Iron condors are usually constructed to have a high probability of success. But that still leaves plenty of opportunity for market events to turn your position into a loser. Because preventing large losses is your top priority when trading iron condors, let’s discuss some strategies you can use to manage risk. Then we’ll look at each of these ideas in more detail.
Some traders consider adjustments as something to be avoided and use them to close a position that has become a disappointment. The pessimist.
Other traders consider making an adjustment to serve two purposes. The first is to reduce immediate risk, and the second is to improve the position so that it has a better chance to earn money in the future. The optimist.
Overall adjustment plan
1. All or none. When the underlying asset reaches a price level that makes it uncomfortable to hold the position, shut down the trade. You can simply close the position and wait for a better opportunity to enter into a new trade, or you can ‘roll the position’ and enter into a new trade at the same time you close the original position.
2. Adjust in stages. Instead of adopting the all or none approach, I recommend adjusting a position several times (if necessary) to minimize the chances of incurring a large loss. For example, if you trade an iron condor with APPL options, and if you choose your iron condor so that the options you sell are 25 points OTM, you may decide to adjust when APPL moves so that one of your short strikes is only 10 points OTM. A second adjustment may be appropriate when AAPL is 5 points ATM, etc.
Alternatively you may decide to adjust when the delta of your short option reaches 30. You would adjust a second time when delta moved to 35 and yet again when delta is 40.
1. Close all or part of the position. The simplest adjustment
2. Buy a small number of calls and/or puts. This reduces delta, gamma and vega risk. It pays to buy options that are closer to the money than your shorts. This can be expensive.
3. Roll all or a portion to further OTM strike prices in the same month. This is not a good idea with less than two weeks before the options expire (it’s too costly).
4. Roll all or a portion to a more distant expiration month, being careful to choose a position you want to own, rather than choosing based only on the price of the options.
5. If the underlying puts are threatened with moving into the money, sell more calls spreads. If the calls are threatened, sell more put spreads. This is a very poor choice. It provides little protection and, if the market reverses direction may place your account in financial jeopardy.
Anything goes. An adjustment is any trade you believe reduces risk. But some plays are better than others. Next time we’ll discuss the all or none vs. the ‘stages’ approach.
Further Reading, Options Trading: