The Profitable Exit

Know When to Fold 'Em

exit
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Question

Can you offer any guidance on when to close a profitable iron condor position? I'm getting familiar with when to get out when my short options are being threatened (i.e., are not very far out of the money), but I am less sure when to exit a winning trade.

I tend to be quick on the trigger when exiting a good position because I want to lock in my profit.  I think I'm losing out on valuable decay (Theta).

For example, I own an iron condor with the Oct 1000/1010 put spread and the 1180/1190
call spread. I've owned this position for 4 weeks, collecting a $3.20 credit. The current price (using midpoints) is 1.65. The current profit is roughly $1.55 (depending on the quality of the trade execution).

However, both the calls (6%) and puts (10%) remain far enough OTM to satisfy my comfort zone. How long should hold the position?

Reply

Let me begin by describing my philosophy of iron condor investing.

   1) How long you owned this position is not relevant
   2) The premium collected no longer matters 
   3) The current profit is not your primary consideration

Yes, I know that this thought process may seem absurd to most traders. I understand why you believe that the current profit is the crucial number in examining this position. However, when the current profit dictates your action, it often leads to to poor decision making.

It is an important consideration, but other factors should be considered first.

Which factors are truly important when you own a specific iron condor? In your example, you can exit by paying the current premium (~$1.65). I urge you to think about these questions:

  • Are you comfortable owning this iron condor right now, at this price? 
  • Does the current risk and potential reward (going forward) fit within your comfort zone?
  • If you did not already own this iron condor position, would you consider opening a new trade at this price today?

If your answer to any of these questions is 'yes', then it is not an appropriate time to exit.

However, do consider position size.

  • Is the size of the position still appropriate, or would it be better to reduce the size?

Perhaps you do not want to own as many spreads as you did when initiating the trade. NOTE: You would not be closing part of the position only to lock in a profit. Part of the motivation would be to open a position that is currently the proper size because size Is a crucial part of careful risk management.

Go through these questions every day. At some point, you will no longer want to own the position. That is the time to exit. How strongly you feel about not wanting to hold the position dictates how aggressive to be when entering your order to exit. If very anxious to get out, you can afford to pay near the asking price. If less anxious, you can be more patient and bid a bit above the midpoint of the bid/ask spread

There are several conditions that may make it desirable to exit:

  • Too little time remains before the options expire. Many traders are not comfortable owning positions with little time remaining because of the effects that negative gamma can have on their portfolio value. 
  • Too little premium remains. It does not pay to hold onto a 10-point iron condor (per your example) when the premium declines to a low level. I cannot define that level for you, but for your trading style, it may feel right to exit when the premium (for the whole iron condor) declines to $0.50 to $0.60.
  • You discovered another position that you prefer to own, and there is no room in your portfolio for both.

As the months pass, and you gain experience with this thought process, you develop a good sense of which profitable situations to hold, which to reduce size, and which to exit. When you have a trade plan, you have a big head start on solving this dilemma.

IMPORTANT 

Sometimes iron condor trades work perfectly; the longer you hold, the more you earn. But that occurs ONLY under ideal conditions.  

The only reason that you feel you are "missing valuable time decay" is because you have not owned iron condors during volatile markets -- and that is when it is difficult (risky) to collect that time decay.

It is important for you to recognize that "holding longer" will be a losing decision in many (but not all) instances.

Do you recall that during the most volatile periods during the 2008/2009 debacle, the markets were so volatile that they were averaging a 5% move every other day? Would you be comfortable with your options being 6% OTM when within the next two days they would likely be only 1% OTM. Would you feel that holding longer represented easy money?

When you hold, you earn more time decay -- but that comes with increased risk of loss. The early exit may feel wrong when the market does nothing. If you are willing to wager that the non-volatility will continue, then sure, you can hold longer. But additional profits are not guaranteed. If you seek the maximum profit from every trade, you will make extra money for awhile.  But at some point, you will discover the wisdom of not being greedy.

Back to the main problem:  For my comfort, $1.65 is too much to pay to get out of a good position. I'd want to pay a lot less that $1.65. I don't know how much less. It's a day to day, or week to week decision based on my comfort zone and market conditions.