Wider Iron Condors

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A recent comment from a reader (Logan) suggested a worthy topic.

Choosing strike prices for any option strategy is important.  Most traders have a method for doing that, such as using charts (selling calls above support and puts below resistance) or statistics (selling options that are a specific number of standard deviations OTM).  Alternatives include selling options within a specific delta range, or perhaps a minimum premium.

Question for credit spread sellers (and iron condor traders): If you always sell 10-point spreads, have you looked at the idea of selling 20- or 30-point spreads? 

NOTE:  Spread width is the distance between the two options that comprise a credit spread.

Equivalent trade

Let's be certain we all understand the position when a wider spread is sold.

Example: GOOG iron condors (Trade itemized is a randomly chosen example.  Please do not consider it to be a recommendation)

Your customary choice is to sell 10-point spreads, using GOOG

Sell 10 GOOG Aug 510/520 call spreads; premium = $1.90

Sell 10 GOOG Aug 450/460 put spreads; premium = $1.30

Trade: Collect $3.20 for 10-point GOOG Aug iron condor

As an alternative, you are considering the 20-point iron condor

Sell 10 GOOG Aug 510/530 C spreads; premium = $3.00

Sell 10 GOOG Aug 440/460 P spreads; premium = $2.30

Trade: Collect $5.30 premium for 20-point iron condor

This may be obvious to experienced traders, but if you never thought about it, or if you are new to options trading, then this simple conclusion may be news to you:

When you own the 20-point iron condor, your position is exactly the same as if you bought each of the two 10-point iron condors.

NOTE:  If you prefer to own the wider credit spread or iron condor, please do not buy each of the more narrow spreads.  Just buy the position you want to own when entering the order.  This is very important because it cuts commissions in half and guarantees better fills (half as many bid-ask spreads to overcome).


In our example, 10 GOOG Aug 510/530C; 440/460P iron condors @ $5.30

is equivalent to

10 GOOG Aug 510/520C; 450/460P iron condors @ $3.20 PLUS

10 GOOG Aug 520/530C; 440/450P iron condors @ $2.10

Thus, if a 10-lot is your correct position size, then 5-lots of the wider iron condor uses the same margin and has the same risk as owning 5 of each of the narrow spreads.


Why is this important?

  • Size.  Owning one double-width iron condor is equivalent to owning one each of two different narrower positions.  Thus, when trading a double-width position, the correct size is HALF your usual size.  This is very important for risk management. 
  • 20-point spreads allow the trader to own two iron condors simultaneous
  • If the CTM (closer to the money) position is near the borderline of your comfort zone, one way to minimize that concern is to cut position size in half and add an iron condor that is one strike farther OTM on each side.  Note, this does not remove the risk associated with the CTM position, but averages that risk with another iron condor.  In other words, you have 5 CTM and 5 farther OTM iron condors.

I always trade and describe the narrow iron condor.  However, there are advantages to the wider position.  In the example, we traded one iron condor, collecting a premium of $320 and another collecting $210.  For most traders, that farther OTM, lower premium iron condor is less risky to own from the point of view that it is less likley to lose the maximum.

RookiesCover747


I'm very proud of The Rookie's Guide to Options.  Unsolicited comments offer almost unanimous praise.  If you are seriously interested in learning about options, this is the book for you.  For the beginner, but it contains much material not discussed elsewhere, and is appropriate for intermediate traders as well.

 


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19 Responses to Wider Iron Condors

  1. dennis mooney 07/23/2010 at 6:47 AM #

    Mark I diligently follow your columns on Twitter and haven’t used RSS. I have you and a few others in a twitter list so that I don’t lose your tweets in the mass of others.

  2. Mark Wolfinger 07/23/2010 at 7:20 AM #

    Thank you

  3. Debi 07/23/2010 at 11:18 AM #

    Mark, great blog. Let’s say I bought a call and the underlying stock moved down, dropping below the strike price. I could try and salvage what is left of the contract by selling the entire position. How much could I possibly get from trying to close down the position early? Is it better to just wait until the end and hope for a miracle?
    Second: If I buy a call and the underlying stock moves up, I sell the option and make a profit between what I paid for the option and what the option is selling for now. I am confused. Do you get both intrinsic value gain and the difference between what i sold it for and the premium. How do you know what you sell it for?

