Working With Positions That Have Become Ugly

When the markets are non-directional, those are the high-profit, glory days for iron condor (or other premium-selling) traders.  Enjoy it while you can because it's not always going to be that easy.

In fact, until yesterday's rally, the market has been moving steadily lower this year – at a pace that suggests 2009 can be much worse than 2008, even when the decline occurs with reduced volatility.

I don't know which strike prices were chosen by other iron condor traders, but until this week I have been very fortunate.  But now some put spreads I sold as part of an iron condor position have moved close enough to being at the money, that I am concerned.  Not concerned enough to make any major adjustments, but I have taken some defensive action.

On Tuesday, RUT traded below 360 and I am short a bunch of RUT March 340/350 put spreads.  I have no intention of holding this position through expiration, but right now I am unwilling to pay the required price to exit the position.  Instead I am making small changes that improve my risk/reward situation.

Before describing the new trades, I want to mention that the purpose of disclosing my trades is not for anyone to keep score of how I am doing (that cannot be done because I do not report all trades on Twitter), nor am I recommending these trades as standalone investment suggestions, but because some of you may find these ideas useful and adopt them for you own troublesome situations.  I must mention that these trades are suitable when trading high priced index options, but are inappropriate for the vast majority of individual stocks.

1) Buy Mar 360P and sell more 340/350P spreads.

On a ratio: Buy one, sell 3,4, or 5 spreads.  I prefer the higher ratio when my position is not already too large for comfort.  The net cost depends on the ratio, but I collected cash by doing 1 x 5.

ADDENDUM: Nov 18, 2009.  The kite spread calls for a ratio of only 1 x 2 (the 360 and 340 puts are 20 points apart; hence 1 x 2)

At first glance the ratio feels wrong, but because you pick up an extra put, losses are limited ($3,000 if the expiration settlement price is 340), and those losses are reduced by $100 per point as RUT moves lower.  A lower ratio costs some cash, but it's well worth it for the ability to pick up extra long puts – and those puts have a very useful strike price.

This is not a good idea for individual stocks because of the increased risk that the underlying can settle near your point of maximum pain.  With the high priced index, this trade provides protection if the market takes a steep dive – perhaps 10%  – a large enough move that owning an extra few options makes a difference.  If your trade a $50 stock and it drops 10%, the final price of $45 will hurt and not help.

2) As an alternative, consider covering some Mar 350P and selling the Mar 330/340 put spreads on a similar ratio.  This is not as 'clean' and the resulting position may 'feel' uncomfortable.

3) Buy a few OTM Apr calls and puts.  No details necessary because you want options that provide help at an RUT price that suits your risk profile.  Your broker should provide the necessary risk graphs. 

Methods 1 and 2 above represent an idea about which I have not previous written.  I'll be discussing other choices as time goes by.  But, I have previously posted some of my ideas about iron condor adjustments.


5 Responses to Working With Positions That Have Become Ugly

  1. Gil 03/06/2009 at 2:25 PM #

    After reading your post about “positions that have become ugly”, I found out that today (March 3)^RUT is indeed under 350 within the range of your original Iron Condor Bull Spread.
    On one hand you have already improved your RR ratio by means of back ratio spreads. On the other hand you claimed you are not going to stick with this position until expiration (and without the RR improvement I can see why). My question is: how you address this now, meaningly after the RR improvement is already in place.
    Thank you

  2. Gil 03/06/2009 at 2:43 PM #

    When improving the RR ration you said:
    “because you pick up an extra put, losses are limited ($3,000)
    if the expiration settlement price is 340,
    and those losses are reduced by $100 per point as RUT moves lower”
    I understand this and fully agree… however, this refers only to the new positions. I believe that you should also take into account your original spreads (you have not told how many you’ve got), which have poor RR!

  3. Mark Wolfinger 03/06/2009 at 9:21 PM #

    This response covers both of your comments.
    1) The answer is a bit complicated. I own several iron condors simultaneously and I do not always manage each one on its own. In other words, if I buy the back spread, the positive gamma works for the whole portfolio, and not for a single spread.
    2) When looking at my position – original plus any modifications (I don’t count the back spread as a modification; it’s simply portfolio protection) – If I decide to exit (or roll) one credit spread (half the original iron condor), then I revisit the back spread. Assuming I don’t need it to protect other shaky positions, I close it. It has served its purpose.
    3) I almost never hold onto a spread position in which the short strike has moved into the money. But because of the position adjustments I’ve made, I still own the position. It no longer resembles the Mar 350/350 put spread. I am long some Mar 360 puts and some Mar 330 puts. I also sold some Mar 310/320 put spreads.
    It’s complicated. But the major points are these:
    a) The position is net long puts
    b) The position has very limited downside risk and makes money if the index plunges.
    b) I have covered some 340/350P spreads and sold extra 300/310P spreads, collecting a small cash credit.
    c) I’m going to continue to modify this position as the days pass,/ and I now have no idea if/when I will choose to exit. I’m set fairly well to make some money, depending on where RUT is priced when the settlement is determined. But there is no longer any potential disaster.
    d) The big risk has been removed, so it becomes advantageous to hold.
    e) These points DO consider my original position, coupled with the adjustments I have made. I did not post all trades on Twitter, but I did some of each of these trades:
    i) BOT Mar 360 put; sold 4x as many 300/310 put spreads
    ii) BOT Mar 340/350 put spread (to close) and sold 2.5x as many Mar 300/310 put spreads.
    iii) BOT Mar 350 put, sold Mar 330/340 put spreads.
    iv) Bot Mar 350/330 Put spreads (to close) and sold 4x as many 310/320 spreads.
    The downside is fine because I own extra puts.
    I purposely did not mention the size of my position because that really makes no difference to the discussion. But I held a 100-lot position (spread over two different accounts), and that’s much larger than I’ve been trading recently.
    I don’t know how this is going to come out in the end, but a great deal of the risk has been removed. If we get the sharp rally, then I’ve spent money to insure the position, and that expenditure will be lost (and I’m surely hoping that happens).

  4. YC 03/10/2009 at 4:51 AM #

    Hi Mark,
    Could explain why you said
    “these trades are suitable when trading high priced index options, but are inappropriate for the vast majority of individual stocks.”?

  5. Mark Wolfinger 03/10/2009 at 9:21 AM #

    I thought this was going to be a very short reply. Until I began writing.
    Here’s what I was thinking:
    If your put spread is threatened – i.e., the short strike looks as if it will shortly be ITM, and if your comfort zone does not require that you exit this position, and if you want to reduce the risk of holding this position, then one possible method for reducing immediate risk is described. [That’s several ‘ifs’]
    NOTE: Ultimate downside risk is not removed. This method merely shifts the risk to a lower strike. I want to stress that I don’t believe this is the best method for handling such positions. Exiting and taking the limited loss is often the best approach. But I know that in the real world many traders (myself included this time) try to work losing positions to improve their situation and allow for the possibility of a much smaller loss, or even a profit.
    In RUT, I have a problem at the 350 strike. I can buy 350 or 360 puts and then sell some OTM puts to offset all or part of the cost of my put purchase. I began by selling more 340/350P spreads. Then did a few 330/340P spreads (in a different account). Finally I sold a bunch of 310/320P spreads. The point is I had choices of spreads to sell. And when selling I could vary the ratio of naked puts bought to put spreads sold: anywhere from 2×1 to 5×1.
    I also had the choice of buying put spreads (340/350) and selling 310/320 spreads, shifting risk lower.
    With a lower priced sock, there are no such choices. If you are short the 45/50P spread in a $50 stock, where can you go? It’s unlikely that the 35 puts are listed for trading, but even if they are, you cannot expect to collect any reasonable premium for the 35/40 spread. You may be able to sell the 40/45 spread while buying in some 50 puts, but unless IV is quite high, the premium will be too small to make the trade attractive.
    I did not mean you cannot use stocks. I meant to say you probably will not want to use lower priced stocks because the trading choices and the premium available will be unattractive in the vast majority of cases.