When is an Iron Condor Trade too Aggressive (Risky)?

A question from a loyal reader brings up a very important topic that I have not addressed.  I've mentioned that my personal choice is to collect ~$300 for a 13-week, 10-point RUT iron condor.  Stating that it's a comfort zone decision, I did not go into much additional detail.  Then comes this question, which is far more important that it may appear:

Hi Mark,

Wondering about $3 out of 10-point spread.  Please correct me: do you mean something like: puts you collect about $150 and calls collect the same $150, total $300/$1000 margin?

To me that is very aggressive, 30% premium collected out of $1,000 margin. Thank you for sharing.

Dauddy

***

Hello Dauddy,

Yes, I collect ~$300 for a 10 point spread.  Margin requirement is $1,000 (but many firms allow you to use cash collected, reducing margin to only $700).

In my opinion, aggressive is not the appropriate term.  However, I understand that you are stating the obvious: Anyone who attempts to earn so much money from iron condor trades is taking too much risk.

'Risk" is a matter of perspective.

 

SmallPremium

At one extreme, consider the trader who sells very far OTM call and put spreads and collects a premium of $20 (after paying commissions) for a one-month, 10-point, iron condor.  The margin requirment is $980 and the trader's potential return on investment is 2%. 

Or, to translate this into a 13-week trade similar to mine, let's say he/she collects $60 (after commissions) for the same anticipated 2% per month return.

How would you define these trades?  Surely you would not consider them to be aggressive.  In fact, some traders consider this to be a very safe methodology and claim to use it to earn steady income.

We know that traders all over the world would love to have a fairly safe method for collecting 2% per month on a very consistent basis. It may take all the fun out of trading, but it would allow for very early retirement for anyone who has a reasonable sum to invest.  At this rate of return, account value doubles every three years.

So I ask – why is this not the investment method for a huge percentage of the trading population? 

You know the answer.  Because it doesn't work.  There are enough big market moves that the trader has two uncomfortable choices: 

  • Cover a dangerous position, paying $300 – $500 (depending on  the trader's exit plan), thereby losing between five and eight months of earnings
  • Hold and hope that the loss disappears and does not turn into a maximum loss of $940

Neither of these choices is fun to make.  My point is that this is an aggressive way to trade.  This is tilting at windmills and hoping that nothing terrible happens.  But, it's a continuous strategy and we know that something unwanted will happen.  And too often for this method to work over the long term.

Which is more aggressive, trading 13-week iron condors and collecting $60 or $300?

With my strategy/plan, I will lose $300 on an iron condor far more often than the FOTM trader.  Far more often.  However, I'll have some good (lucky) results and earn $250.  Not only that, but my maximum loss is $700, not $980. One more point:  I'll trade fewer contracts that the other guy.  If that FOTM trader wants to make any money, he/she must trade a bunch of contracts.  And that's where real risk enters into the discussion.

 

Larger Premium

There are professional traders who believe that collecting an even higher premium is the best and safest method for trading iron condors. The rationale is that the trader has smaller positions and any bad result is not going to wipe out the trader's account.  And yes, the number of wins is reduced, but consider this:  If you take in $500 to $600 as the initial credit, there's no urgency to make adjustments. I have  no experience managing these, but if time passes and the market is ever near the original starting price, I'd guess that the trade can be closed for a good profit.  Years ago there was a discussion of this topic on the Elite Trader forums (but I canot find it)

To make any decent money, the $60 premium trader must continue to build size in an attempt to grow the account.  A single disaster can easily destroy an entire trading career.

Risk can be defined as the most money that can be lost for a given trade.  It can also be looked at as the probability of losing any money on a given trade.  Or some combination.

I feel my risk is right where I want it to be.  My worst loss should be in the $300 range and my best gain is about $250.  Obviously the vast majority of my results fall between those ends.  I don't have any records of my trades because I own multiple iron condors at any one time and manage the account risk as well as the risk for an individual call or put spread.

This is not aggressive in my opinion.  However, if you would feel better trading iron condors with a $200 or even $150 premium, then that's what you must do.  There must be a premium level that provides the chance to earn enough – but with an accceptable level of risk.  However – opening the trade is just the first step.  Risk management is the factor that will determine how well you do over the longer term

852

Small_logo
December 2010 issue will be published next Monday.

Subscribe now

, , ,

6 Responses to When is an Iron Condor Trade too Aggressive (Risky)?

  1. Dauddy Bahar 12/13/2010 at 6:20 AM #

    Thank you Mark,
    Hmmmmm never looked at it that way….I surely will try.
    Thanks again,
    Dauddy

  2. Antonio 12/13/2010 at 5:32 PM #

    Hi Mark,
    When you say your worst lose is in 300$ range you mean you usually cut your loses when one of he two spreads is doubling the credit you got wih the hole IC?