  4. Mark Wolfinger 07/23/2010 at 11:52 AM #

    Debi,
    Good questions.
    I plan to publish a complete reply Tuesday.
    I am sending the rely via e-mail so you don’t have to wait that long.
    Regards

  5. Logan 07/24/2010 at 12:12 AM #

    Im glad to see more discussion on this subject. I see the advantages of this longer term, wider spread idea but still having trouble estimating proper entry triggers. For front month I would place BC when I thought the market was in the upper limits of the range and BP after some downfall and overselling. I believe now that this isnt as important on a 3 month term and that volatility level could be more of a trigger but not sure what would be considered favorable climate in this area. For instance, the RVX is above 30 which I think would be considered above the mean and may be considered good time to sell but not sure.
    Example:
    A 760/790/530/500 Oct IC on the RUT is a -8 and 12 delta and currently bringing in 16% credit. Seems like decent trade but just not sure whether it is a good time to pull the trigger or if there is something else I should be considering.
    Would you consider this a decent trade at a decent time now or be looking for something else prior to entry?

  6. Jill 07/24/2010 at 10:35 AM #

    I’m not sure where I’m supposed to post this. I have a question about covered calls is you write about those too.
    I’ve owned Verizon stock for a while. It has a good dividend and not very volatile. Recently purchased more when it hit a 2 yr low around 26.15. This stock usually only moves up or down a few dollars over a few months. It started trading over 27 and I decided to sell options against for income and sold them at 28 which expire in Sept. Shortly after they just had an earnings announcement that moved this up over $1.50 in 2 days to over 28 already.
    I still have almost 2 months on these options and not sure what I’m supposed to do now. Can I have someone go ahead and buy my stock? The options are showing a loss but should I close both or do I have to hold them another 2 months? I’d rather get out now if possible but not sure if I can. Thank you

  7. 5teve 07/24/2010 at 4:48 PM #

    Hi,Mark
    Sorry to be off topic a bit. This question has bother me for quite a while. This is a case about when you own a ITM call option that reaching expiration.
    For American style option, your call option will get automatic exercised if it is in-the-money. you will be owning shares, what would happen if you don’t have enough cash on account to buy the shares? Will your position incur a loss that the ITM call option just got expire worthless?
    For European style option, in same situation, if you don’t sell ITM call option at the time of expiration, will you be automatic get the intrinsic value of the call option, or it will be expire worthless?
    hope i make the question understandable. Thanks

  8. Mark Wolfinger 07/24/2010 at 5:15 PM #

    Hi Jill,
    You found the correct place.
    The first thing you have to understand that the option owner decides whether and when to exercise the option to buy your stock. There is simply nothing you can do to ‘have someone go ahead and buy’ your stock. As the seller of an option, you have no rights.
    However, you do NOT have to wait another two months. All you have to do is what we refer to as: “unwind the position.”
    That means you can buy back the call you sold earlier. Then you can sell your stock. It’s a pretty simple process.
    You have two choices: You can make the two individual trades (buy call first, then sell stock) or you can enter an order to execute both parts of the trade simultaneously. If you do that, please set a limit for how much cash (stock price minus option price) you want to collect for the combination, and do not enter a ‘market order.’
    If you have a problem, your broker can help you enter the order. But try not to pay for a ‘broker assisted trade.’
    Regards

  9. Mark Wolfinger 07/24/2010 at 5:20 PM #

    5teve,
    No such thing as off topic, if it’s options related.
    The option will NOT expire worthless. Some brokers will notify you that you don’t have the cash to exercise the option and request that you sell it (That’s a good idea anyway).
    Some brokers will allow the exercise to occur. Most of the time you will be able to borrow needed cash from your broker (you do have a margin account).
    If you don’t have enough equity to borrow the needed funds, the broker will issue a margin call. You will not have much choice and will be forced to wire cash to the broker or sell the stock.
    Make it easy on yourself and sell the option when you are ready. Hopefully that will be prior to expiration.
    With a European style option, there is no problem. You just get the cash value.
    Thanks for asking. Very understandable.

