In the last couple of articles, I've discussed how traders might use a position-charting system to test various adjustments or hedges. Keeping the attitude of "play" in mind can be helpful as it allows a testing of many ideas, some of which might not otherwise have occurred to a trader thinking in more rigid terms. This promotes a testing of many ideas to determine which best fit the trader's outlook on the markets as well as the particular trade. I used freeware Options Oracle to test various throw-them-out-there ideas to demonstrate how a trader might go through this process.

As I was editing the last of those articles, a trader wrote into a trading group to ask if his iron condor trade needed to be adjusted going into last weekend. This was the weekend when the European troika was due to meet and either pull the magic rabbit out of the hat or delay the event another few days, as did happen. No one knew how cute or ugly that rabbit was going to be, either. The markets had been gapping up and gapping down, running rather quickly in a wide range. The SPX, at least, had that morning that the trader wrote gapped and run up above the top of that range, and was poised near the day's high at the time the trader asked that question.

I certainly understand the impetus to consider weekend risk. I was considering it, too. However, the trader's trade wasn't in any trouble. It was an iron condor, 27 days from expiration. The sold call had a delta of about 11.00, and the sold put, about -9.00. The delta of the whole position was about -5.00. This was a wise trader who had a plan before he entered the trade. His plan upon entry was to adjust the iron condor rather aggressively, when the absolute value of the delta of either put or the call was at about 16.00.

He wasn't at an adjustment point. Neither the sold put nor the sold call was close to that adjustment point. Barring a 50-point move that day, he wasn't like to be at an adjustment point by the end of the day, either. Why was he asking about adjustments? After the move we saw just last Thursday, that might seem a silly question to ask, of course, but we have to remember that over-adjusting can be as dangerous a practice as not adjusting when adjustments are needed. In this case, the trader was worried about upside risk, and you might be thinking that going ahead and rolling up would have been a very wise and fortuitous thing to have done Friday before last. However, that trader's plan was to roll up the threatened side, although that was that trader's term and not mine for a spread when the sold call had a delta of 11, and also to roll in the non-threatened side to help pay for the roll. If you remember what happened on October 25 and 26, you might understand that the rolling up of the non-threatened side, the put side in this case, might have proven more than uncomfortable on those days. In fact, it might have meant that sometime Tuesday, the trader was just as concerned about adjusting again in fear of downside risk, just before the reversal. If that had happened, that trader would have been presented with disaster on the morning of 10/27. We all know that day was going to require an adjustment. It perhaps might have been possible to recover from that adjustment, but not if the trader had first adjusted upward and then adjusted downward in the previous week, undercutting the trade's profitability and loading it with extra commission costs.

So, let's discuss what brings a trader--not this particular trader--to adjust before an adjustment point is reached. What are some of those reasons? A trader perhaps hasn't backtested enough and doesn't feel confident enough of the trade's workability to let it work as intended. Back in the days when I first began trading iron condors, I didn't know of any platforms that allowed backtesting. What I did do, however, was follow the outcomes of iron condor trades on the Option Investor website for a prolonged period of time, about a year, satisfying myself that the trades were profitable the expected number of times and that money could have been made. Satisfying myself that this was a workable strategy was key to success. If a trader isn't confident that the strategy can be workable, any jit or jot in the profit and loss numbers can prompt an adjustment, which is then immediately abandoned when the jit reverses into a jot.

Another cause might be that the trader has reason to doubt her ability to stay with the plan. This might be due to inexperience or to a bad experience in which she did not heed her plan. If this is the problem, then writing down the plan and checking it each time she worries that she should be adjusting might help. If she fears that she'll be unable to pull the plug when an adjustment is needed, setting up an alert reminding her or even a contingent order to trigger at the adjustment point, if in a highly liquid security, might be a good idea. While contingent orders have their problems, particularly on an index such as the SPX, having a working contingent order is better than having nothing if one is prone to deer-in-the-headlights syndrome. If the trader's fear is that she will adjust too soon and too often, weighing down a trade with too much commissions and slippage on getting in and out of adjustments, the same solutions can help. Has the alert sounded? She might ask herself. If not, it's not time to adjust. Some trades, especially butterflies and calendars, might need the alerts to be changed every couple of days or so. Depending on what the market and implied volatilities are doing, the expiration breakevens might be changing quite a bit.

