Adjusting Iron Condors

Cutting Risk when Trading an Iron Condor

Adjusting a Trade

Comments and questions from a reader:

Thanks for an excellent article on getting even. It was very timely for me. Now I am trying to learn about iron condors. I don't want to jump in too quickly and have begun to paper trade. However, I may not be ready for paper trading because I must be clear on my overall game plan for trading IC's

I think I get the picture when it comes to initiating a position.

What I am not sure about is adjusting. Here's the problem: I read at a few forums that having a well-defined game plan -- including when and how to adjust -- is necessary. I don't have clue as to how to come up with this game plan. Can you provide some guidance?.

  • Should I plan to adjust the position as soon as the stock gets close to a short strike price (say 1% OTM)? [Quick answer: Yes, but adjust much earlier than 1%]
  • Is it better to wait until the stock price moves beyond the short strike? [Quick answer: Only for very experienced traders.]
  • Is rolling both the call and put spreads always a good choice when compared with closing the position? [Quick answer: No.]

The reply

1) Paper trading is right for you now. It provides an opportunity to see how money is made and lost with a real position. Sometimes it is difficult to appreciate just how quickly losses mount or how slowly gains accumulate.

The best part is that you cannot make costly mistakes. If you notice something that you would do differently next time, take notes and consider that to be a free lesson. Be certain to describe the rationale for doing it differently next time. Be very careful that the reason is not: "My decision lost money." Unfortunately, intelligent and sound decisions do not always work out well. However, they succeed most of the time and winning most of the time is your goal. 

To learn faster, maintain more than one or two iron condor positions  simultaneously. Use different expiration dates and/or different underlying indexes. When you begin using real money, that is the time to own only one position at a time - until you are confident that you can handle more than one.

There is no substitute for hands-on experience.  And paper trading does not cost you a dime. Please be honest with yourself. Never take the attitude that it is only play money.

2) It's good to have a personal game plan. But, it takes some experience to know how to formulate that plan. Don't be concerned that you don't have a complete plan right now. A good game plan for beginners is:

  • Don't allow positions to become uncomfortable to hold or make you afraid of losing too much money. If that happens, adjust or close the position. Learning what makes you uncomfortable dictates your game plan. 
  • For now, I suggest a broad game plan. Such a plan might be (please choose something that fits your comfort zone:  Adjust when one of the short options reaches a Delta of 25 or 30. I know it may be tempting to wait until it moves ITM, but it takes am experienced trader to handle that risk. Why? Once that happens, discipline is required to lock in a loss by closing the position. Prove that you have this discipline in the real world before taking any chances. You do not want to tackle this difficult situation with your current experience level.
    If you do exit one of the two spreads, close the other. Do not hold on -- hoping to cut losses. There is too little to gain and too much to lose.

    Remember this:  There is no single 'best' adjustment plan. You have three goals when adjusting: First, to get out of positions when ​the risk of further loss is too high. Note that 'too high' is a relative term and each investor must decide the place when that occurs. That's where experience comes in and paper trading helps you get some of that experience.

    Second, don't get stubborn.  You must not allow  losses to get so large that they overwhelm your profits.  Adjusting is not fun, but do not allow a loss to become painful. That concept is essential for long-term survival.

    Third,and most importantly: Make an adjustment ONLY when you want to own (and are comfortable owning) the post-adjustment position. It is ​a bad strategy to adjust -- just to do something -- and then discover that the new position is too risky.

    3) 'Always' is not a good plan for traders. Yes, when adjusting the losing side of an iron condor, it's usually best to cover the winning side. Why?  Because if adjusting the puts, then the calls are probably cheap enough (i.e., the remaining reward is just too small for the risk) to cover. Then you may (or may not) elect to sell a new call spread to go with the new put spread --giving you a new iron condor.

    Because you want to maximize the chances for long-term profitability, it is essential to take risk management very seriously. It only takes ONE disaster to wipe out months or years of earnings – depending on how much risk you take. Those who want maximum gains tend to take more risk than the average investor. If you decide to take that path, you must own protection against a disaster. If you neglect that safety net, the chances are good that you will live to regret it.