Condor premium value change vs. stock price change

L

ll00l0l

Hi, another question from a new IC trader: How does the overall value of the IC premium respond to a small price movement of the stock? For example, if the stock price drifts in one direction or the other, while staying between the short strike prices, will the total value of the options remain fairly constant, other than subtracting time decay? I would think that if the stock moves up, the calls would increase in value and the puts would decrease by about the same amount, so most of the premium value change would be time value decay. Is this right?

I know that the premiums can also increase when volatility increases, so this will also be a factor.
Thank you!
Jeff
 
A move to either inner strike will produce about the same gain (or loss) depending on if you bot or sold the IC. It's pretty much symmetrical. Toward the outer strikes the change will be greater to downside which would be less good for you if you had sold the inner strikes. Time decay would add/subtract to this result depending on whether you were long or short.
 
Quote from ll00l0l:

Hi, another question from a new IC trader: How does the overall value of the IC premium respond to a small price movement of the stock? For example, if the stock price drifts in one direction or the other, while staying between the short strike prices, will the total value of the options remain fairly constant, other than subtracting time decay? I would think that if the stock moves up, the calls would increase in value and the puts would decrease by about the same amount, so most of the premium value change would be time value decay. Is this right?

I know that the premiums can also increase when volatility increases, so this will also be a factor.
Thank you!
Jeff
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If the moves are small, you an expect to gradually gain money as time passes.

Yes, the call spread should lose money when tehs tock moves higher, but implied volatility usuallu falls when stock rise and it's possible that the call spread would not increase in value, unless the stock moved near the strike price of your short option.

I understand why you wan to know the answers to these questions, but you will learn far more if you build a position and then use a calculator to look at the theoretical value of your position under various circumstances.

Mark
 
Welcome to IC trading! As a general rule, if price changes are modest you can expect gains, particularly on the side the price moves away from. It is not unusual for there to be declines on both sides if the price changes are modest. It will probably come as news to many that you may have a calculated positive delta, see the underlying price rise modestly and actually see the position have a small decline in profitability. I've seen this happen many times, as IV and skew are also factors in the profitability as well as specific demand for individual options which can temporarily cause a minor shift in the price structure. Over a few days, though, you can pretty much count on gains from favourable price behaviour.

As a general rule, options which are further from the money have more erratic price behaviour because demand fluctuates more on percentage basis relative to the open interest in that option. This may cause some options to become temporarily over or undervalued. It's also a reason not to write your IC a huge distance from the money. The bid-ask spread widens (as a percentage) and it is harder to buy and sell them for a good price. You also have much less credit to work with for the same margins, lowering your percentage returns, but not preventing catastrophic losses.
Price fluctuations also have a less predictable effect when the delta is fairly low. The delta may be overwhelmed by theta, as well.
 
If I can ask a question to IC traders, sort of a philosophical approach. I'm more of a directional trader, usually using TA and fundamentals to determine my trades. So for me, I would enter in a neutral position when I expect a trading range market.

I've heard that it might be better not to bet on direction when trading IC. Since your prediction could be wrong many times anyway, it's better to get into both sides. The important part of IC is the management of the trade, and how you adjust, and this to me seems like an art - usually not a completely mechanical way to adjust. But it also seems that when and how you adjust the position is related to your outlook of the market - how fast it moved against you and what support/resistance points you see on the chart (or other techniques). So are you making more of a prediction on price move during adjustments than you do when setting up the initial IC position?

Thanks.
 
Quote from OptionSeeker:

So are you making more of a prediction on price move during adjustments than you do when setting up the initial IC position?

Thanks.
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It's an individual comfort zone decision.

I adjust for risk that I perceive in the current position. If the underlying has moved too far in one direction, I try not to allow for what I expect will happen - because I know that my predictive powers are not helpful. I adjust to reduce risk.

You can look at it and call it a prediction on future price, but I don't. I look at it as: "If it continues to move in this direction, I will lose too much. I must reduce that risk."

If you feel more comfortable predicting future price, then I see no reason to trade iron condors. But if you do, you are certainly free to lean long or short to initiate the trade.

There are no rules here. You either have no opinion and manage risk, or trade your opinion - but you must still manage risk. Don't get stubborn.

