I have the authority of actual experience when I speak of trades going bad right away. The day before the Flash Crash, I entered a 60-contract SPX iron condor. That's not the kind of trade-management experience we want to garner, and such one-time events don't teach us much about more typical trade-management skills.

Let's imagine something less severe. Imagine that you'd planned to enter your SPX iron condor on Wednesday, November 20, but implied volatility had been so low that you couldn't get as much premium as you wanted for selling the iron condors. At about noon, the iron condor you wanted (ten points between the sold options and the further-out long options, delta on the sold call near 10, delta on the sold put above -9) would have returned just about $1.08 per contract. In the afternoon, however, a quick downdraft pushed the implied volatilities higher, and then was followed by a bounce off the lows. You were able to get into an iron condor that almost exactly met your parameters, with the exception of the delta of the sold call being 11.18 instead of nearer 10, for $1.30 per contract. That sold call is only 10 points lower than the original call you'd been looking at earlier in the day.

Ten-Contract SPX DEC13 Iron Condor Makeup as of the Close, November 20, OptionNet Explorer Chart:

The $100 amount by which the trade is down includes two-way commissions to both open and close the trade. I've got OptionNet Explorer configured so that it always shows those two-way commissions.

Imagine that you like to adjust before your iron condor trade gets into big trouble, so you adjust when the absolute value of the delta on your sold call or put reaches 16. That's one typical adjusting tactic for an iron condor trader. You hope that the whole probability thing upon which the iron condor is built works out perfectly and you don't ever have to adjust. By thirty minutes before the close the next day, November 21, however. The trade already needed adjustment according to your plan. Uh, oh.

Same Trade, Next Day, OptionNET Explorer Chart:

The legend on the upper left-hand side shows that the delta of the sold call is now 16.87. For those who are visual type traders rather than traders looking at the Greeks, you'll want to flatten that profit-and-loss (PNL) line to the upside so that the loss doesn't hit your planned maximum loss on a possible gap higher the next morning. On this charting system, that maximum loss will occur at the point when the PNL line turns red. The SPX had moved 14.41 points or 1.37 standard deviations the day after your entry. If it moved another 14.41 points the next day, the loss would be dangerously close to that planned maximum loss.

For those who trade by the Greeks, you'll want to raise the delta higher than that -40.82 that you now have so that the loss won't grow as quickly with a further move higher. For those who are rule-based traders, your rules say it's time to do something.

What are your choices to raise the delta and avoid hitting that maximum loss? Some possibilities are the following:

Buy a long call.
Roll one or more of your sold calls five points higher, only five points away from your long calls.
Put one or more call debit spreads in front of your sold calls.
Buy to close one or more of your call credit spreads.
Roll one or more of your call credit spreads to higher strikes.
Realize that this trade isn't going as expected, going bad so early in the trade, so close it with a minimal loss.

Let's look at some of the choices.

Buying a Long 1830 Call to Trim Delta Risk:

The blue line shows the current expiration graph. The green expiration line shows the expiration graph if the adjustment is made.

This choice trims the delta risk quite a bit, raising delta to -10.37 from the prior 40.82. Perhaps some traders might choose a less expensive call that raised the delta to about -20 instead of -10.

Instead of theoretically hitting the planned max loss at about 1811, that loss wouldn't be hit until about 1838 with the addition of the 1830 call. This gives the trader a little more breathing room, but it trims more than the delta risk. Theta is cut from 52.48 to 36.10, so that the trader might be locked in the trade longer before profit appears, if it's going to ultimately be profitable. In addition, that potential profit has been reduced by $605 plus commissions, the cost of the long option. It would be possible to buy in one of the sold calls for a little less, but it would offer a little less protection, too. Ultimately, we know now, the SPX was going to move higher before turning down again, and it's possible this would not have been enough of an adjustment, but the trader making the decision in the moment doesn't know what's going to happen next.

What about spending a similar amount of money to put some call debit spreads in front of the credit spreads? Buying three 1830/1840 call debit spreads would cost about $610 plus commissions.

Buying Three 1830/1840 Call Debit Spreads on November 21:

This choice raises the delta by about half, to -22.69, but it doesn't offer as much upside protection. It does not cut down the theta as much, however, so it better maintains the time-related decay. Because it cost about the same thing as buying the single call, it cuts down the potential profit by about the same amount. A call debit spread bought when the trade was first initiated, when it would have been cheaper, would have worked better than buying it once the trade was in trouble, although that tactic does offer some benefit even now. I know some iron condor traders who have been buying call debit spreads in front of their iron condors at the initiation of the trade.

What about buying in one or more of the credit spreads?

Buying in Four Credit Spreads:

This choice also lowers the delta risk, raising delta to -21.27 from the original -40.82. The max loss is not reached until about 1822, so the trader also gets some breathing room with this choice. Theta is also trimmed, but not as much as it had been by buying only a long call. Potential profit is also trimmed, by almost exactly the same amount as in the first examples. The maximum profit is now $1,160 minus commissions rather than the original $1,750 minus commissions. As we know, the SPX continued higher and more adjustments would have been likely.

Next week's article will take up where we left off with this one, but the list of possible adjustments will still be too long to include them all. If you're interested in homework, why not use whatever simulator is available to you and set up a similar SPX iron condor, then test rolling some or all of the sold calls up five points closer to the long call?

Linda Piazza

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