Managing Greeks, Not Trades

Wed, Apr 15, 2009 | Jared Woodard

Here’s an insightful comment sent along by long-time member B. D.:

I have really learned so much about iron condor trading by seeing how you adjust the portfolio over time. If this month ends up about break-even, I actually think it will be one of your best months ever from a trading expertise perspective, given the huge short-term trend up. Some of the other iron condor newsletters that I used to read must be getting killed by putting on all their trades at the beginning of the month with small credits. The last month, let alone the last 6-8 months demonstrate this is not a viable strategy, though that is what most of the other iron condor newsletters advocate.

He raises some important points. One problem that arises for certain traders is the tendency to think of trades as distinct entities, to reify them ontologically. This leads to all sorts of problems, the most serious of which is the tendency to care about the outcome or ultimate fate of some particular trade. An option is not a thing; it’s just a collection of properties or dispositions, namely, the tendencies expressed by the greeks. So an option spread is not a thing, either, and should be regarded instead as a set of shifting exposures to various kinds of risk.

For example, let’s say you just placed four trades on SPX this morning: you sold a front month OTM call vertical, bought an ATM put butterfly in the next month, sold a wide front month iron condor, and bought a put diagonal a couple of months out. What do you have: four positions, or a set of exposures to various kinds of risk? Technically, of course, you have both, but thinking of all those long and short options as divided up into distinct “positions” can be counterproductive, when what really matters is whether the views about time, price, and volatility expressed by those options matches up with your views about the underlying asset.

B.D. mentions the tendency of some people who trade iron condors to put on one monster position every month, usually for a very small credit, and then to leave it and hope for the best. That approach seems typical of what you might call “position-based” thinking, and the past several weeks have indeed offered decisive proof of how important it is to think in terms of greeks instead. Instead of selling one iron condor each expiration cycle, we trade multiple spreads and tailor each trade to the specifics of the aggregate greek profile we want to achieve. For more on this in the context of the April 2009 expiration cycle, see Options, Timing, and Risk Management.

Tags: Greeks, iron condor, options

2 Trackbacks For This Post

Iron Condors and Vertical Skew | Condor Options Says:
June 17th, 2009 at 2:21 pm

[...] Assume we want to risk $5000 on this trade. In the first variation, the maximum possible loss on a 1-lot trade would be $71, or the distance between the short and long options ($100) less the credit received ($29). To risk the desired amount, we’d trade 70 contracts of the first position. In the second, wider variation, the maximum possible loss on a 1-lot trade would be $902 ($1000 – $98), so to risk the desired amount we would trade 5 contracts. (Since that second trade is actually only risking $4510, I’ll set the first trade to use 63 contracts so that they really are risking the same dollar amount.) To address D.S.’s first point, while it’s true that the second variation brings in a larger credit up front, and while the break-even points at expiration on the second trade are slightly further out, I don’t regard this as a significant factor, for a couple of reasons. First, I rarely hold trades through to expiration. More importantly, the conditions that cause me to exit and enter trades have nothing to do with some fixed profit/loss level, but have everything to do with the various greek exposures I want to maintain. [...]

Iron Condors and Vertical Skew Says:
June 22nd, 2009 at 11:58 am

[...] Assume we want to risk $5000 on this trade. In the first variation, the maximum possible loss on a 1-lot trade would be $71, or the distance between the short and long options ($100) less the credit received ($29). To risk the desired amount, we’d trade 70 contracts of the first position. In the second, wider variation, the maximum possible loss on a 1-lot trade would be $902 ($1000 – $98), so to risk the desired amount we would trade 5 contracts. (Since that second variation is actually only risking $4510, I’ll set the first variation to use 63 contracts so that they really are risking the same dollar amount.) To address D.S.’s first point, while it’s true that the second variation brings in a larger credit up front, and while the break-even points at expiration on the second trade are slightly further out, I don’t regard this as a significant factor, for a few reasons. First, I rarely hold trades through to expiration. Secondly, assuming we risk the same amount on each variation, any differences in the nominal credit received will obviously balance out. Finally, the conditions that cause me to exit and enter trades have nothing to do with some fixed profit/loss level, but have everything to do with the various greek exposures I want to maintain. [...]

0 Comments For This Post

Iron Condors and Vertical Skew | Condor Options Says:
June 17th, 2009 at 2:21 pm
[...] Assume we want to risk $5000 on this trade. In the first variation, the maximum possible loss on a 1-lot trade would be $71, or the distance between the short and long options ($100) less the credit received ($29). To risk the desired amount, we’d trade 70 contracts of the first position. In the second, wider variation, the maximum possible loss on a 1-lot trade would be $902 ($1000 – $98), so to risk the desired amount we would trade 5 contracts. (Since that second trade is actually only risking $4510, I’ll set the first trade to use 63 contracts so that they really are risking the same dollar amount.) To address D.S.’s first point, while it’s true that the second variation brings in a larger credit up front, and while the break-even points at expiration on the second trade are slightly further out, I don’t regard this as a significant factor, for a couple of reasons. First, I rarely hold trades through to expiration. More importantly, the conditions that cause me to exit and enter trades have nothing to do with some fixed profit/loss level, but have everything to do with the various greek exposures I want to maintain. [...]
Iron Condors and Vertical Skew Says:
June 22nd, 2009 at 11:58 am
[...] Assume we want to risk $5000 on this trade. In the first variation, the maximum possible loss on a 1-lot trade would be $71, or the distance between the short and long options ($100) less the credit received ($29). To risk the desired amount, we’d trade 70 contracts of the first position. In the second, wider variation, the maximum possible loss on a 1-lot trade would be $902 ($1000 – $98), so to risk the desired amount we would trade 5 contracts. (Since that second variation is actually only risking $4510, I’ll set the first variation to use 63 contracts so that they really are risking the same dollar amount.) To address D.S.’s first point, while it’s true that the second variation brings in a larger credit up front, and while the break-even points at expiration on the second trade are slightly further out, I don’t regard this as a significant factor, for a few reasons. First, I rarely hold trades through to expiration. Secondly, assuming we risk the same amount on each variation, any differences in the nominal credit received will obviously balance out. Finally, the conditions that cause me to exit and enter trades have nothing to do with some fixed profit/loss level, but have everything to do with the various greek exposures I want to maintain. [...]

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