It's time for an adjustment, but what kind of adjustment do you need? The flexibility of options often provides you with many choices. With each choice comes pros and cons.

What kind of adjustment do you need? Our subscribers range from newbies to those who could teach classes in how to manage volatility trades. They trade different-sized accounts and have different risk tolerances. They trade many different strategies.

It's impossible to give a single answer, even if we know the strategy being traded. In the simplest terms, traders need adjustment policies that offer a way to increase profit potential or stop the damage being done by a price or volatility movement.

Not every possible adjustment will work for every options strategy. Not all will work for all periods in a trade's history. The ones that work for 30 days to expiration might not work when adjusting a week before expiration or vice versa. Not all adjustments will feel comfortable for all traders or be available to them, considering the sizes of their trading accounts. Let's run through some possibilities, looking at a simulated four-contract iron condor trade theoretically established midday on Wednesday, October 22, 30 days before November's regular monthly options expiration.

Four-Contract NOV14 RUT Iron Condor:

Now let's advance the time six days forward.

Six Days into the Trade, Near Noon:

When I traded iron condors, I tended to adjust when the absolute value of the delta of a sold option--the NOV14 1180 Call, in this case--reached 16. That's one possible adjustment guideline, but it's not the only one and it's not a specific trade suggestion, of course. Let's run through a few possible adjustments if a trader were going to adjust by those guidelines.

Buying-to-Close Two of the Call Credit Spreads:

The green expiration and "today" lines represent the trade if it were adjusted by buying-to-close two of the sold call credit spreads. Both the current expiration graph and profit-and-loss line (in blue) and adjusted expiration graph and PnL line (in green) are displayed. The green today line had flattened as a result of the proposed adjustment. The rate at which losses would increase would flatten somewhat. A 15 percent loss--when the today line turns red--would be hit at about 1157 rather than the approximate 1146 in the unadjusted trade. For those experienced with the Greeks of option pricing, the proposed adjustment raises the trade's position delta from about -20.08 to -8.77. Profit potential lowers significantly, however, as is demonstrated by the lower ceiling on the green expiration graph.

Raising the delta appears to be the right idea, the ultimate goal of an adjustment in this instance. Is there a way to raise the delta without lowering the profit potential so much? What about buying back all the in-trouble call credit spreads and then rolling up into two times the original number of call credit spreads at higher strikes? Theoretically, the additional sold call credit spreads would make up for some of the loss incurred when buying back the in-trouble call credit spreads. Since the sold strikes would be at higher levels, that would give the underlying more room, too, before the trade got into trouble again, wouldn’t it?

Rolling the Four 1180/1190 Credit Spreads up to Eight 1200/1210 Call Credit Spreads:

Oops! That adjustment didn't work as well as expected. The expiration graph shows that the margin required has dramatically increased due to the increased losses that can be incurred on the upside. The dark green expiration chart shows a much deeper potential loss than the dark blue expiration chart. That's because twice the number of ten-point spreads have been sold. Moreover, the decreasing implied volatilities as the RUT price rose meant that the new credit spreads could be sold for only a theoretical $0.52/contract or $416 for 8 contracts. The cost of buying-to-close the in-trouble ones was $1.59/contract minus the original $0.63/contract taken in when they were first sold. That's a loss of $1.59 - $0.63 = $0.96 per contract that would be realized, at a cost of $384 for all four contracts. Subtracting $384 from $416 nets $32.00 total profit after commissions for the call credit spread side, but the extra commissions to close four contracts and sell eight more mounts up to $30.00 if the commissions are a typical $1.25. Is it worth it to take on extra risk? Not really, in this extreme case. This is a frequent problem with rabid rallies accompanied by dropping implied volatilities. In that condition, it's hard to get enough premium to make it worth it to roll call credit spreads if they're being rolled by again selling the first call with a delta under 10. Moreover, although the upside expiration breakeven was shifted the right, the point at which the trade would hit a 15-percent loss was not much changed.

