Managing a Short-term, CTM Iron Condor

[Kim 7,512]

From Mark Wolfinger, Options For Rookies

 

A trade plan from a member.

 

I added some comments, which I trust will prove helpful. The one thing that is missing from this detailed plan is a voluntary exit for the trade. In other words, do you have a target profit in mind? Is there a price that you want to pay to get out of the whole position? I urge you to establish such a (flexible) target.

 

Mark, my rationale for adjusting in stages is the following:

1) I believe that the market will be bullish to neutral in the next month;

2) Since I’m holding a front month CTM condor, there’s not much price movement required to bring the call side ITM (35 points distance from index price to the short strikes.)

It’s a 100% probability that I will have to roll down the call spreads;

 

I assume this is a RUT iron condor position. When I look at the 35-point OTM options that expire Feb 15 (AM settlement), I see that the iron condor is valued well under $1. How much did you collect? What were the original deltas? When was this trade made?

 

CTM iron condors require large cash credits so that risk can be managed efficiently. Collecting a small premium and anticipating a profit – especially when you know that one side will be ATM almost every time you make this play – is unrealistic.

 

When a position is 100% likely to require an adjustment (and this position is far from 100% for the upside), that adjustment cannot be an exit, or partial exit. think about it. You are planning a trade, knowing that your very first move is going to lock in a loss. It makes more sense to plan an adjustment that spends some of that very high premium collected to make the position worth owning. In other words, this is a situation for which the risk-management plan is inconsistent with profitability. Is your ONLY path to profits the hope of making zero adjustments and exiting prior to expiration? That’s an outcome with a low probability.

 

3) So I can wait until one of the sides goes ITM, roll down and take a significant loss in this case (that happened to my Feb position, the price did a rocket jump and I simply had no opportunity to react);

 

Of course our usual risk-management plan involves waiting until we get a ‘do something’ signal. In this case, you believe that an upside adjustment is imminent. My only question is why wait? If the answer is that you do not want to play your market prediction, they waiting is the best alternative.

 

Here is a mindset difficulty: When you collect a large premium for a CTM iron condor, rolling down, and paying the cost to do so, is NOT locking in a large loss. It is spending some of the initial premium for additional (even if temporary) protection. Making the roll-down is part of the plan. Repeat, making the roll down is part of the plan. If a gap opening last month caused a delayed adjustment, that is unfortunate. However, when trading CTM iron condors, it is necessary to have a risk-management plan that is consistent with the CTM position. The roll-down appeals to me as that best plan. However, I recognize that you may find another plan to be preferable.

 

4) Obviously I’d like to minimize losses on the way up without increasing risk on the way down (just in case if the market decides to reverse, you never know when it happens). I’m trading a 4-lot, so there’s not many options available. Before I used to buy an OTM call, but we had a discussion about that and now I understand that this not the right way to go for an iron condor;

 

In my opinion, the problem is made worse by the fact that you own the front-month, high-gamma position. Of course, most IC traders prefer that rapid time decay. Plus, today’s low IV environment makes it difficult to trade longer-term spreads. A true dilemma, and I see why you own a front-month position.

 

5) So I decided to unload the threatened side in stages. If the price is halfway to the strike, I unload half of that side.

 

The loss is still not big and I accept half of it when doing this. Positive effect: the risk is reduced, realized loss is small, position is close to delta neutral, no impact on margin, opposite side (put spreads in this case) risk is not increased – if the price reverses, I’m not seriously hit. Negative effect: impact on theta, less credit available;

 

Adjusting is stages is a sound risk-management plan, for the right type of iron condor. However, please give serious consideration to the bigger picture. Your trade begins life as a close-to-the money iron condor. Each short option has a high probability of being touched by the underlying asset. Do you really want to CLOSE part of the position before it becomes an ATM option?

 

That plan requires locking in a loss – and you probably have to do that more than once. It is not a viable plan (again, my opinion) for the CTM iron condor.

I suggest two ideas:

• These options are too close to the money for your comfort
• 4-lots is too many for this strategy at this time. Why not trade 2-lots and pretend that you began with 4-lots and covered half of each side at a beak-even price. Would that make your position more comfortable to hold? And you would not have to lock in any loss to own it.

One of the primary concepts for option traders seems to be difficult to accept.

The trade plan and the risk-management plan have to work well together.

 

There is so much going on here that planning to collect profits based on time decay – and not buying back part of the position – is not viable. There are just too many buy-backs. The problem, as I see it, is that 4%-OTM iron condors cannot be handled this way.

