Iron Condors and Stupidity

[JohnGreen]

Mark, a question for you--what amount of your gross premium do you set aside to use in debit "insurance" spreads? Obviously, a person wants to be collecting theta, so I assume you don't use all of it, but you do use them, so I'm curious about how you work this strategy.

In my case, I'm working with a setup this month that has two 'inside' spreads against 5 Further OTM credit spreads that are somewhat wider.

I've noticed that the relative values of these spreads varies noticeably (and is only partly related to the VIX numbers). As a general rule, if the underlying does not move much, the value of the Further OTM should decline somewhat faster than the closer in ones, shouldn't they-especially if a significant fraction of the time to expiry passes?

I set up my IC last Wednesday, and overall the market moved up, and now it has come down to the same place it was a week ago, but the inside spreads have lost relatively more value than the outside spreads (it's not dramatic, and the options expire in June, but that is the case). Care to comment on that relationship?

[By the way, the overall package is doing fine so far. I find it less worrisome than having a regular IC. My current delta and gamma have absolute values less than one, so I'm not exactly shaking in my boots about this position, even though I check it everyday of course.]

 

[dagnyt]

Quote from JohnGreen:

Mark, a question for you--what amount of your gross premium do you set aside to use in debit "insurance" spreads?

I cannot answer. It's not constant. And the bad news (for me) is that I do not always buy insurance. I like to leg into it, one or two straddles at a time. If the market moves too quickly, I will not have bought enough.

Obviously, a person wants to be collecting theta, so I assume you don't use all of it, but you do use them, so I'm curious about how you work this strategy.

I remain positive theta and spend no moe than 25% of the premium collected from the iron condor. But, I usually spend less. I don't use any 'rules.' Perhaps I should!

In my case, I'm working with a setup this month that has two 'inside' spreads against 5 Further OTM credit spreads that are somewhat wider.

I've noticed that the relative values of these spreads varies noticeably (and is only partly related to the VIX numbers). As a general rule, if the underlying does not move much, the value of the Further OTM should decline somewhat faster than the closer in ones, shouldn't they-especially if a significant fraction of the time to expiry passes?

I set up my IC last Wednesday, and overall the market moved up, and now it has come down to the same place it was a week ago, but the inside spreads have lost relatively more value than the outside spreads (it's not dramatic, and the options expire in June, but that is the case). Care to comment on that relationship?

Don't forget implied volatility That counts also

By the way, the overall package is doing fine so far. I find it less worrisome than having a regular IC. My current delta and gamma have absolute values less than one, so I'm not exactly shaking in my boots about this position, even though I check it everyday of course.

You want to learn how this owrks before you have a positions that akes you shudder. that's good.

Barring a HUGE move, buying insurance is a losing proposition, You don't expect to make money by owning it. But you do cut losses significantly on those occasions when its needed.

Mark

 

[jwcapital]

Quote from JohnGreen:

Mark, a question for you--what amount of your gross premium do you set aside to use in debit "insurance" spreads? Obviously, a person wants to be collecting theta, so I assume you don't use all of it, but you do use them, so I'm curious about how you work this strategy.

I used to sell naked puts. The margin required was enormous. Now, if I do a bull put spread, the margins are so much lower, so I can do more of them and get the same premium as I got doing naked puts. I, too, seem to set aside about 25% of the premium received from the short option. IMO, implied volatility is the most important factor to the success of bull put spreads, for it really determines everything else. I have found that as long as IV decreases--no matter what the underlying does, the spread loses value quickly (therefore giving me a profit). A downward move with decreasing IV (typically profit-taking as opposed to panic selling and short selling) even can show a profit. The problem are the bear call spreads. They increase much more quickly as IV decreases than the bull put spreads. This leads me to beleive that even with short straddles, iron butterflies and even IC's, you still need to determine direction of the underlying, despite all of the greeks and IV at the time. As Mark always mentions, management of the your trades is the most important aspect. If you place an IC (thinking rangebound) and you are wrong, you gotta manage it to minimize losses. Your approach to varying your spreads is a good way to reduce risk.

 

[JohnGreen]

Thank you Mark and jwcapital for your commentary.

Mark-- I probably should have mentioned that these were SPX options, so the VIX relationship is pretty directly related to the IV for these options. I find that the skew smile actually shifts noticeably over time, which reflects the market sentiment at the time--for what that is worth

Back in December and January, you hardly wanted to be bothered selling call spreads. Anyone could buy them for about half the usual values despite the high VIX numbers, but I always worry about selling something that is very cheap by historical standards--it makes me think I'm selling the lows, not at a reasonable price, and those who sold call credit spreads in early March probably wish they hadn't as a result.