This is the tactic, however, that I used to take when my iron condor trades were in trouble whenever I could get enough credit to make the roll worthwhile. I could sometimes make enough money to make up all the loss, although other times I was left with a situation such as the one illustrated above and no roll was possible. When I first initiated a trade, I left plenty of money in my account to roll this way since it was my preferred adjustment strategy, plus leaving more funds in reserve for other adjustments. I could keep rolling as needed. The problem is that no matter how much money you leave in reserve, the time is going to come eventually in your trading life when it doesn't make sense to roll in this manner. Markets might appear to be in a runaway mode, either to the upside or to the downside. Then, each time you roll and the price keeps going in the wrong direction, you're caught with more at risk, not less. This doesn't happen often, but it's confidence-shaking and perhaps account-destroying when it does, depending on how big a percentage of the trading account a trader sinks into the rolling technique.

What if the whole iron condor is rolled higher and not just the call credit spreads? What if that is done with the number of contracts and spread widths remaining the same? Theoretically, the profit taken when the safe side is rolled would help make up for the loss taken when the in-trouble side is rolled.

To collect more premium on the new call credit spreads, those spreads could be rolled only 10 points higher rather than the 20 illustrated in the previous example. They could be butterfly-rolled higher with an order placed to buy a +4 1200 C/-8 1190 C/+4 1180 C butterfly position. The -4 1000 P/+4 990 P credit spreads could theoretically be bought to close for $0.21/contract and then resold at the 1040/1030 strikes for $0.60/contract to make up some of the loss on the call side. If market conditions were favorable for a multi-legged trade, this could be accomplished in a single condor order: -4 1040 P/+4 1030 P/+4 1000 P/-4 990 P.

After Rolling the Whole Condor:

Margin or risk in the trade rises but not as significantly as it did with the previous adjustment. The today or PnL line is flattened, the result of position deltas that are raised from about -20 to about -8. Both expiration breakevens are shifted to the right. Profit potential is lowered, both by extra commission costs and the difference in the cost of buying-to-close the original iron condor and selling the new one. However, there is profit still to be collected. The trader will have a few more points before the planned 15-percent max loss is hit, but only about six more points leeway. A trader who thought it likely that the advance would slow but who didn't fear too big a downturn might elect this type of adjustment, since it increased the margin by only about $180. However, the trader who thought the RUT would either zoom higher, powered by scared shorts, or roll over and see extreme selling might not want to choose this adjustment.

What about a different adjustment tactic, putting a debit spread in front of the in-trouble credit spread?

Adding a 1170/1180 Call Debit Spread to the Original Iron Condor:

This tactic decreases the maximum possible risk to the upside without increasing the downside risk much. It lowers profit potential, but doesn't erase it. Hmm. Perhaps this tactic would have shown more potential at if it had been utilized at the beginning of the trade, before the RUT had shoved quite so near the sold call, and not utilized as an adjustment after the RUT was in trouble?

Looking at the Same Tactic, if the Debit Call Spread Were Added at the Beginning, not as an Adjustment:

In fact, some iron condor traders who fear big upside moves more than downside ones elect to add one or more call debit spreads at the inception of the trade. Some find that this tactic works even better as a way of building the trade than it does adjusting it after things have gone wrong.

This article is already too long, but it doesn't even begin to cover all possible adjustments for the iron condor, much less for other types of trades. Practice the old "brain-storming" techniques that used to be popular in education. Don't censor yourself when you're practicing possible adjustment ideas on paper.

Options are flexible, and you don't want to censor yourself too much as you explore their flexibility. However, do censor yourself when it's time to evaluate those ideas you've thrown out. There's always a negative to match any positive in a chosen adjustment tactic. Think long and hard about adjustments that add risk, either in the form of more margin in a trade or in a trade that will be quickly hurt in a reversal. I certainly got hurt by rolling up call debit spreads, increasing their size to make up for realized loss in the in-trouble ones I had closed for a realized loss. I still wince when I hear others talk about employing this tactic because I know myself to be cautious and usually trustworthy about taking losses when necessary, and I got caught in a way-too-big loss in the spring of 2010 because of a situation similar to the rolling situation illustrated earlier. When you've employed this tactic and a deleterious move continues, especially when it continues with a huge morning gap, the losses can mount quickly and shockingly.

Spend some time being inventive, exploring. Don't forget to invent scenarios in which all your plans go wrong, too. Know what you'll do ahead of time and then relish the flexibility of options.

Linda Piazza