The Fine Points

We can look at the iron condor strategy in very simple terms: We sell some premium and hope the options expire worthless.

Better yet, we can use our intelligence when trading iron condors and manage risk, as necessary. With this approach, we never shut our eyes and hope for the best. Instead, we plan ahead and establish a target profit.

    If certain unhappy events occur before we can close the position and collect that profit, we act:

    –We should set a maximum loss that we are willing to accept – and exit if that loss occurs.

    –We can establish a specific risk parameter, and when risk reaches that level, we adjust the position to reduce risk. Such parameters can be: delta of short option; a specific monetary loss (but one that is less than our maximum acceptable loss; it can be when the short options are a specific number of points OTM, etc.

Even better for traders who have the time and ability to adopt more sophisticated methods, we can think about ways to reduce risk while waiting for our profit target to be reached.

    –We can adjust in stages, reducing risk in increments, rather than all at once

    –We can recognize that all iron condors are not created equal, and that our method of managing our positions has to change when the basic structure of our trade changes.

      –The primary situation occurs in the example (when this post is continued). When trading close-to-the-money (CTM) iron condors, our thinking changes. Our plans change. This has to be well understood in order to successfully trade CTM iron condors (or credit spreads). I have discussed this repeatedly, so for today’s post, let me just reiterate: CTM iron condors (defined as positions that include the sale of options that are CTM, compared with your usual iron condor position) are very likely to require an adjustment. In fact, when we sell puts and calls with a 25-delta, the probability is essentially 100% that one of the options will be in the money before expiration arrives. When we choose higher delta options (such as 30-delta in the trade illustrated in part 2), the probability that one option will move into the money is closer yet to 100%.

      Therefore, this conclusion should be obvious to all CTM traders:

      When that inevitable adjustment is made, the cost must be small enough to leave a sufficient potential profit to justify the risk of making the trade.

      That boxed statement should be read multiple times every single day of your trading life — until such time as you fully understand and agree.

      This means that the trader cannot continue to think and plan trades as if CTM iron condors were nothing extraordinary. They are plenty extraordinary. They require a new mindset. The position is still an iron condor and we do not ignore everything we already know about iron condors. However, the approach taken to manage risk is different and that has to be understood before placing the trade.

    It is important to begin learning about options at the beginning. Jumping into more advanced strategies can be difficult (for some traders) because the trader has not gained experience managing many trades and coming to understand – from experience and taking lessons – how to handle a variety of trade decisions. It is not easy to recognize when something is truly different, or more complex, when the trader has not had to make many of those less complex decisions.

…to be continued


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