Mark
 
Quote from OptionSeeker:

I've heard that it might be better not to bet on direction when trading IC. Since your prediction could be wrong many times anyway, it's better to get into both sides. The important part of IC is the management of the trade, and how you adjust, and this to me seems like an art - usually not a completely mechanical way to adjust. But it also seems that when and how you adjust the position is related to your outlook of the market - how fast it moved against you and what support/resistance points you see on the chart (or other techniques). So are you making more of a prediction on price move during adjustments than you do when setting up the initial IC position?
More...
Some here rail against adjustments because they view positions statically and think that every adjustment is an attempt to stem losses. In reality, adjustments can also be made to take profits from a leg, a side, etc.

Some believe that when you make an adjustment, you're making a new trade. However, if you view positions dynamically, you will focus focus more on the big picture rather than the components.

Art versus science? I suppose the art could be figuring out/guessing where underlying is reversing but there science involves knowing where you P&L is in real time as well as knowing what you can do to minimize the ongoing risk and/or maximize the potential profit. I guess the short answer is that every position is a prediction even if it's a neutral outlook. It's no different at the outset or at the time of an adjustment. The essential key is to manage risk at all times.
 
Spindr0 makes an excellent point about the adjustments. With an IC, you almost never make an adjustment that doesn't involve taking a profit on one side or the other, which is unlike many other positions which simply worsen with market movements against you. With the IC, it can't worsen on both sides at once.

As an example, if you have an IC on NDX and the NDX drops by 50 points in a week, you will certainly have a profitable position on the call side and perhaps it will have dropped in value to the point where it is only worth say $0.50. This means the most it can drop is $0.50. You have seriously limited protection at that point against further downside moves. In order to reduce risk, you might want to roll the call spread downward and collect more premium credits. Is this an adjustment to a losing trade? I don't think so!

Now, on the other hand, the put side in this case may not be doing so well to say the least. Many IC traders will then use some of the new credits to move the put position downwards and try to reduce the risk of having the put spread going close to or into the money. This adjustment will involve taking a modest loss on the put side to reduce the risk. Overall, you may still preserve your original credits (or reduce them somewhat) in return for a position that is now "centered" properly with much reduced risk.

This is now the situation that Mark is referring to--it's not so much about predicting the market, but rather keeping the risk in check and avoiding catastrophic losses. As an experienced IC trader, I heartily endorse that point of view as well.

The IC is not the "holy grail". You can and will have occasional losses. It's how much you can control and minimize those losses and maximize your good months that determines whether or not you are making an excellent return or losing your shirt.

Many of us also use some other techniques to keep the gamma/ delta situation nicely in check and preserve our credits within the overall context of the IC structure. I also recommend a trip through the elite trader archives for the "SPX Credit Trader" thread started by optioncoach who is still lurking about. It is long and involved, but contains much valuable insight into the inner workings of the thought processes of several veteran traders who used IC's as well as double diagonals and various credit spreads as their primary trading tools.
 
Quote from dagnyt:

It's an individual comfort zone decision.

I adjust for risk that I perceive in the current position. If the underlying has moved too far in one direction, I try not to allow for what I expect will happen - because I know that my predictive powers are not helpful. I adjust to reduce risk.

You can look at it and call it a prediction on future price, but I don't. I look at it as: "If it continues to move in this direction, I will lose too much. I must reduce that risk."

If you feel more comfortable predicting future price, then I see no reason to trade iron condors. But if you do, you are certainly free to lean long or short to initiate the trade.

There are no rules here. You either have no opinion and manage risk, or trade your opinion - but you must still manage risk. Don't get stubborn.

Mark
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I see what you're saying. When and how much protection to put on depends on your comfort zone and not necessarily on your outlook.

I do feel more comfortable predicting direction than not predicting direction, and most of my trades are directional. I'm just trying to get a different perspective, and looking at the various vol strategies on this board. Thanks, Mark.
 
Quote from spindr0:

Some here rail against adjustments because they view positions statically and think that every adjustment is an attempt to stem losses. In reality, adjustments can also be made to take profits from a leg, a side, etc.

Some believe that when you make an adjustment, you're making a new trade. However, if you view positions dynamically, you will focus focus more on the big picture rather than the components.

Art versus science? I suppose the art could be figuring out/guessing where underlying is reversing but there science involves knowing where you P&L is in real time as well as knowing what you can do to minimize the ongoing risk and/or maximize the potential profit. I guess the short answer is that every position is a prediction even if it's a neutral outlook. It's no different at the outset or at the time of an adjustment. The essential key is to manage risk at all times.
More...

Thanks spindr0. I was mainly wondering if predicting what the market will do next is a factor in the way you adjust - when and how much. I guess this is something like the reverse of gamma scalping? If you buy a straddle, you have to determine when you want to scalp and how much.
 
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