Putting it all together

This is a lengthy post and offers much of my philosophy on how a trader can learn to trade efficiently and earn money. If you like these ideas, become a member ($37/month) that comes with an unconditional 30-day money back guarantee.

Learning to trade is a big deal. It is not something that can be learned overnight. It’s often repeated but:

Doctor wannabes go to medical school; then they become interns. They do not practice medicine without an education. Likewise, lawyers, pharmacists, teachers, etc go to school and receive training before practicing their crafts.

However, many people believe that trading is easy and requires zero training. In reality, trading is a difficult occupation and becoming successful requires skills that not everyone can develop. It takes discipline and other personal traits that some people lack.

Taking lessons, reading, attending seminars may be boring to some people. However, there are important lessons to be learned along the way. There is no reason to lose money by trading something that was not quite what you envisioned it to be (VIX options are a good example).

Trading does take learning a bunch of lessons, and that is especially true for option traders. Options are unique tools. The fact that they have limited lifetimes is only one major consideration. Options also come with measurable risk characteristics: we know the rate of time decay (theta); how many shares of stock represent an equivalent position (delta); how fast that share equivalency changes (gamma); and how volatility expectations affect the price of an option (vega). No other trading vehicle offers these possibilities.

Among the lessons to be learned, some are unexciting (exercise and assignment process, how the OCC separates buyers from sellers and guarantees all option contracts…). Others are far more interesting because they involve specific trade ideas that lead to earning profits. Still others, such as risk management, are vital – and the newcomer to options may not pay enough attention to them because they are only indirectly related to making money.

When you learn the lessons, remember them. Put them to good use.

Hi Mark:

I have a question regarding the discussions that we had tonight (Jul 3, 2012) at the Live Meeting. As luck has it, I opened a RUT Iron Condor position yesterday (07/02) for July monthly expiration. The call spread portion of it is 840/860 for .72.

When I opened this position, the delta for the short call was 12. After the RUT moved higher yesterday and today, the delta for the short call has gone up to 22. Still perfectly reasonable – but let’s just say this is getting close to my “discomfort level”.

If I look at closing the call spread, it’d cost $2.88 – so now this position is down $2.16, right?

Let’s say if I want to roll down to 850/870, the midpoint was $1.32. So, let’s just say that I was able to get it for $1.30.

I guess my confusion is this – the move from 12 to 22 delta caused the position to lose a little bit when trying to roll it down.

If I waited until 35 delta before rolling down, won’t it be too late? I mean, won’t the cost of closing the call spread be too high? Isn’t it unlikely that I’d be able to roll down and obtain sufficient premium to maintain a profitable position? Or, is it better to assume that once we reach 35 delta, then any adjustment is done mainly to minimize the loss?

Thanks for your help


Thank you for this excellent question set. The reason it is so important is that it brings up the one issue that is not easy to get newer traders to understand:

A trade requires some planning. We cannot trade efficiently when certain parts of a trade plan are incompatible with other parts. An important aspect of your eduction is learning how to recognize when a total trade plan is well thought out versus when it has been put together without much thought.


1) The fact that you collected 72 cents for the call portion of the iron condor is immaterial. I encourage you to think of the cash credit for the whole iron condor. [I later learned that this was $1.34.]

When you made the trade, you KNEW that one side would not be in trouble (at least not as the same time as the other side), so the total premium is what you have to work with. Do not believe you own a winning put spread and a losing call spread. You own one position: The iron condor.

2) Beginning with the delta of your shorts being 12 is a very solid choice. For brand new option traders, I prefer 8 to 10. More experienced traders can own positions with higher deltas, if they so desire. That discussion involves CTM [close to the money iron condors and is beyond the scope of today’s lesson] options.

3) I agree that holding the current position with the short call delta at 22 is reasonable. One of the things you want to understand – is where the borders of your comfort zone lie. You cannot discover that in a single trade, but you apparently have a good sense already. If you are near that point right now – with the 22 delta position – then something is missing from your game plan. More on that below.

4) Yes, the call spread is losing $2.16, but I urge you not to think this way.

You do not own one call spread and one put spread.

