you think that hedging the delta of iron condor with buying stock is not good and risky?

  13. Mark Wolfinger 01/30/2010 at 11:55 PM #

    Yes. That is what I believe.
    I know you hate paying theta. I know you hate buying options.
    But when your iron condor runs into trouble, it’s not the delta that keeps you in trouble.
    It’s the negative gamma. That negative gamma makes the delta grow at an ever increasing rate. My suggestion is to buy some positive gamma and to pay the necessary theta. That makes your position safer.
    If you prefer to buy stock, then do it. But stock provides no gamma. It only supplies delta.