I'm a rule-follower. How does that translate into trading behavior?

I want rules. Not guidelines. I want rules that include lists of if this happens, then you do that. I can even tolerate some contingencies, such as if this happens more than 30 days before expiration, then you do that. However, if this happens less than 30 days before expiration . . . . well, you get the picture.

Unfortunately, it's just not possible to postulate guidelines that cover each and every contingency. Too many contingencies, permutations or what-the-heck-happened events prevent us from being able to chisel trading rules in stone.

For example, I entered my February trade on January 9. I'll show the trade, but let's move forward to January 15, a day when the RUT made a 1.5 standard deviation move to the downside. I typically adjust just once a day, usually about thirty minutes before the close. I like to keep the profit-and-loss line fairly flat, and I do that by keeping the position deltas for the whole trade at about +/-5 deltas per butterfly contract. Newbies can often consult training videos for your platform to determine how to see a profit-and-loss line or find position deltas for your trade.

In addition, per the suggested guidelines (not rules) set by a trader named John Locke, I would expect to roll my butterflies lower if and when the RUT moved twenty points below the central strike of those butterflies. Let's see how that trade would have looked on January 15 at 2:30 pm CT and compare that with the guidelines.

Chart on January 15 at 2:30 CT, Graph by OptionNET Explorer:

What do we see? First, all the options comprising this trade were option positions entered on the day the trade was first opened. This is the way I structure this trade. Notice that I had hedged my trade to the upside with a deep-in-the-money long call at the FEB 1170 strike. That first day I'd opened the trade, I'd also opened a FEB 1170/1190 call debit spread, with these hedges meant to even out the profit-and-loss line to the upside. They're part of the initial trade setup. In addition, although most traders employing this trade don't buy extra insurance in the form of an extra long put, I do. Buying that extra insurance costs me money and that translates into less profit, but I'm willing to pay that price. Most traders don't think it's necessary, but there goes the first break of the trade "guidelines" as Locke set up them but not as I trade the trade.

If I'm a rule-follower, why would I break a guideline at the inception of this trade? I employ the extra long put as a volatility hedge as well as a price hedge. I've talked about that tactic in other articles. I tend to use it in all butterfly and iron condor trades that would be hurt by an explosion higher in implied volatilities.

Look again at the graph. See the -279.40 vega on that pull-down tab? That negative vega explains why my trade was showing a 3-percent theoretical loss that day. Implied volatilities had jumped, sinking that profit-and-loss line even though the RUT's price was under the tent. Time had passed since the trade had opened, and that passage of time should have benefited the trade, too, but the rise in implied volatilities undercut that potential gain. My theoretical loss would have been much higher without that extra long put, almost double the loss.

I have traded long enough to know that sometimes the impossible happens. Sometimes you put on a 60-contract SPX iron condor the day before the Flash Crash. (Ahem. That would be me.) I'm older. I don't want to wake up one day with my trade hitting its maximum possible loss at the open: not the maximum planned loss but a much deeper maximum possible loss. So, I'm going to break the rules/guidelines by buying that extra long put and willingly pay a penalty for doing so. A trader with a different risk tolerance might not choose to do so.

What about other guidelines that afternoon? When I did my end-of-day examination, were any adjustments needed, according to the trade guidelines? Was the delta outside that +/-5 deltas per butterfly contract guideline? No, it wasn't. I had ten butterfly contracts, and the delta was 47.91, or +4.79 deltas per contract. The deltas/contract may have been close to the guideline's adjustment level, but it was not outside the boundaries and, by the guidelines, needed no adjustment.

Was the RUT's price at or more than 20 points below the central strike of the butterfly? No, the central strike was at 1170 and the RUT was 1157.75. By the guidelines, this trade needed no adjustment. But what about important developments that might occur overnight or early the next day?

Forex Factory Calendar for That Night and the Next Day:

The U.S. portion of the next day's economic calendar featured a few red items, those that might roil the markets. But the guidelines say nothing about the schedule for economic releases. Moreover when I backtested this trade, I didn't call up a calendar and double-check how the trade performed before, during and after certain releases, including UofM Consumer Sentiment days. No, there were no inducements to break the rules/guidelines on this calendar, either.

What if your examination of the price chart showed you that a gap lower the next morning could break the RUT through important support? Without a quick reversal the RUT could quickly drop toward 1140, as it had done on December 15.

Price Chart on January 15, from Think-or-Swim:

A drop to 1140 with increasing implied volatility could bring the loss uncomfortably close to the lower edge of my preferred $250-300 range/butterfly contract. A pro-active adjustment--perhaps moving a couple of the butterflies--would lessen the impact of a sharp drop without overwhelming the trade too much if the RUT bounced instead.

However, this pro-active adjustment wasn't in the rules/guidelines. And I'd back-tested the trade following those guidelines.

But what if about an hour earlier, you'd gotten word that your mother-in-law, in rehab after a fall that had broken her hip, had fallen again? She'd reinjured her hip and perhaps broken her arm and was on her way by ambulance to the hospital, and that hospital was in another town four hours away? As the close of trading neared, you didn't know if you'd be sitting at her side the next morning in that hospital in another town.

I made the pro-active small adjustment.

Actual Live Trade at 2:30 PM CT on January 15, OptionNET Explorer, After Adjustment:

I moved two of those original flies lower, centering them at 1140. This was just enough of an adjustment to stabilize the trade. For those who trade by the Greeks, it lowered my delta by almost 20 points. For those who don't trade by the Greeks, it flattened my profit-and-loss line and lowered my downside breakeven from the previous 1138.97 to 1131.94. The adjustment was meant to give me enough wiggle room so that I'd be able to set contingent orders and feel that the trade was stable even if I couldn't tend to it.

What's the point that relates to trading? I tend to be a rule-follower, but it's just not possible to figure out every contingency ahead of time. Back test by all means. Have confidence that a trade can work. Test all kinds of adjustment methods so you have some flexibility and facility with those you can employ.

If you need to adjust but need that adjustment to be as low-cost as possible, what can you do? Can you take off some butterflies instead of adding something else? Can you move a few of the flies instead of all of them? Can you move out one wing or separate the center strikes? The goal is to have a repertoire of possible choices in case you cannot or should not follow the guidelines due to market conditions, a need to put a stricter limit on capital in the trade or have to trade around a life event that deservedly requires your attention or time.

I wanted to point out that I don't want to give Locke the blame for the way I trade my trade right now. As all of us do, he's changed some of his original guidelines, altering them due to changes he's observed in market behavior, just as I've altered the way I trade it by adding that extra long put. Each of us still has guidelines, guidelines that we follow for the most part, but each of us realizes that sometimes unanticipated contingencies must be faced.

Linda Piazza