Iron Condors: Should They be Rebalanced?

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At a recent live meeting, we had a discussion that involves deciding whether to rebalance an iron condor position.

To clarify, in this context, ‘rebalance’ means to change our existing position into one that is

  • more comfortable to hold
  • a position you want to initiate now
  • nearer to delta neutral

The bottom line: Should the existing position be rebalanced? It is better to start a new position? Is it more efficient to continue to hold the current trade?

Assumptions

  • One month ago we bought a 13-week iron condor, collecting $270 as the premium
  • If we choose, we can exit by paying $190. Profit: $80 (less commissions)
  • We are not delta neutral. The calls are 8% OTM and the puts are 6% OTM. This is well within our comfort zone
  • This is a voluntary exit. The iron condor is not currently ‘at risk’
  • If the trade is not in trouble, and if one month has passed, the trade is almost certainly profitable at this point

Question: Does it pay to rebalance good positions?

The Pros

It’s a good idea to own a portfolio of positions that are as near ‘perfect’ as possible. However, stocks change price and our positions frequently stray from perfection. However, they don’t necessarily reach the point of being too uncomfortable to own, and rebalancing does cost money (commissions plus those bid/ask spreads).

The point of this discussion: Why own good positions, when you an own ‘better.’ Sure we understand that terms such as ‘good’ and ‘better’ are relative, but if we can exit one trade that is good and open another that we prefer to own, is that something we should do?

In our example, we did pretty well for one month. The margin requirement was $730 ($1,000 less the $270 premium collected). If we assume a net profit of $72 after paying $1/contract in commissions, that’s almost 10% in a single month. Let’s take that gain and open a new trade.

The Cons

The current position is excellent. Our shorts are still well out of the money, and there is no reason to exit. But more than that, there is no reason to anticipate that we can earn the same, or more profits, by opening a new trade. All we would gain is extra market neutrality, and it may not be worth the expense of making the switch.

We do have a bit more negative gamma {when compared with 3-month options) if we hold the 2-month options . However, time decay is more rapid – and that’s the tradeoff.

The major reason for not rebalancing is that the cost. I never skip a trade because of commissions (if your costs are too high, find another broker). However, when we trade an iron condor, it’s necessary to battle over the price of the trade. We must always pay more than the midpoint of the bid/ask quotes to buy. And we must accept less than the midpoint when selling. Thus, closing one trade and opening another is not free.

I make this position switch only when the current position is not good enough to own. Ultimately this is a close decision.

Conclusion

Establishing a trading plan that calls for exiting a 13-week iron condor after only 4-5 weeks is a bit unusual. Rebalancing can be appealing, but as a rigid trading rule, it has little appeal. I don’t believe in having too many rigid rules.

Thus, my recommendation is to reevaluate positions on a regular basis and decide whether our portfolio requires that one or more positions be rebalanced. Do not make rebalancing a requirement.

Note: We are not speaking of normal risk management in which we never hold positions that are uncomfortable to own. However, when one position is not much better than ‘okay’ then replacing it with another position that meets our requirements for a new trade makes sense.

‘Rebalancing’ is similar to rolling. But the mindset is very different. Rolling is done under duress, when the threat of losing money is imminent. This time the discussion involves a voluntary ‘modification’ of our portfolio. It involves going from good to better.

Why bother to talk about this?

Some believe that rebalancing is an essential part of managing risk. I agree that the concept has merit. However, I encourage Members to consider rebalancing and recognize that is is often a waste of time, effort, and money.

4 Responses to “Iron Condors: Should They be Rebalanced?”


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