  3. michael b 12/13/2010 at 9:22 PM #

    Hello.
    Just found your blog, read a few articles and found them realistically useful.
    A question then: I have spent quite a bit of time studying options, how they work, what strategies to use etc. And even with that don’t feel I am equiped to just hurl myself into the fray. So I have seen and engaged some newsletter/recommendation sites for some helps.
    My question is this: Will you comment on a specific company and your experience if any with them? If so I would deeply appreciate your opinion of Schaeffer Research and Motley Fool Options. Schaeffer interested me because of his touted success. But I have a niggling sense that it is in the past.
    If you cant do that(but I hope you will!)
    can you speak to positive/negative experiences re signing up for and paying for a service like this in general terms.
    thanks.

  4. Mark Wolfinger 12/13/2010 at 9:34 PM #

    Antonio,
    I do so many different things when trading a bunch of different iron condos at the same time, that I shouldn’t say ‘usually.
    But, yes. I try to buy back my losing positions when the losing side costs about $500 to $550.
    It has nothing to do with doubling the credit because I don’t care how much I collected originally. I only care about current risk – and that $550 is about as far as I’m willing to go.
    I usually make an adjustment before the risky position gets as far as being worth $500.
    Regards

  5. Mark Wolfinger 12/13/2010 at 9:49 PM #

    Michael,
    Glad to hear it. That’s my intention.
    1) I probably will have zero experience with any company that you would mention. I have never bought a newsletter nor paid any attention to anyone’s trade recommendations.
    2) If I slam Schaeffer, I’ll make enemies that I don’t need. If I praise him, it will sound like a recommendation. I would never recommend that anyone pay him a dime.
    I’ve mentioned him before.
    Here’s what I know about Schaeffer – and it’s not from personal experience. It’s from some of the things he writes. His track record seems to be terrible, yet he charges significant money for his advice.
    3) I have disliked Motley Fool from its inception. I cannot tell you why. They offer some decent advice in general. But I have no idea whether their ‘picks’ have any value
    4) Touted success? Who touts his success?
    I always tell people that paying for trading picks is very foolish. I believe you will do much better in the long run by learning for yourself. That may take time, but to me it is worthwhile.
    In general terms: I have zero personal experience. However, the evidence that I see tells me that asking someone to give specific trading advice is stupid. Plain stupid. First, the service costs too much. Unless you have the cash to trade a large number of contracts, you may not earn enough to cover the cost of a subscription. Next, if they lose money, you are out the cash plus the expense. Third: The honest truth: I know one company that made 23 consecutive losing trade recommendations – and the subscription cost $5,000.
    No one should be able to lose 23 consecutive times.
    My advice is to only buy a subscription when you have corresponded with people who truly bought, paid for, and prospered from subscribing. Do not believe the hype. Demand audited proof of success. Audited.
    There are some honest Joes out there. But I don’t have a clue how to find them.
    Good luck

  6. Jake 03/12/2015 at 6:43 PM #

    Hello,

    You say you do some kind of adjustment before reach your maximum loss. Could I know which adjustment you do? I ask that, because I have the idea that you repurchase some of the credit spreads you sold, but if you do that – sure the loss wont be the maximum loss for all the IC, but also the statistic won´t be to earn 250$ two of three IC you sell…

    Hello Jake,

    I do not always use the same adjustment strategy. There are several good choices, and my decision is based on which I believe will work best for the current trade.

    Yes, I do recommend repurchasing (covering) some of the credit spreads that were sold earlier because it is a very easy to understand adjustment method. Keeping things simple (when possible) is always good because it minimizes the chances that a trader will make a mistake in judging exactly how to adjust.

    It is important to note that our initial profit target for the trade changes over time. Sometimes the markets are calm and we can hold longer than the original TRADE PLAN called for, and sometimes the market makes unhappy (for us) moves. When that happens we should take steps to prevent getting hurt. That means out profit target must be reduced. Sometimes it means that we must accept the fact that there will not be any profit.

    The rationale for adjusting in a timely manner is simple. And if you do not believe the following statement to be true, then you (this applies to every trader) should not be using the strategy being discussed (iron condors): “Trading iron condors is a long-term profitable strategy, but

    • You must devote time to understanding risk (what can go wrong)
    • You must demonstrate the discipline to take a loss when necessary — to prevent losing too much money on any specific trade.
    • You must not be greedy. Establish a plan for each trade and follow that plan.
    • Never, never expect to earn a profit from every trade. It is almost impossible.