Maybe you've heard this story from me previously. Many years ago, I was sitting at a seminar for would-be iron condor traders. My broker attended, too. One of the other participants, a long-time iron condor trader and OIN subscriber, told me during a break that my broker had suggested that the conditions might be changing, and that iron condors might prove more problematic in the future than they had been.

He was right. We went through a prolonged period of time when extremely low volatilities meant that iron condor traders didn't bring in much premium when compared to the risk they represented. Some iron condor traders adjusted their strategies, selling closer-in options than they had previously or opening their positions further out in time. Either way, they were taking on more risk--price or time--than they'd been required to take previously to collect the same premium.

Unless they did so, however, there just wasn't much credit to cushion the adjustments the iron condor trader had to make when an underlying blew up or went airborne. Over the last few months, that's been true again, and I'm worried about what might happen to some subscribers who may have taken such steps to increase the premium they took in on iron condors. If you're one of those, give some consideration to some out-of-the-money insurance puts or tactics you might employ to hedge risk if the market turns down. Markets might keep climbing and the VIX might keep dropping, but at some point, those conditions are going to change.

Not only did the lower volatilities mean that the premium collected were small, but also lower volumes for a while lately meant that the fills are sometimes further away from the midprice level than they were a year ago. Sometimes an order that previously would have been filled just a little off the midprice a year ago would sit for days without a fill that same distance from the midprice.

The third problem encountered lately is one I mentioned recently: gapping markets at the open. In the old days of options trading, an iron condor trader who stuck to the major indices could evaluate a position near the end of trading each day and have some degree of confidence about where the index would open the next day. If the position wasn't on the verge of needing an adjustment, the trader could sleep pretty well that night, knowing that even if the action moved against the position the next day, there would likely be an opportunity to adjust during the trading day. These days, gapping indices occur with some regularity. Option prices are temporarily inflated due to the gap and normal amateur-hour behavior, no matter which direction the gap. Spreads widen, so the debit you'll pay to exit them gets bigger. That means that a trade that looked fine the previous afternoon might be well past an adjustment level at or within a few minutes of the market open. Those opening gaps have been heading either direction, too, so that if a trader chooses to adjust early, the markets just might gap the other direction the next day, forcing the trader to scramble to adjust the other direction, with the position having been worsened by the early adjustment made the prior day. Traders can begin to feel that they're doomed if they do adjust and doomed if they don't.

I'm always evaluating the type of trades in which I engage, trying to decide if something else fits my style or current conditions better or whether changing would amount to throwing out the baby with the bath water. I had believed that double diagonals would probably be the way I would head. Double diagonals involve selling puts and calls in the front month and buying further-out hedging longs in the back month options. Varying how far out those long back-month puts and calls are purchased can produce a double diagonal that is long vega, short vega or neutral. That means that traders can construct an iron-condor type trade that doesn't suffer as much from changes in volatility as do the iron condors.

Although butterflies share the iron condor's short-vega characteristics, they have some benefits over iron condors, so I've also been trying those. They're often constructed by selling at-the-money options to form the body and then buying half the body's number of contracts above the sold strike and half the body's number of contracts an equal distance below the sold strike. They can be all call butterflies, all put butterflies, or iron butterflies, which are essentially a scrunched-up iron condor with both the sold puts and sold calls at the same strike. I've grown to like some aspects of trading butterflies, particularly in the fact that they're easier to adjust.

As with many decisions about options trading, no single right or wrong decision exists. I thought I'd discuss some of the pros and cons of each strategy as an example of the kind of thinking an options trader might do when deciding between various strategies. As this article is roughed out on October 30, I can drop the double diagonal from consideration. Despite its flexibility, a major drawback exists right now. A FINRA-enacted stance in margin requirements means that all those trading Reg T accounts now pay margin on both sides of a double diagonal at all the brokerages that have been audited by FINRA this year. Because they don't fit any FINRA-recognized strategy setup, they don't get the balanced iron condor's preferential treatment. Until that margining requirement is changed or until I elect to switch to portfolio margining, I won't be putting on these trades.

This example pinpoints the need for options traders to consider their returns on a certain strategy as well as the need to keep up with changing regulations. You can't always count on your brokerage to let you know what changes the SEC or FINRA or some other agency is considering, and maybe not always what changes have been enacted. Clients of one brokerage woke up one morning with their margin requirements changed when FINRA started auditing firms and requiring them to change their margin requirements. They hadn't been prepared for the possible change, some having employed all or most of their margin for their current trades. They didn't know what had happened and weren't told until they contacted the brokerage. Some received margin calls.

In the aftermath of what's happened in the last few years, we must be aware of changes that might be afoot. It's our responsibility to ourselves. For example, the SEC's published agenda for the November/December 2010 period include discussion of "rules to adjust the threshold for 'qualified client'" for Investment Advisers and "revisions to rules regarding due diligence for the delivery of dividends." Back in September, FINRA released news that it is proposing that "all investors filing arbitration claims [have] the option of having an all-public panel." I hope I never have a need for arbitration, but if I do, FINRA believes this will create a sense of fairness. Traders might get in the habit of checking both the SEC's (with .gov appended to the name) and FINRA's (with .org appended) sites for news that might impact them.

If I temporarily discard double diagonals, that leaves the iron condor and butterfly as the negative-vega trades up for consideration. Both are likely to be hurt by an expansion in implied volatilities, particularly if that expansion occurs soon after the trade is initiated, before time decay has begun to work. Depending on how the strategy is constructed, the iron condor often has wider expiration breakevens, reflecting the fact that its probability of profit is typically higher than a butterfly's. How does this translate into real-life trading? Unless the markets are unusually cooperative and just sit still for a time, you're more likely to have to adjust a butterfly than you are an iron condor. I've had a few IBM butterflies just work without any need for adjustment, but that's rare, and even my IBM butterflies caused me angst and a loss when IBM took off to the upside a couple of months ago.