You own one iron condor and all calculations should include the whole iron condor trade. That change is not going to help much in reducing the current unrealized loss, but it is a much more efficient way to think about trading iron condors. And that is important for you to understand.

If you manage iron condor risk separately (as I encourage) – i.e., as one call spread and one put spread – and also keep your arithmetic separate (which I DIScourage), then you truly have two separate positions. The truth is that you don’t. You have only one. Keep the trade finances as a single unit, and manage risk as two separate positions.

5) OK. Let’s assume that you can roll down for $1.30.

DO NOT assume that your loss would be $1.30 minus premium collected when it was $2.88 minus premium if you choose to exit.

***Important mindset***

    Your position has a certain value at each and every moment that the market is open for trading. Currently, the trade is losing money. Nothing can change that: you have an unrealized loss that is equal to the cost of closing the entire iron condor minus the cash received when you initiated the trade. That is a fact.

    That loss is not changed when you make a trade.

    If you exit, the trade is finished (assuming you make the risk-reducing decision to cover the put spread at a low price now. There is no point in taking too much risk when the remaining profit potential for that put spread is small. Don’t bid the asking price, but do enter a reasonable bid. And then raise it by 5 cents if not quickly filled. When you cover that put spread, you can calculate the loss for the trade.

    If you choose to roll down and pay $130 per spread, then your current loss remains unchanged. The difference is that you have an open position. That position can earn money from this moment into the future, or it can lose money. The result is unknowable right now.

    However, you can calculate the maximum possible profit, which is the original cash credit minus $1.30 per iron condor. If that number is negative, then you cannot earn a profit. If it is positive, there is still some room for profit. But, believe it when I tell you that is not a major consideration. What counts most is that you make a decision that allows you to comfortably hold the position. If you want to leave it alone for now, that is ok. BUT DO NOT LEAVE IT UNCHANGED JUST TO PREVENT THE LOCKING IN OF A LOSS.

    When trouble looms, your priority is not to earn a profit. Repeat that to yourself as often as necessary until you believe it to be true. It is true.

    Your priority has become preserving your assets and not allowing yourself to get into a position where you become afraid and where you may make a trade decision in panic. You want to remain in control of your emotions and your money. If you are not comfortable with a 22 delta, then do something: reduce size, exit, or make an adjustment (rolling down is a good choice). Come out of any decision holding a position that makes you comfortable right now. If that means making no changes, so be it. But remain diligent and be ready to do something to reduce risk – if and when necessary. If you can do it, try to decide when you would be at that point.

I accept that loss when the roll down is not attractive. I accept that loss whenever I prefer to exit.

But when the roll down leaves me with a position I want to own, at a price I am willing to pay, then I go for the roll down. Speaking for myself, I do not choose the roll down because it gives me a chance to come out with a profit. I choose it independently because I prefer to own the trade. If I must pay enough for the adjustment that it locks in a loss, that does not matter (to me). I want to have the position that I want to have. If it’s going to be a loss when all is said and done, at least it has a good chance to be a smaller loss than my current unrealized loss – that’s why I want to own the position. I like the profit potential from here into the future. I cannot change the past.

Keep in mind that expiration is 3 weeks away, and the nearer it is, the less attractive the roll down becomes (because you may not be able to sell the new spread at a decent price, making the roll down too costly).

7) Yes, the cost to roll down will be much higher if you wait until your short delta is 35.

Yes, it would probably be too late to have any chance to come out of this trade with a profit.

That is not your main problem: Once any roll down adjustment is made, you must accept the fact that you will have to settle for a smaller profit than you hoped to earn. And it some cases, you may not be able to earn any profit. If that profit is crucial to you (and I suggest that you place risk management to protect your assets ahead of the need for a profit from every trade), then do not pay as much as your original credit to roll down. I cannot tell you what the delta of your short option will be at that time.

I don’t know how much longer you should wait before pulling the roll-down trigger – because I cannot get into your head to recognize how uncomfortable you are.

But there are two conflicting things going on:

  • Wait longer and you may lose too much
  • Wait longer, and the market may reverse, temporarily saving you from making the adjustment

Also remember that as time passes, the roll down becomes less attractive.