Another helpful tactic would be to follow the trade--from inception--on a site such as Options Oracle or a paid risk-analysis charting site. On the day in question, the trader could look at the "today" profit-and-loss graph and roll it forward to the next Monday. This site and most other similar position graphing or analysis sites, including TOS's analysis page and BX's somewhat clunkier strategy graphing page, allow one to change the implied volatilities, too. Some also allow one to overlay a standard-deviation move, which would allow the trader to see where the profit-and-loss would be if the underlying's price moved a standard deviation in a day. In this environment, I would suggest that the trader look further out, to a 1.5 or 2.0 standard deviation move. That way, the trader can see if the trade is going to be in trouble with a 1.0-1.5 standard-deviation move, keeping in mind that markets have often moved a full standard deviation in the first few minutes of trading over the last few weeks. Determining that the trade would not be in trouble even with a 1.0-1.5 standard deviation move, if that turned out to be true, would perhaps reassure the trader that no adjustment was needed that Friday and would have allowed for some equanimity going into the weekend. If it was determined that a 1.0-1.5 standard-deviation move on the open would get the trade past an adjustment point and a 1.5-standard-deviation move would reach maximum loss, the trader has obtained important information. The trader might be alerted that his worries are justified, even though the trade didn't look in trouble on that Friday. As a hint, although a reasonable climb usually drops implied volatilities, I would not have rolled the implied volatilities lower if I were testing for a one-standard-deviation jump in this particular circumstance. I don't think the implied vols would have dropped immediately at the open, anyway, although they might have dropped quickly afterwards if it was deemed that a solution had been reached and that it was a viable one to which all countries would adhere. In fact, that's what happened on this last Thursday morning. Options were expensive and call spreads wide that Thursday morning.

Another cause of overtrading is that the trader might be in trades that are too big for his comfort level or account size or too big to handle comfortably in the market conditions ruling at the time. If that's the reason the trader is asking about adjusting when an adjustment isn't yet needed, then the solution is different. I use a can-you-sleep-at-night or can-you-hear-your-spouse-talking test. If you can't sleep and you see trading screens flashing across your vision and hear an alarm going off in your head, drowning out the sound of your spouse's voice, then it most definitely is time to adjust, whether the trade calls for an adjustment or not. The trader caught in this kind of obsessive circuit can't think clearly and is highly prone to deer-in-the-headlights inaction if a true adjustment point is reached.

What is that adjustment in this case of a trader in over his head? It's the same every time: lower the risk. The way that can be done is many fold, however. The iron condor trader could have bought in some of his contracts, so that the risk was low enough that it wasn't worrying him, accepting that profit potential was lowered along with the risk. Even if the trade didn't need adjusting, he could have employed one of the hedging techniques we discussed over the last couple of weeks, if he feared that market moves might make the trade gap so hard on open the next Monday that it would gap past the planned adjustment point. Iron condor traders are in a particular bind because they take in less credit as related to risk than do some other traders. It's easier to smooth out that "today" line in butterfly trades and still keep some profit potential than it is in iron condor trades, for example. Traders feel differently about this, but particularly if a trade wasn't in true trouble, I wouldn't have wanted to change the delta value by more than half. In other words, if the delta of the position (not just a sold strike) was -44 and the trader feared an upside move that Monday morning, I wouldn't have wanted to bring the delta any higher than -22 (higher because these are negative numbers and -22 is higher than -44). Depending on the situation, others would want to flatten out the deltas completely, something again that is more viable in a butterfly trade than an iron condor one. We have to remember that all strategies have their pros and cons. This is one pro of a butterfly trade, balanced by the con that butterflies have to be adjusted more often than iron condors because their expiration breakevens are closer in.

I don't think the trader who asked that question was in over his head. His position size was in keeping with his experience level, his account size and the market conditions. It was small. These are just trying times for any trader, and those market conditions bring about more angst than many of us are used to feeling. As it turned out, I had occasion to hear from that trader again on Thursday, 10/27, and that trader did need to make an adjustment that day. However, that trader had not burdened the trade with an adjustment for upside risk the previous Friday and another one for downside risk the previous Wednesday. I am not certain whether the adjustment allowed for a profitable trade but it certainly had more potential for one because that trader had not previously over-adjusted.

I am certainly not arguing against considering events that might present more risk and adjusting trades if necessary. After the bounce from the lows on 10/26, I bought in one of my 11 sold strikes on my remaining call credit spreads. I wanted to lower the risk in case of a gap higher. However, I did not buy in enough to completely flatten the trade. Of course, in retrospect, I wish I had. But what if the European troika had not been able to come to an agreement or Friday morning's GDP had been a big disappointment? Then I would have had price action and a rise in implied volatilities both hurting my trade. I lowered risk because the bounce from the daily 9-ema told me that the SPX was still finding support on daily closes where it had been finding it since 10/4, but I'm not prescient and I could not know Europe's decisions or the world's reaction to those decisions. I'm not always right in my reactions, and you won't be, either. I tend to be an over-adjuster myself, something I have to work against. Friday morning, I wished I hadn't worked so hard to reform my over-adjusting ways, but over the long run, over-adjusting can hurt trades, too. Right now, I continue giving the advice I've been giving for months: until markets settle down, trade in smaller than normal size. If you're inexperienced, trade on paper. Have a plan, and make sure that plan includes a planned maximum loss you'll accept. Do not ignore the unrealized losses, thinking that you won't need to take them because you're in the trade until expiration! I've followed my own advice, and I'm trading in much smaller size than I typically do. These market conditions are not ideal for my type of trades, trades that depend on the market behaving in statistically normal ways. We are seeing historic norms being broken all the time, 1.0-1.5 standard deviation gaps at the open during which a trade can't be defended.