  10. Jill 07/24/2010 at 6:16 PM #

    Thank you. Maybe I’m looking at this wrong buy my option price is at a loss right now and if I close I’ll actually be worse off because of the option instead of had I not sold one at all. Right? For some reason I thought if it reached my stock price I would get the stock gain plus the option income but I’m actually losing on the stock gain because the option is at a loss. Am I looking at this wrong? Is there any benefit to waiting or do most just close it out when it hits is mark?

  11. 5teve 07/24/2010 at 6:29 PM #

    Thank you for the clear and fast answer, as always, Mark ^^
    Sometimes I try to sell the option near expiration, but I find it a bit difficult to get filled at a price I want.

  12. Mark Wolfinger 07/24/2010 at 8:12 PM #

    Jill,
    You are looking at this correctly. But, there is more than one way to look at it. This explanation is worthy of its own post and I’ll do that next week.
    Yes, you would lose money on the option – but you will have earned far more on the stock that you own. Thus, you earned a profit.
    This is a concept that is difficult for some people to understand. That is not a knock on someone’s intelligence. It’s a psychological thing – in my opinion. It’s a way of looking at a trade.
    Once you sold the call, your new position is a covered call. That means your position consists of two parts: long stock; short option.
    You earned a profit on that position. Period. You don’t have a profit on each part of the position (although that is sometimes possible). You have a profit on the total position. You made more on the stock than you lost on the option. That’s a good thing. That’s how a risk-reducing hedge is supposed to work.
    Please do as I suggest below, and that is to evaluate alternatives. Please don’t fall into the bullish trap of just buying the call and holding stock.
    There is a benefit to waiting. There is also risk. The benefit is that the option will eventually be exercised and you will get to sell your shares at 28 without having to pay an extra premium to buy the call option. Net cash to you, $2,800.
    However, if the stock falls back to 26, you won’t like that because the position would be worth only $2,600. There is a benefit – but it comes with risk. That’s normal when investing.
    Most do not think about the stock ‘hitting its mark.’ When you write covered calls, you are doing two things. You are collecting time premium. That’s good. Everyone likes that part.
    You are also obligating yourself to sell the shares at the strike price. But – you do not have anything to say about the timing of that sale. Nearly all the time, the option owner waits until expiration to buy your stock. [On occasion the exercise is made early so the option owner gets the stock in time to collect a dividend]. Thus, included in your obligation to sell shares is the obligation to WAIT until the option owner chooses to exercise. You should assume that will not occur before expiration. [When that happens, you don’t learn of that exercise until Sunday or Monday morning]
    CHOICES
    Thus, you can repurchase now, paying some time premium (i.e.,when you buy the call and sell the stock, you cannot collect $2,800. If you wait for expiration and IF the stock is above 28, then you get the whole $2,800). That’s the situation.
    Consider how much more you can earn; consider how long it will take to earn that money; decide the likelihood of VZ being above 28 when the market closes on Sep 17, 2010. Considering those things, do you want to exit now – or hold?
    If you choose to hold, you get to make that same decision every day from now through Sept expiration. You don’t have to do the math every day. The point is you always have the alternative of closing or continuing to hold.
    Jill this is a basic, but important concept. If you still have any doubts or follow-up questions, please don’t hesitate to ask.
    Regards,

  13. Mark Wolfinger 07/24/2010 at 8:17 PM #

    We can’t always get our price. That’s just part of your life as a trader.

