First, great blog - I've spent a few hours reading the older posts, and they've added remarkable clarity and focus to my investing. Thank you!
I've been running my own numbers on trades for the February cycle, and for a delta of 0.08 I came up with 720/710 for the put spread (using historic volatility for calculations). My question is: do you use the current implied volatility when calculating your delta, or is this your opinion of where the market is headed in the next month (down, hence the extra few dollars of safety)? You could also hedge this by buying a few extra contracts of insurance at the low end of the range...do you typically run these tradeoffs in your trade planning phase?
Love the blog so far. Really interesting strategy. One question I had is did you use this strategy during the volatile times of September 08 through March 09? If so, was it successful? Also, what is the scenario when you experience max pain on this trade? Is it when you are holding just a few days prior to expiration and you can a significant loss or incredible gain, but not enough for the insurance to kick in? Is there any way to really adjustment in that scenario?
In a down market you have volatility and price working against you (PUT) and in an up market just price (CALL). We tend to model our trades to be cautious on the downside.
During the volatile market of the 9/08 thru 3/09 all you had to to is ratio the trades and begin to close systematically your short puts. You may start with short 15 long 15 on the put side and reduce the short by 5 to 10 and then gradually to 5 and then sometime to zero. Hope you get the idea, this is not a static process but dynamic. Actually you end up making a lot of money in the 09/08 - 03/09 market.
You only experience max pain when you short strikes either Call/Put are breached. The goal is to managed the trade such that they are never breached.
I checked the premiums right after your Feb-11 trade cycle post and they had dropped to about $0.65. Is the trade still worth doing at this price? Suggestions?
No, the trade is not good at $0.65. Because of the change in delta and theta it has to be put on at a different strike price and better credit, at least a credit of about $1.10.
Then I do not know how to look at the single iron condor purchase and tell if it is still a good play. I only see the one credit. Is it always desired to have it around 1.00 to 1.10 to be in balance? Or is there something other way to look at it to know. Forgive the ingnorance. Lots of options trades but never iron condors before.
Is there a rule of thumb for how close? Such as one no more than 10x the other to pick a number out of the air? If we miss your initial announcement, we need to have a way to know if still in range or if need to wait for a better opportunity.
How about this for an adjusted Feb-11 trade, using IWM and multiplying the number of contracts by 10: long 67P @ 0.17 delta=-.04 theta = -0.01 short 68P @ 0.21 delta= -.07 theta= -0.02 short 83C @ 0.27 delta=0.13 theta= -0.02 long 84C @ 0.16 delta= 0.08 theta = -0.01 net credit = 0.15 (or $1.50 equivalent on RUT)
Delta for Put side is 0.03/call side is -.05 short positions have twice the time decay as long positions
You have to understand the dynamics of an iron condor which combines a Bull Put Spread and a Bear Call Spread, and also the importance of time decay and volatility. We try to set up the combination of the spreads such that the difference between the call and the put credit is between .10 to .20 cents. The thinking behind this is that as the index moves in one direction one credit spread might be losing money whilst the other makes you money. Hence if they are skewed you lose that advantage.
The credit from the IWM is pretty small and you need a lot of contracts to make it worth while. The larger the contracts the more transaction cost you are paying.
For your scenario to replicate the RUT you have to trade 100 (10,000 shares) contracts instead of 10 (1000 shares). Your transaction cost will be at least 30% of your net premiums.
But I guess you have to make the judgement call if the risk reward justify such a huge transaction cost.
From you "We try to set up the combination of the spreads such that the difference between the call and the put credit is between .10 to .20 cents. " I understand all in theory but in practice need to make sure I am following what you said. Do you recall the prices when you set up the trade, or can you just give an example of all 4 prices and the math to give the .10-.20 range?
705 P +15 $1.9 715 p -15 $2.45 870 c -15 $1.35 880 c +15 $0.75
The credit from the put was $0.55 and the credit from the call $0.60 for a total credit of $1.15 , so in this case the difference was only $0.05 between the two credit spreads.
As you can see currently, since the setup of the trade the RUT has gone done so the credit on the Call side has collapsed to about $0.07 and the credit on the PUT has widened but the over all portfolio is down about $65 as of market close. The only reason the losses has been minimized is because of the distribution of the premiums when they were set up. It than makes it easier to adjust and roll down the position if the RUT keeps going down as you collect almost all the premiums on the call side and roll down to collect additional premiums to make up for the losses on the put side and to move the puts down as well, as well pay for insurance if you have to.
Thanks for that. Last question I promise. So is your target then really to have the credit >$1.00 and the spread <$0.20 meaning it could be biased that far to the call or the put side and not be too out of balance?
First, great blog - I've spent a few hours reading the older posts, and they've added remarkable clarity and focus to my investing. Thank you!
ReplyDeleteI've been running my own numbers on trades for the February cycle, and for a delta of 0.08 I came up with 720/710 for the put spread (using historic volatility for calculations). My question is: do you use the current implied volatility when calculating your delta, or is this your opinion of where the market is headed in the next month (down, hence the extra few dollars of safety)? You could also hedge this by buying a few extra contracts of insurance at the low end of the range...do you typically run these tradeoffs in your trade planning phase?
