When I entered a 60-contract SPX iron condor trade on May 5, 2010, I expected to be watching paint dry for a week or two. When the iron condor was my trade preference, I tended to enter between 55-70 days to expiration. For the first week or two, nothing much happens with an iron condor that far out unless the underlying moves big.
If you recognize that date, you know that the SPX did move big the next day. Instead of watching paint dry on May 6, I was trying to manage a 60-contract iron condor during the Flash Crash. While we thankfully don't face Flash Crashes every day, that experience illustrates how the date of entry can change the outcome of a trade.
What can we learn from my experience? Stuff happens. The SPX had already been declining. In fact, I had entered when I did because the decline and heightened implied volatilities had made it easier for me to swing my put credit spreads further out of the way. I thought.
Moreover, because of the shape of the decline, I had entered only the SPX iron condors and not the RUT iron condors I also typically entered at the same time, cutting down the amount I had at risk. That's the other take-away from that experience. We can't predict when the next Flash Crash might occur. That kind of timing is beyond the abilities of those of us who lack skills in the psychic realm. However, we can always make sure that we won't have to list the house with a realtor if a trade goes bad.
This last year, I've been watching paint dry again, but with a different strategy, the butterfly. Because I was following in the footsteps of a master butterfly trader when I began switching to butterflies, I back tested the trade starting at 58 days to expiration. The back test showed me that the trade was the kind of trade I wanted: easier to manage risk even if butterflies tend to require more frequent adjustments than iron condors.
I'm patient, and I prefer watching paint dry to the adrenaline rush of trades started and completed in a day or two or even an hour or two. However, the longer it takes for a trade to unfold, the more event risk it faces. In a recent article, I recounted Jim Bittman's assertion that those selling far out-of-the-money options might want to consider opening their trades at the two-month mark and closing them at the one-month mark rather than opening them at the one-month mark and closing them near expiration. The converse is true: when selling options at or nearer the money, the biggest decay tends to occur in the thirty days prior to expiration.
An iron condor features selling options out of the money, of course, and sometimes very far out of the money. Except for speculative butterflies, the butterfly trader tends to sell options closer to the money. So why was I following in someone else's footsteps and opening my butterfly trades 58 days until expiration? From Bittman's research and my own prior experience, I had solid reasons for starting my iron condors that far out, but maybe it didn't make as much sense to me to start my butterflies that far out.
I've been back testing an entry 37 days till expiration. When back testing, I automatically exited at 7 days to expiration, if the trade hadn't already met its profit target. Occasionally, if the trade is well positioned, I might trade into the beginning of option expiration week, but then I'm met with all the risks of a weekly trade. The results of the new back test were as workable as the original back tests with the 58 DTE entry. Moreover, there was less risk of overlap between two months. Typically, there would be only two days of overlap, at most. Event risk was lowered, both due to the shorter period of time the trade was open and to the reduced likelihood that two months of butterflies would be open at the same time.
What about those of you who trade or want to trade weeklies? Timing becomes even more crucial. Dot Hazlin has been ably guiding subscribers through various weekly options strategies on the Couch Potato site, and she frequently mentions timing when talking about entries and adjustments. Here is where timing becomes even more crucial, especially when the trader prefers to exit before the weekend to avoid weekend risk. The advantage to weekly trades is the oft-quoted statement that you have 52 possible trade entries with weeklies, rather than the twelve with monthly cycles. One disadvantage is that when these trades go wrong, there's not as much time to recover.
What's the lesson to be learned from Dot's careful discussions of these trades? Some of you with technical analysis skills might prefer to use your favorite indicator to time an entry so that odds are you in your favor, but this discussion is not meant to be about that kind of timing.
This discussion is about the way you must adjust your thinking when you change the timing of entry of a trade. Because there's so little time to recover from a big market move with weekly options, would-be weekly traders must be able to trust themselves to adhere to their trading plans. Trades must be exited when the planned maximum loss is hit because losses can grow quickly. If the morning craziness has passed, weekly traders must adjust when the adjustment point is reached. They must avoid entering a trade just before a potentially market-moving economic event. And, as Dot cautions, the timing just isn't right for entry some weeks. For example, in her May 29 Couch Potato post, she warned that the environment was not a good one for the SPX weekly iron butterfly. Excessive volatility rendered the timing unfavorable.
We can't always predict when an outsized move will occur. We may think we got the perfect entry, but stuff happens sometimes. If we can't always time the perfect entry or avoid one that's at the wrong time, we can ascertain that we're not risking more than we can afford to lose, either in actual monies or time spent in a trade. As I found out when I back tested a different entry point, it may be that changing market conditions, a change in strategies, or your own preferences require a rethinking of the best timing for trade entry. Test for yourself, through back testing, if that's available to you, or through paper or simulated trading through at least several cycles, preferably with at least one trade including a quick move down. Adhering to one's trading plan and exiting when a maximum planned loss occurs is always important, but recognize that the less time until expiration, the more important it becomes. If you can't trust yourself to exit when your exit points are reached, then do as Dot suggests and set OCO orders to exit at your profit target or the max loss, whichever is hit.