Over the last few weeks, Options 101 articles have addressed the decisions traders must make as they're shifting from pure directional trades into more complex trades. Those articles, appearing from January 18-February 15, can be found in the Options 101 archives.

Those archived articles employed examples of iron condors and butterflies, both positive-theta and negative-vega strategies that tend to benefit from the passage of time. Another positive-theta position, the calendar, is a positive-vega position that also benefits from an increase in volatility, within limits.

Such increases in implied volatilities tend to occur during downdrafts, and too big a price move to the downside will swamp the beneficial effect to the calendar of the increase in implied volatilities. It's the opposite problem that leads to my spotty performance with calendars, however: the vol crush that occurs during prolonged rallies. I can't seem to devise calendars that are immune to this problem: hence, my spotty results with calendars. Because my own performance with them is spotty, I'm certainly not going to attempt to discuss them with any authority on these pages. I do encourage you to backtest calendars on your own and determine if you feel differently about them. I know of several active traders who prefer calendar trades above all others.

It's time to wrap up the series. To summarize the previous articles, butterflies will likely need more frequent adjustments than iron condors over the course of time. Individual months may vary. However, the greater profit/risk profile for the butterfly allows the trader to make more adjustments without swamping the trade. The iron condor trader has to be careful not to let the cost of the adjustments eat up the much smaller profit potential when making the less-frequent adjustments. Those adjustments might be less frequent with the high-probability iron condor, but they'd better be made when the unrealized loss starts steepening. Once in trouble, those iron condors can get into worse trouble quickly, and there's much more money to be lost in an iron condor than it's possible to make with one.

That doesn't mean that one trade is preferable to the other. Each has its pros and cons. During the course of these articles, we have seen that adjustments that unbalance an iron condor or butterfly can also lead to a rapid expansion of the margin requirement or buying-power effect. Especially for those of us trading in Reg T rather than Portfolio Margining accounts, that difference can be significant. It's my experience that butterfly traders tend to run into this difficulty more often than iron condor traders, although that's just anecdotal information. FINRA interpretations of what constitutes a butterfly are quite strict, and the adjustment that actually removes risk--such as narrowing the wings on one side of the butterfly to lower price-based risk--can result in a much higher margin requirement. I've advised that traders check with the trading desks on their platforms to ask about how butterfly margining is handled.

Two of the initial concerns the trader should consider when choosing a complex position is whether that trader wants to adjust and how frequently that trader is willing or able to adjust. Two others include how much the trader wants to invest in the trade and what vehicle the trader will be employing. Those last two questions may be linked. The trader who decides that she prefers the more flexible adjustments of the butterfly and is willing to adjust any time an adjustment is needed may be working from a $5,000 account or a $500,000 one. All traders starting a live trade for the first time should trade small and build up only after they've endured a hard trading month with a loss equal to or less than the typical gain in better months. However, the trader with the $5,000 account perhaps doesn't have all trading vehicles open, even if trading with small numbers of contracts. The following charts and discussion exemplify the problem.

RUT ATM Butterfly:

On February 14, 2013, a RUT all-put ATM butterfly showed a theoretical price of $25.80 or $25.80 x 1 contract x 100 multiplier = $2,580. Commissions and slippage would be required on top of that. Even at one contract, this trade is too big for a $5,000 account, especially when the costs of potential adjustments is considered. Several risks arise when trading that big a trade in that size account. The first is that, when an adjustment is needed, there might not be the funds to make the adjustment. In that case, a viable trade must be closed because it can't be adjusted. That might lock in a loss that didn't need to be taken. Worse, because there are not enough monies left over to comfortably make an adjustment, a trader might be seduced into ignoring a needed adjustment. Depending on how the trader adjusts and how volatile the underlying is that week, the trader with the $5,000 account might run smack into that "Three Day Trades" rule, too. The trader up against that three-trade rule might also be seduced into ignoring a needed adjustment or else required by the inability to adjust to close out a trade that might have remained viable. The other risk is that a catastrophic event that leads to a major portion or all of the trade's maximum loss being hit. Such a loss would severely undercut a $5,000 account when the maximum risk is more than half of that. While it's unlikely that the maximum loss will be hit unless the trader flies off to a holiday, forgetting that a trade is open, traders are sometimes paralyzed by a sudden turn of events and let losses accumulate while they try to make decisions.

IWM Butterfly

For those who don't know the IWM, it's the iShares Russell 2000 Index Fund. Its performance is tied to the RUT's, making it a decent trading vehicle for some strategies and a good practice vehicle for those who want to eventually trade options on the RUT. Traders should always know their vehicle, however, and one problem with the IWM is that it goes ex-dividend close to options-expiration week at times. Trades must be watched closely for assignment risk if you're trading as the ex-dividend day approaches.

A two-contract IWM butterfly as shown above theoretically costs $484 plus commissions and any slippage. Even in a $5,000 account, this allows extra monies to be set aside for adjustments. Moreover, because this consists of two contracts rather than just one, more adjustment possibilities exist. For example, if price has moved toward an expiration breakeven on either side, the options trader might elect to sell one of the original butterflies and buy another ATM butterfly. Some traders will want to make sure they don't "step" on any of the strikes of the original butterfly when they do so because that can trigger much higher margins than had been anticipated. Still the flexibility exists to adjust, and if a trader develops "deer in the headlights" syndrome and lets a trade go far too long without adjusting, the account is not wiped out.

Therefore, the amount the trader wants to risk in a trade can't be isolated from the choice of the underlying or vice versa. More factors govern how much you want to put into a trade. Sometimes it's time to get into a new trade and the old one is still working. The decision needs to be made ahead of time as to whether you'll overlap trades in different months. If so, enough money needs to be left in the account when the first trade is entered for adjusting that trade, entering the next month's, and adjusting that one, too, leaving money left over so that the account remains viable should the unthinkable occur.

In general, it's probably not a good idea for a newbie trader to have too many trades going at once, but you make up your own mind, whether newbie or not. Personality governs this as well as money. If too many decisions at once prompts that "deer in the headlights" syndrome for you, then trades on multiple months at the same time is not the right tactic for you, no matter how much money is in the account. If you have a $500,000 account, but you start getting nervous when anything more than $4,000 is risked, then you shouldn't risk more than $4,000, no matter how much money you have. Scared traders are not good traders.

What about market conditions? Should that impact the size of trades? Certainly when market conditions are tricky, and especially when implied volatilities are extremely low and may pick up on any downturn, it might make sense to cut back the size of these types of trades. However, if we traders didn't trade when markets were tricky, we'd never trade. Use logic when weighing the "tricky markets versus size of trade" question.

I have another test for the size of the trade. If you have even once gotten up in the middle of the night to check futures, you're trading too big for your comfort level. If you're trading too big for your comfort level, you may get yourself into that impossible and dangerous "can't take a loss because it's too big" frame of mind. In general, if your trades are keeping you awake at night, whether or not you're getting up to check those futures, that trade is too big. That may be because you're not experienced enough in the trade or because you are experienced and know that the market conditions are dangerous for your trade.

These discussions have not been exhaustive. They've been meant to be basic discussions. As always, backtesting followed by live trading with small size trades is the best way to ease into a new strategy, adjustment plan or vehicle.