 

Remember: This trade began as a CTM position, and holding a ‘winning side’ until it become VERY inexpensive cannot be part of the game plan. Do you have a target price for buying back one side when it reaches a suitable price? For CTM trades, that prices is probably not less than $0.40 to $0.50 – and perhaps is higher. I do not believe it is viable to wait for the same $0.10 to $.20 that we typically wait for before covering a more traditional iron condor.

 

After covering one half, the smaller position size corresponds with smaller potential gains and losses, so less theta and a reduced profit picture are part of the package. I must stress this: In my opinion, theta is not important. Yes, it represents your daily profit for taking the risk of holding onto the position. However, the amount of money that can be lost on a significant one-day price change is so much greater than theta, that obsessing over theta is self-destructive. It takes your eye off the real risk. Yes, if theta is too low, the reward may not be worth seeking. If that is true, then there is no reason to own the position.

 

Maintaining a high theta just keeps alive the risk you are trying to minimize. That is a real conflict.

Traders are in the risk-management business, not the theta-collecting business.

 

6) Next step – unload the other 1/2 of the call spreads when they go ITM. I did some testing and it shows that in this case my total realized loss will be about 50% of what I would’ve sustained in case of waiting until the whole call side goes ITM and rolling it up after this. After closing the other half, I can finish rolling down the call side by opening another full size (4-lots) call spread position where I find it comfortable. This can potentially include rolling up the put side too;

 

This is the part you may want to reconsider. With expiration so near (it is only two weeks right now), it is a big decision whether to stay with the Feb options or move on (when ready) to a longer-dated expiration. Rolling-up the put position is fraught with danger for very little reward.

 

Advice: Do not plan how to manage risk with no idea of the actual cost. That is necessary because the planed adjustment must be consistent with the trade being made. For example, it does not make sense to collect $150 for an iron condor and spend that $150 on a stage I adjustment- especially when that adjustment is virtually certain to be needed.

 

If it saves one half the loss to exit in stages, exit half at the time the trade is opened (as suggested above) and trade only 2-lots. Know the chances of earning a profit if even one adjustment is needed. Know how much cash you can collect from rolling up the put spread and decide if it is worth the risk.

 

7) What if the price doesn’t go up? If it stays neutral, I’m fine. This decreases my target profit, but the environment is not IC friendly, so it’s an acceptable tradeoff for being in the market and not sitting on the sidelines. After all, one of the ways trading in this environment is trading reduced size;

 

If you adjust and the market does not move farther against your position, that is a GOOD thing. The adjustment is made (primarily) to cut risk – and you will have done that. The secondary, but very important, purpose is to own a position worth holding. You will have done that also. The remaining questions are: What is the estimated cost of that adjustment; how much profit potential remains; and how often do you anticipate making this adjustment (in this example, it is 100% of the time).

 

It is less important to be concerned with theta than with being alert to risk.

 

8) What if the price goes down? The position is delta neutral and the down side risk is not increased, so it won’t be hammered. I can think of appropriate adjustment and act accordingly.

 

You may not be hammered, but you will not like the result when the value of that put spread moves back to near its original level. At that point, it once again becomes a virtual certainty that another adjustment will be needed. Remember that on rare occasions, the down market comes as a gap opening, which leads to large losses.

 

Here is my thought – it does not have to be yours: When trading CTM iron condors, there has to be a target profit that can be achieved without holding the position until the options are almost worthless. The whole CTM strategy calls for big profits when markets are cooperative and smaller, but good profits when a roll-down (or two) is needed. The CTM condor is not designed to be closed in stages. That is just too costly and too likely to occur.

 

Another idea for CTM condors is to have a profit target. In other words, the plan should not be to hold (unless the market is deadly dull). It should be to exit as soon as the (flexible) target is reached. There also has to be a price target for being happy to exit only one side of the iron condor.

 

So I have several assumptions here – low IV, bullish to neutral market, front month CTM condor and little time to react before one of the sides goes ITM. Based on these assumptions I think that this plan can work. Probably it won’t work for other position setup, like 2 or 3 month condors.

 

My opinion is that it would work far better for 2- and 3-month condors because: a) Premium is higher and thus, protection is higher; negative gamma is less and the loss is less when the underlying asset moves

 

Have you considered just quitting this trade ASAP just to get out of this mess? If truly bullish, why own this trade?

I sympathize with your dilemma.

 

Mark Wolfinger
Options For Rookies