Thanks,
Love the blog so far. Really interesting strategy. One question I had is did you use this strategy during the volatile times of September 08 through March 09? If so, was it successful? Also, what is the scenario when you experience max pain on this trade? Is it when you are holding just a few days prior to expiration and you can a significant loss or incredible gain, but not enough for the insurance to kick in? Is there any way to really adjustment in that scenario?
ReplyDeleteEric -
ReplyDeleteIn a down market you have volatility and price working against you (PUT) and in an up market just price (CALL). We tend to model our trades to be cautious on the downside.
Kevin -
ReplyDeleteDuring the volatile market of the 9/08 thru 3/09 all you had to to is ratio the trades and begin to close systematically your short puts. You may start with short 15 long 15 on the put side and reduce the short by 5 to 10 and then gradually to 5 and then sometime to zero. Hope you get the idea, this is not a static process but dynamic. Actually you end up making a lot of money in the 09/08 - 03/09 market.
You only experience max pain when you short strikes either Call/Put are breached. The goal is to managed the trade such that they are never breached.
No insurance for Feb trade?
ReplyDeleteI checked the premiums right after your Feb-11 trade cycle post and they had dropped to about $0.65. Is the trade still worth doing at this price? Suggestions?
ReplyDeletefoolishtrader -
ReplyDeleteWe are monitoring the overall delta for this trade and so far it is manageable. We will put up insurance if our model changes.
jjage2354 -
ReplyDeleteNo, the trade is not good at $0.65. Because of the change in delta and theta it has to be put on at a different strike price and better credit, at least a credit of about $1.10.
I see it at 1.17 this morning assuming I read it correctly.
ReplyDeleteThen as high as 1.32. Am I not understanding what I see or is that in great buy territory?
ReplyDeletefoolishtrader -
ReplyDeleteMost of the premiums you are seeing is only from the PUT side. The Call premiums have decayed to only .20.
Then I do not know how to look at the single iron condor purchase and tell if it is still a good play. I only see the one credit. Is it always desired to have it around 1.00 to 1.10 to be in balance? Or is there something other way to look at it to know. Forgive the ingnorance. Lots of options trades but never iron condors before.
ReplyDeleteFoolistrader -
ReplyDeleteYou want the credit to be closer in distribution, rather than skewed.
Is there a rule of thumb for how close? Such as one no more than 10x the other to pick a number out of the air? If we miss your initial announcement, we need to have a way to know if still in range or if need to wait for a better opportunity.
ReplyDeleteHow about this for an adjusted Feb-11 trade, using IWM and multiplying the number of contracts by 10:
ReplyDeletelong 67P @ 0.17 delta=-.04 theta = -0.01
short 68P @ 0.21 delta= -.07 theta= -0.02
short 83C @ 0.27 delta=0.13 theta= -0.02
long 84C @ 0.16 delta= 0.08 theta = -0.01
net credit = 0.15 (or $1.50 equivalent on RUT)
Delta for Put side is 0.03/call side is -.05
short positions have twice the time decay as long positions
foolishtrader-
ReplyDeleteYou have to understand the dynamics of an iron condor which combines a Bull Put Spread and a Bear Call Spread, and also the importance of time decay and volatility. We try to set up the combination of the spreads such that the difference between the call and the put credit is between .10 to .20 cents.
The thinking behind this is that as the index moves in one direction one credit spread might be losing money whilst the other makes you money. Hence if they are skewed you lose that advantage.
jjage2354 -
ReplyDeleteThe credit from the IWM is pretty small and you need a lot of contracts to make it worth while. The larger the contracts the more transaction cost you are paying.
For your scenario to replicate the RUT you have to trade 100 (10,000 shares) contracts instead of 10 (1000 shares). Your transaction cost will be at least 30% of your net premiums.
But I guess you have to make the judgement call if the risk reward justify such a huge transaction cost.
Thanks for the post, ko...
ReplyDeleteI don't have level 5 yet, so I'm stuck with IWM/SPY.
From you
ReplyDelete"We try to set up the combination of the spreads such that the difference between the call and the put credit is between .10 to .20 cents. "
I understand all in theory but in practice need to make sure I am following what you said. Do you recall the prices when you set up the trade, or can you just give an example of all 4 prices and the math to give the .10-.20 range?
foolistrader -
ReplyDeletethese are the prices for the Feb trades
705 P +15 $1.9
715 p -15 $2.45
870 c -15 $1.35
880 c +15 $0.75
The credit from the put was $0.55 and the credit from the call $0.60 for a total credit of $1.15 , so in this case the difference was only $0.05 between the two credit spreads.
As you can see currently, since the setup of the trade the RUT has gone done so the credit on the Call side has collapsed to about $0.07 and the credit on the PUT has widened but the over all portfolio is down about $65 as of market close. The only reason the losses has been minimized is because of the distribution of the premiums when they were set up. It than makes it easier to adjust and roll down the position if the RUT keeps going down as you collect almost all the premiums on the call side and roll down to collect additional premiums to make up for the losses on the put side and to move the puts down as well, as well pay for insurance if you have to.
jjage2354
ReplyDeleteYou don't need level 5 to trade RUT, you should see it even on a level 2 platform.
Thanks for that. Last question I promise. So is your target then really to have the credit >$1.00 and the spread <$0.20 meaning it could be biased that far to the call or the put side and not be too out of balance?
ReplyDeletefoolistrader-
ReplyDeleteYes.