Track That Trade 110525

Correct trade data

This data is from May 26, 2011. I do not have the numbers from the time of the original trade.
However, one day later, with index 10 points higher, the put and call each have a delta ~16.

The greeks in the green columns to the right are: gamma, theta, vega. Delta is just to the left of those

Bought RUT Aug 710/720P; 900/910C iron condor.

Credit $2.75; added more at $2.85

May 26

Let’s assume a volume of 10 contracts, 5 @ each entry price. Thus, we own 10 iron condors and collected a credit of $280 per.

Rationale for the trade

    1. The 12+ week iron condor provides a relatively high premium with very little negative gamma – when compared with shorter-term iron condors. Not everyone likes this trade idea because the position accumulates profits slowly and there may not be much action involved in managing the trade. That has to be acceptable. After all, we may love action, but that is not the path to becoming a successful trader. The next trade that we track will have more action.

    2. By selling options with deltas of 15 and 16 [just a reminder than the put has a negative delta. But in terms of this discussion, it is the absolute value of the delta that matters]. For many traders this position may already feel too risky. Sure the greeks are neutral, but those 31 total delta for our two short options tells us that there is a 31% chance that one of these options will be ITM when expiration arrives.

    But something to remember: We plan to exit this trade prior to expiration. With less time remaining, there is a reduced probability that one of these options will finish in the money – and thus, risk of the big loss is less than that 31 total delta suggests. [Just for those for whom it may not be obvious: If we exit three or four weeks before expiration, then this trade will live for only 8 or 9+ weeks. With a projected lifetime of three fewer weeks, there is a reduced probability that one of these options will finish ITM.

    To get a good feel for that probability, we can look at the delta for the July options – with the same strikes as the options we sold in the iron condor. We must remember that July options have a different implied volatility than August and that delta depends on volatility, but as a first approximation, this is a very reasonable process.

    As I write this, the July options (the strikes we sold) have deltas of -11 and 7, while the August options carry delta of -16 and 15. Using this data, the probability that one of our Aug options will finish ITM is 31 (sum of August deltas). But note than for July it is only 18. Thus, if we execute our plan to be out of the position very near June expiration, then we should use the July delta to estimate probabilities. Why? By exiting one month early, then our Aug options have a ‘real’ delta that is the same the Jul options because the lifetime of the Aug in our hands is less than the true lifetime.

If this is not clear, please tell me and I’ll restate it in more detail.


Update May 31

Trade Plan

When initiating an iron condor, the optimal plan is to wait…and then exit when a predetermined profit is reached. Such a plan requires little thought – other than choosing the target profit.

I have two ways to look at this and find either to be acceptable. The first is to choose a profit target. Having collected $280 for this trade, coupled with my person willingness to pay a price below $1.00 when I can close BOTH sides of the iron condor simultaneously, I’m setting $0.90 as the target exit price. This total is not written in stone. I would probably not be willing to pay this much if there were two-weeks remaining prior to expiration. However, it is a realistic target when the markets are 100% cooperative.

Earning $190 in two months [the estimated time at which we have a chance to exit at our price. Of course, that is completely dependent on implied volatility levels at the time) is definitely on the greedy side because the target is a 10% monthly return (based on margin requirement of $1,000)].

Let’s be clear abut this. This is a greedy target. Markets do not always cooperate. NOTE: We will not take unnecessary risk to achieve this goal. It is merely today’s target, subject to revision.

The second plan for exiting the trade is to select a target date. That’s the week of July 25 and would get us out of the trade three to four weeks before expiration. Again, the plan is to pay in that 90 cent area, but market conditions will play a role in the final decision. If the market is especially calm, we could choose to milk the trade for another dime or so. On the other hand, if volatility has reared its head, it may be wise to pay up to avoid owning too much short-term negative gamma. As a reminder, negative gamma is far riskier when the options have a shorter lifetime than when more time remains before expiration.

Specific risk minimization plans: In truth it is good to have these established in advance – for traders who feel they may be subject to panic or indecision when it’s time to adjust. Below are a few reasonable choices:

  • Buy back 2-3 of the iron condors, leaving 7-8 outstanding
  • Exit the trade if it makes you uncomfortable to hold
  • Buy a small quantity (play with the risk graphs to determine how many you may need, but let’s call it two) of debit spreads
    • Strike price of option bought is less far out of money than that of current short option
    • Examples include: RUT Aug 730/740P spread or the RUT Aug 880/890C spread
    • Buy RUT Jul call or put as a temporary fix. Example RUT Jul 750P or Jul 870 C
      • The limiting factor on these trades is the cost
      • If it costs too much, it may be better to choose a less expensive adjustment
      • – specially because this trade is so temporary. NOTE: IF you do go ahead and exit this trade near Jul expiration, then this Jul trade makes a lot of sense. If you plan to hold far longer, then the Jul protection will disappear, leaving the trader with a risky position

Exit. July 19, 2011

It’s time to bring these puppies home.
The iron condor is offered at 70 cents and I’m certain it can be bought for less than that. For me, there is no longer any reason to hold this trade. There is not enough reward p[potential for the risk involved.

If trading this position right now, I’d enter separate orders for the call and put spreads, trying for a better price. But I see no reason to hold this trade.

Admittedly there is little chance anything bad will happen – but with the debt ceiling crisis not yet resolved, why take the risk?

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