Now, things are fairly evenly balanced again, so IC's make more sense, but I still like buying a little insurance. I used about 30% of my funds to buy insurance. I realize that there is only a 20-30% chance of either of the debit spreads actually expiring in the money, but I'd probably sell out before expiration week anyway. I really do expect that the market may move in one direction or the other by the June expiry, and I will shift my credit spreads around (hopefully not too often) while keeping my debit spreads in place. The ideal situation for me would be to have the market meander fairly quietly until the first week of June. At that point the "outside" spreads are pretty well worthless, and can be bought back for 20 or 30 cents. Then, I would start hoping for a sharp rally or a crash in the next week or so to make my debit spreads very valuable.
Of course, chances are nothing will happen, so in that case I'd sell for a little cash- perhaps enough to pay for the repurchase of the credit spreads, and start another round. The other sensible possibility is to leave them in place while I am instigating the next batch of IC's and have double protection for a couple of weeks. During that time, a sharp market move could actually be profitable which would be a pleasant surprise for an IC writer. I have also given a little thought to the idea of using two different months--one (the near month) for the protection debit spreads, and the other for the far month credit spreads. This could make life interesting! Comments??

jwcapital--I totally agree with your comments about IV-- for an IC writer, it's always good when it declines after you have written the option spreads, and usually painful when it rises. Despite my delta and gamma neutral position (practically speaking), my vega is around -100, which is not neutral at all!

I also agree that spreads are the way to go. I'm totally comfortable with losing on 50% of my transactions, just as long as the overall position is fine. I try to think of each month's spreads as a connected unit, and try to manage the whole unit to be profitable, which means adjusting occasionally. This isn't always possible, so sometimes you let it go-- and that happens when IV rises dramatically or the underlying makes a significant move, but usually it works out pretty well. It always pays to have your decision points figured out well in advance so that there is no panic.

I welcome comments by others as well. It helps to have a good discussion of things to clarify issues and clear up misconceptions. Hopefully, we can all learn and gain insights as well as trading ideas.

 

[dagnyt]

Quote from jwcapital:

Quote from JohnGreen:

I used to sell naked puts. The margin required was enormous. Now, if I do a bull put spread, the margins are so much lower, so I can do more of them and get the same premium as I got doing naked puts...

JW

I hope that method is working for you, but it's one of the things I tell my rookies to avoid doing.

Selling several credit spreads is <i>far more likely</i> to result in a substantial loss than selling a since naked put. In my opinion, the enticement of 'limited loss' can be a big trap.

Question: Do you trade to collect (for example) $1,000 premium, rather than thinking: 'If the stock moves this far, I'll lose this much?' that's another way of asking: How do you compare the risk of the naked put with that of the put spread?

Mark

 

[dagnyt]

Quote from JohnGreen:


I have also given a little thought to the idea of using two different months--one (the near month) for the protection debit spreads, and the other for the far month credit spreads. This could make life interesting! Comments??

I like your idea. It's exactly what I do when I buy insurance.

Few want to own near-term options as protection for later month positions - because of rapid time decay, but owning them allows three big benefits:

a) they are less expensive and you can buy more of them, if you want to do so

b) you can buy 'more useful' strike prices for less money than further OTM options that expire in a later month.

c) If something happens, the explosive gamma of your long options is going to work miracles.

Mark

 

[Whisky]

Quote from JohnGreen:


I welcome comments by others as well. It helps to have a good discussion of things to clarify issues and clear up misconceptions. Hopefully, we can all learn and gain insights as well as trading ideas.

Do you guys check SPY options, SPX options, OEX options, ES future options, for pricing before making a transaction?. There is usually a skew since the bid/ask spread is normally very wide in these instruments. So typically there are execution advantages in one vs the others. And positions taken on any of the above instruments typically mirror each other in the longer-term to expiration or offset. They also offer about same leverage.

Which of the above instruments do you find more efficient (lower costs) to trade?. Has anyone here become member of an exchange and how has that benefitted your bottom line?.

I'm a different JW than jwcapital, just to clarify.

JW

 

[dagnyt]

Quote from Whisky:

Do you guys check SPY options, SPX options, OEX options, ES future options, for pricing before making a transaction?.

JW

Careful. You do not want to get short any OEX options (American style exercise).

Mark

 

[MTE]

Quote from dagnyt:

Careful. You do not want to get short any OEX options (American style exercise).

Mark

Mark,

Your warning is incomplete. American-style is not that much of a problem in itself, the real problem comes from the pairing of American-style with cash settlement.

 

[jwcapital]

Quote from dagnyt:

JW

I hope that method is working for you, but it's one of the things I tell my rookies to avoid doing.

Selling several credit spreads is <i>far more likely</i> to result in a substantial loss than selling a since naked put. In my opinion, the enticement of 'limited loss' can be a big trap.

Question: Do you trade to collect (for example) $1,000 premium, rather than thinking: 'If the stock moves this far, I'll lose this much?' that's another way of asking: How do you compare the risk of the naked put with that of the put spread?

I am not quite sure I understand your comment; what is a"since naked put?" I have a comfort zone just like you do. I recognize that "limited risk" is a myth, both for naked puts and bull put spreads. The "insurance is an ultimate backstop, but I will exit a spread prematurely if I think I can avoid a big loss. Capital preservation is my prime concern. At the same time, I have to let the trade work, and not panic every time the market goes down or IV goes up. When I traded naked puts, my risk and actual losses were greater than my bull put spreads. Currently, I have adopted a new philosophy for placement of the short leg and long leg. In addition, timing of the entry and exit as well as the number of trades matter to me now. So, for me, bull put spreads now are lower risk, higher reward. Having traded IC's as well, I needed to make a determination fo the appropriateness of the strategies. My May trades happen to be bull put spreads only; my Aprils were IC's. If my April's were bull put spreads, I would have been a happier puppy.

Mark