8 ) “Is it better to assume that once we reach 35 delta, then any adjustment is done mainly to minimize the loss?”

***Your last sentence is the whole enchilada***

1) We initiate a trade to earn a profit
2) We manage the trade to take care of risk

These goals do not remain aligned, and my philosophy is to pay attention to #2 and focus less on #1. I do agree that when you can manage risk and take into consideration profitability – that is good. But many times, you cannot do that. Take a look at my weeklys trade for Jul 3, 2012. The maximum profit was $600, yet I ‘invested’ $1,740 to manage risk. To some people that is heresy and is never done. If the market tumbles, I lose far more from my adjustment than I could ever have earned from the initial trade. I can see that is how you prefer to think. You don’t want to spend so much on any adjustment that it locks in a loss.

    NOTE: I made that trade adjustment because exiting would have been as costly, and I PREFER to own this position rather than no position. It is not the original $600 that mattered. It is the cost to exit now that counts. In other words, I have to play the hand I hold now, not the hand I was dealt earlier. So my trade choice was personal, and not a recommended trade for anyone else. Yet, it is an idea to consider because considering alternatives – even if you reject them – is one way to grow as a trader.

The real problem

The real problem is that you are learning and absorbing much material very rapidly. I do not recommend iron condors as an option trader’s first strategy. [Yes, I know you have been trading very short-term iron condors, but the risk management technique for those is very different, and there is much to learn].

Plus, there are many lessons to learn about options trading in general – before being ready to take the plunge into iron condors. I admire what you are trying to do, and I want to help. However, it is difficult to give you a set of lessons as quickly as you need them.

You ask good questions, so are obviously intelligent and understand what you are doing. But even smart people study algebra and geometry before taking calculus. In the lessons on writing covered calls, collars, etc is ‘stuff’ you want to understand. If you have the patience, I encourage going through the videos in the Complete Introduction to Options course – at no additional cost.

My bottom line is: You already have the loss. It is not realized, but it is real. The ONLY problem you have now is: What position do you want to own today (7/5)? You can hold, exit, reduce size, roll down etc. After the fact, one of these choices is going to be BEST. But now, when you have to make the decision, there is no way to know which choice that is. Right now, as always, you have to make the best decision you can make. This is one reason why making practice trades (one lots or paper-trading) is effective. It gives you real experience in making decisions.

Again, in my opinion, trading iron condors (or anything else) is not following a set of rules. Sure, the ‘rules’ help you make some decisions when opening the trade. It may even help with closing the trade. However, the trader is always faced with situations that are not simple to solve. It takes experience. It takes a good mindset and way of thinking.

The true danger to experimenting with (for example) holding to 35 delta – is that the market may reverse, and the trade may become a big winner. Why is that a problem? That will teach nothing. In fact, it may give you false confidence that waiting (again for some unspecified higher delta) is a good idea. That’s a real danger: delaying needed risk-reducing trades.

When we make money me MUST understand why we were profitable. Was it good luck with the market behaving? Or did we influence the result by making a good (intelligent, even if it does not work out) decisions along the way. We learn nothing from good luck – other than we deserve some and will get it from time to time, but we cannot count on it.

The bottom line is that a trade plan takes it all into consideration: When will you exit to cut risk? Do you prefer to adjust rather than exit? That makes a difference because, as you touched on, exiting locks in the larger loss and adjusting gives you a chance to recover all OR PART (and ‘part’ is good enough for me. ‘All’ requires thinking in terms of making #1 more important than #2). When a trade goes sour – and not all of them will – instead of the big profit, think in terms of the small profit, and more importantly, not allowing the uncomfortable, large loss.

There are a bunch of decisions that go into a trade plan, or an overall game plan. A plan for each trade is best, but most traders do not want to bother. An overall game plan is necessary: Know the answer this question: How do you plan to make money?

Tomorrow, I respond to another question that continues the conversation. I’ll get to a couple of the important points when constructing a game plan.

But, right now, I will say this much: If you are going to get uncomfortable when delta reaches 22, you cannot begin the trade with a 12 delta. These ideas are incompatible becasue you would adjust yourself into oblivion.

2 Responses to “Putting it all together”

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