Condor Options

As promised, here are some techniques for hedging or managing an iron condor trade that is moving against you.

For illustrative purposes, we’ll use the same example trade throughout. Some weeks ago, you sold 10 contracts of an iron condor on DIA with strikes at 113/115/130/132, for a credit of $0.58. DIA is currently at 130.73, it would cost you about $1.05 to exit the position, and there are 12 calendar days until expiration. Since the underlying has now moved above your breakeven point on the call side (130.58), you’re wondering how best to deal with this trade.

Here are 8 possible actions to take:

1. Let the Statistics Play Out – This is the action we officially endorse. As we mentioned in Part 1, one advantage of putting an emphasis on asset allocation (which entails putting on many small trades instead of a few large trades) is that no one position will have a dramatic impact on your account, freeing you psychologically to let the probabilities work themselves out: “In short: when probability is on your side, it only makes sense to let those probabilities work themselves out. Imposing artificial stop losses or entering expensive or risky hedges can actually worsen the overall performance of the strategy. Instead of putting on one or two huge positions and then having to worry about what happens to them, try putting on lots of relatively smaller trades across multiple underlyings, multiple strike prices, and multiple timeframes.”
2. Open new positions – This second action fits nicely with the first. If you’re looking at a possible losing iron condor, you immediately know that the market has made a significant move since you first opened the position. That may mean that you have an excellent opportunity to open a new position: if the market has fallen hard, there will be extra volatility premium for you to capture; if the market has rallied hard, there may be fewer reasons to worry about a major correction in the near future (and remember that markets tend to fall harder and faster than they climb). In our example, with only 12 days until expiration you would look to the next expiration cycle for a possible trade.
3. Exit early – Now, per our trading rules, you already know you’re going to be exiting all of your front-month positions within 4 to 10 calendar days of expiration. If for some reason you feel that the trade is likely to move further against you, it may make sense to take a relatively smaller loss now, rather than holding out hope for a miracle and risking a larger loss later. In our example, exiting for $1.05 represents a 33% loss on capital risked, which isn’t as bad as, say, a 70% or 80% loss if you hold through the following week; remember that negative gamma becomes more pronounced as expiration looms, making every move against you in the underlying that much more significant.
4. Sell vertical spreads – This is an excellent way to control or reduce your delta risk, and to help a struggling position recover. If the underlying moves against you, you can sell additional vertical spreads that are consistent with the trend. In our example, since the underlying has rallied and is threatening your call spreads, the DIA position will have a significant number of negative deltas; selling some out of the money put spreads (long one OTM put, short one OTM put that is closer the underlying price) will add positive deltas, reducing your directional exposure. Now, if the underlying continues to rally, the new put spreads you’ve sold will decay in value and allow you to keep the credit received from the sale; and if the underlying reverses and moves back down, while those new put spreads may become less profitable, they will be offset by gains made in your original trade. Choosing which strikes to select and how many spreads to sell will be largely a function of your current delta exposure, your overall risk tolerance, and the size of your existing position.
5. Sell butterflies – You can trade a few butterfly spreads on the threatened side of your iron condor and bring in some extra credit while nudging your breakeven point further out. For example, you might sell a third as many broken wing call butterflies as you have iron condors – in our 10 contract DIA example, one butterfly trade might be +3 130 calls, -6 131 calls, +3 134 calls for a net credit of $0.46. Besides, the additional credit, this trade pushes your breakeven point on the call side out from 130.60 to 130.98. Warning: this type of trade adds loads of negative gammas along with the positive thetas, so it’s much riskier when entered late in the expiration cycle; you’re effectively “doubling down” on the thesis that the underlying is going to reverse direction or at least not move much higher. Butterflies are perhaps more useful as protectives measure entered simultaneously with the initial position: you can enter a traditional equidistant butterfly for a very small debit and gain an added buffer so that your position actually makes more money as the underlying approaches the short strikes of your iron condor. Click here for an example risk profile for such a setup.
6. Roll up/down with call/put condors – sometimes “rolling” a position is just a less painful way of saying, “I’m going to close out this losing trade and open a new one that I like better.” Rolling an existing position up or down doesn’t undo the fact that you’ll effectively be locking in current losses and further limiting future gains; that’s why we say that most “adjustments” people make to iron condors usually just add another measure of risk and lock in existing losses. To roll an iron condor up or down, you do two things: 1) buy to close your existing put vertical and sell another put vertical that is higher (lower) than the one you’re closing (depending on whether you want the resulting position to be higher or lower in the strike chain); 2) buy to close your existing call vertical and sell another call vertical that is higher (lower) than the one you’re closing, consistent with whatever you did on the put side. In this example, since you’d prefer to have a higher set of strikes, you might close the 113/115 put vertical and sell the 124/126 put vertical. Executing those two trades at the same time will mean simply selling the 113/115/124/126 put condor, for about a 0.15 credit. You’d do the same thing on the call side, buying a call condor with strikes at 130/132/134/136 for an 0.87 debit. After all that, you’re left with a 124/126/134/136 iron condor which you now own for a 0.14 debit. In other words, you absolutely won’t make any money on this trade, and if DIA expires in 12 days between your new short strikes (126 and 134), you’ll only lose 14 cents on the trade. That’s before commissions, and assuming that your new trade really does expire worthless. As you can see, trying to “adjust” or “fix” a losing trade is rarely worth the added risk. It’s much better to do your risk management and loss prevention up front.
7. Roll forward in time – Just to belabor the point, you could roll your position forward in time instead of up or down. If you really think the underlying will close in the following expiration cycle between your current short strikes, you could simply close your front month verticals and open them in the following month. On the thinkorswim platform this will appear as a “Vertical Roll,” appropriately enough.
8. Roll diagonally – And of course you could combine #6 and #7, and roll your contracts forward in time and up/down in strike price.

Again, with #6-#8, note that you’re effectively just exiting your current position at its current price and opening a new position all at the same time. Maybe this saves you a little in commissions and/or slippage, but it’s always absolutely necessary to ask yourself before routing any rolling orders, “If I didn’t have a losing trade I was trying to deal with, would I still open this new trade at this price, right here, right now?” Unless the answer is yes, you’re better off not rolling, because holding a new position that you felt forced to enter is not a happy place to be. We’re not market makers – we don’t have to just take whatever random order flow comes at us – and that means we should only ever enter positions that we really want to be in.

So to sum things up: you can manage risk up front by entering lots of smaller positions, maybe with some butterfly hedges in place if you really want to get fancy, and if things move against you early on, you can sell additional iron condors and vertical spreads to balance out your risk. It’s a good habit to just check on your aggregate Greeks a few times a week, and if something isn’t to your liking, sell a vertical!

Beyond that, any other methods of “repairing” or “adjusting” or “fixing” trades are largely a matter of shuffling the deck chairs on the Titanic. Apologies for mixing metaphors, but there really is no magic wand that can turn a losing trade into a winning trade (if there were, every options trader would already be fantastically rich, right?). That, again, is why we prefer to let the science of probabilities do all our magic for us.