Iron Condor - Part Five: Making Adjustments

In the world of trading Condors, many people think that making "adjustments" is the holy grail. The truth is, just as there is no magic to picking strikes, or executing the trades, there is no magic in making adjustments. An "adjustment" is really nothing more than a new trade. A better title for this might be "What to do when things go wrong. When the risk profile for my trade changes I might not like it any more, so I will do something to change it.

The first question is: How do I know when the risk profile is no longer desirable? The answer to that is different for everyone. Personally, I don't like big losses, so I have a set of trading rules for Condors that requires me to take smaller losses more frequently, rather than big losses occasionally. As I describe my trading rules, take a quick look at the profile of my current RUT Iron Condor:



The red line in the middle is the current price of RUT. Notice how it is nicely centered, just the way we like it. The curved white line is the profit picture for today, and the green tent is the profit picture at FEB expiration. The one thing you will notice about the curved white line is that it gets steeper as price moves away from center. In other words, as the price moves closer to the tent edges I lose money faster... I don't like that so I don't let it get too far off center.

My rule of thumb is that when the Delta of my short strike reaches 10 points more than where I started the trade I do something. You might remember from Part Three: Choosing the Strikes, that I start with a Delta of around 8-10 on the call side, and 6-8 on the put side. So if I put on a call spread with a 9 Delta, and it hits 19, I do something. If I initiate a put spread with a Delta of 8 and it hits 18, I do something. One of the quickest ways to lose big money is to let these get away from you. It happens very fast as the curve gets steep.  There are also a few other times when I might make an adjustment, such as when the market is whacky, breaks a support line, or volatility moves quickly.

The next question is: What do I do? What is the best adjustment? If you've been trading Iron Condors, this always seems like the million dollar question, but I believe that every adjustment is just another trade off. One adjustment is not necessarily better than another. But it's true there are many options:

• You could do nothing. Many people just ride it out and adjust position sizes so that a max loss is tolerable.
• You could take the spread off. I know of one trader that watches his condors until they are down by the amountof the original credit, and then removes them. He wins more often than he loses, and his losses and gains are aboutthe same size...a winning strategy.
• You could add other trades. Some people will add a put or call on the side where the price is moving and flatten the overall deltas of the position a bit. Some will add other spread including more credit spreads, or even calendars.
• You could roll the position down. In other words, if the short strike hits 18 (when I started it at 8) I could close it and then reopen a new trade down at the new 8 Delta.

These are all viable strategies under the right circumstances, and I think with some consistency and diligence they can all be made to work. I believe, however, that choosing the right strategy has a lot to do with my beliefs about the market, so I always begin my adjustment with a look at the chart and the implied volatility. I try to form an opinion about where I think price is going, and whether IV is rising or falling. I'm not always right of course, so I AM going to make an adjustment. I just choose which one based on some reasonable technical analysis.
Most frequently I do one of two things. Either I roll the spread down, or buy a put or call on the side where price is moving to flatten the Deltas. If I think price is about to reverse, based on my technical analysis, then a roll down may make sense. If I'm not really sure, flattening the Deltas makes more sense. That way I'm not hurt too bad either way. If price DOES reverse, I can always sell the call or put and I'm right back in the middle of the tent. There is a cost for doing this, but I just consider it "insurance".
The bottom line with adjustments is that every adjustment is a new trade. Once the new trade is on, the new position needs to align with my view of the market direction. Over time you will see me do some adjustments on the site here and hopefully my style will become more clear.
Good Trading...