If you're the type of trader who doesn't like to go to a lot of trouble and would prefer to just let theta (time decay) work its magic, you may be thinking that your choice is easy: it's the iron condor for you. Wait a minute, though. That's not the whole story and all that should be considered, even for those of us who would prefer trades that we're not adjusting all the time.

Using end-of-day prices available on October 30, a 3-contract RUT December call butterfly with 50-point wings cost $4,020.00. With $1.50 per contract in commissions, that trade cost $4,032.00, the margin or buying-requirement for the trade. Expiration breakevens would be at 663.10 and 736.60. The probability of profit at expiration would be 40.20 percent. Some butterfly trades aim for about 20 percent of the margin requirement as their profit target, making that profit target $806.40.

At the same time, a typical three-contract iron condor as I establish them would take in $522.00 in credit after commissions and have a margin of $2,478.00. Expiration breakevens would be at 598.26 and 761.74, and there's an 80.7 percent probability of profit at expiration.

So, it seems that the iron condor trader can go a lot longer without needing to adjust and has a lot larger chance of the trade being profitable, but is that true in the day-to-day trading of these strategies? For example, what if, a few moments after establishing that iron condor, we had had another flash crash? Imagine that implied volatilities pop up 3 percentage points, although they might pop up more than that. Imagine that the RUT drops twenty points in a heartbeat. One profit-loss chart shows that you would have theoretically lose 4 percent, although I think it would likely have been more than that. What if the RUT kept dropping through the next few days? By midweek the next week, you might find your trade down by that same $522.00, which is the maximum amount you could have made in the trade, but you have a much higher risk if the RUT keeps dropping. Are you going to just let the RUT keep traveling toward that sold strike without adjusting?

I used to wait to roll until the absolute value of the delta on the sold put got to about 20, but if that drop occurs soon after a trade is established, your unrealized loss may be greater than your planned maximum loss before your usual iron condor adjustment guidelines. I don't want that unrealized loss getting bigger than the maximum loss that I intended to take when I initiated the trade, usually about 11 percent of the buying-power effect or margin on the iron condor trades. If the underlying drops quickly, right after a trade is initiated, and volatility pops, the spreads will widen, and the need for adjustments will occur sooner than it would if the same move occurred after much theta-related decay had already occurred. Depending on the time passage, the volatility changes, your courage, foolishness or method of trading, you might find yourself either holding on and trusting in the ultimate profit potential for the iron condor--not something I recommend--or adjusting way ahead of that expiration breakeven. The point is that you can't count on the iron condor's wide expiration breakeven to show you that the iron condor will be easier to manage than another strategy. I didn't happen to be in butterflies on the flash crash day, so I can't speak to the differences that might have been found that day, but I suspect that both iron condor and butterfly traders were scrambling that day.

Because the iron condor takes in so little credit in comparison to the margin withheld, there's just not much cash to play around with when you have to buy back an in-trouble spread and then roll into a further-out but cheaper spread. Iron condor traders are sometimes faced with tough decisions. Do they roll into the same number of contracts at about the same delta-level as they used initially? If they do, they're taking a whole lot less money, and cutting down their potential profits while keeping the risk level the same. Do they roll the opposite side to make up some of the potential profit lost in the going-wrong spread? If they do, they risk the markets whipsawing and moving back to challenge that rolled-into spread.

Butterfly traders find that they're able to adjust and still keep much of the potential for profit in their positions, at least through a few adjustments. Adjusting, however, often means adding another butterfly or two, therefore increasing the margin above that held initially. If the adjustments result in an unbalanced butterfly, then FINRA's tough stance on holding to strictly defined strategies may mean that you find yourself with margin suddenly held on both sides of the butterfly, too, at least at some brokerages. Also, in many cases, the butterfly's long options are further away from the sold options. As time passes, they may not be as good a hedge as they were initially, and they may need to be moved in. Many a butterfly trader has had a great-looking butterfly going into the week before expiration, only to see a big move result in a bigger loss than the theoretical profit-loss chart showed them would occur at that price point. That's because those further-out options may be decaying at a different rate than the closer-in ones. The extra adjustments that may be necessary with a butterfly result in extra commissions, too, so choosing the right brokerage with the right commission structure proves important. A volatile market can result in so many adjustments that the commissions eventually swamp the profit potential for a butterfly.

I think I'm leaning more toward butterflies, but some situations these last months have made me glad I'm still mostly in iron condors. I like the flexibility of butterflies and the way profit potential is preserved, but I'm sometimes better able to weather these wild and crazy moves we've had without having to make adjustments, only to see the trade reverse as soon as I do. That didn't stay true when the markets just kept climbing and climbing, eventually forcing a loss in December's iron condor, but it had in previous months.

I've invited you along on these rambling thoughts. Options offer us many possibilities, but we pay for that flexibility. We must do our homework, thinking seriously about what works best for us and our trading styles. We must recognize that situations change, both in our lives and in the trading conditions, sometimes due to regulations that change in a way that makes our trades more or less workable. It's up to us to keep up with those changes as well as we're able, and to reevaluate our trades when they happen. A year ago, I likely would have told you that I expected by now to have gravitated into double diagonals, combining the best of both worlds, offering flexibility but also the familiarity of an iron-condor-like trade. Whether that would have happened, I don't know, because I had only a few months of double diagonals under my belt when the new margin requirements took them out of consideration for me.