  14. Jill 07/27/2010 at 1:02 PM #

    Thank you for your reply. I have read it a few times. I am still holding the stock and options and baffled that it continues to rise. I have held Verizon for a few years for the dividend and it never has much action to speak of which I liked.
    Instead of having a down day it continues up and is now around 28.70. I spoke with a friend of mines advisor who suggested “rolling” the sept 28 option into oct 29 calls to take advantage of the stock gain and reduce some of the option loss?
    Does this make sense?

  15. Mark Wolfinger 07/27/2010 at 1:27 PM #

    Jill,
    In theory, it makes sense. However, in the real world we have to deal with real dollars.
    1) Only you can answer this question: If you had not sold the call options, would you still own the shares, or would you have been thrilled to sell them at some price – perhaps $28, perhaps $28.20?
    We all get greedy when things go our way. You know this stock will not rise forever, so you must decide whether you have a selling price, or if you prefer to hold the shares indefinitely.
    At one time you would have been happy to sell stock at $28. If that is still true, then DO NOT take your friend’s advice.
    You have the two choices mentioned in the post. Wait or exit now. You can collect $27.58 right now. That means holding for two more months gives you a maximum additional profit of $42. Plus you may collect the dividend if there is one between now and expiration.
    If you are happy with the profits, exit. If you want to try for more, then hold.
    2) Let’s looks at friend’s advice. You can make this trade by paying $112 for Sep 28 calls and collecting $65 for the Oct 29 calls. Cost: $47 plus commissions.
    If you make this trade, and if you hold for one additional month (thru Oct expiry) and If the stock is above $29 at that time, you will collect an extra $53, less those commissions. That’s a bunch of ‘ifs’
    To me, someone with no opinion on the future price of VZ stock, this is a bad deal. The maximum gain is less than $50 per 100 shares. The risk is that VZ stock may retreat to its former level.
    It should be an easy decision. The risk and reward are right there in front of you.
    Choose among these:
    a) hold
    b) exit now
    c) roll to the 29s.
    One big skill for a trader is being able to evaluate risk and reward without emotions getting in the way. VZ is moving higher. You can say ‘good for me; I made a nice profit from my covered call’ or you can say ‘woe is me. I made a bad trade. I should never have written those calls. I want more profit.’
    I hope you have a good method for making this decision, but I truly believe there is far too little to gain by turning this into an October position.
    Good discussion.
    Regards,

  16. Jill 07/27/2010 at 4:16 PM #

    How much do I owe you? I appreciate your quick response. I think that is my biggest hang up that I dont really want to sell the stock. I have about 2,000 shares and have sold options against them about 4 other times and never got in a situation like this. If they do sell I’ll just want to buy them back at some point and continue to hold, collect dividend and sell some more options. That was the plan at least.
    Thanks again

  17. Mark Wolfinger 07/27/2010 at 5:07 PM #

    Jill.
    It’s my pleasure.
    Drop in periodically to see what’s going on.
    You have one obvious alternative: Hold for now and when expiration arrives let 500 shares go and do as your friend suggests with the other ~1500 shares. At that time you can choose which Oct (or Nov) call to sell.

  18. David Mansigian 08/06/2010 at 6:52 AM #

    Mark, a rookie question on covered calls. What do you think about buying equal dollar amounts of etf’s that have a very high negative correlation (say, TLT and XLP) and selling monthly calls or cash secured puts?. It seems like the negative correlation provides downside protection as you collect monthly premium. Thanks.
    Dave

  19. Mark Wolfinger 08/06/2010 at 7:12 AM #

    Dave,
    1) I believe it’s okay to write covered calls on any stock or ETF you are willing to own
    2) Do not buy leveraged (2X and 3X) ETFs
    3) Diversification and asset allocation are well-accepted methods of risk reduction. In my opinion, this does not work as well as it did years ago (everything is more correlated these days), but it does provide some risk reduction.
    Bottom line: It is one (very reasonable) way to reduce risk. But please be certain that you choose to own the specific ETFs. Don’t choose a pair at random – just because of the neg corr. After all, a huge downside move in one of them is still going to result in losses.
    Thanks for participating.