Adjusting the Iron Condor Kerry W. Given, Ph.D. (Dr. Duke) Parkwood Capital, LLC

Transcription

1 Adjusting the Iron Condor Kerry W. Given, Ph.D. (Dr. Duke) Parkwood Capital, LLC

2 Disclosures and Disclaimers Buying and selling stocks and options involves risks and may not be suitable for all investors. Prior to buying or selling an option, the investor must receive a copy of the booklet, Characteristics and Risks of Standardized Options, from your broker or from The Options Clearing Corporation, 1 North Wacker Drive, Suite 500, Chicago, IL The information in this presentation is presented for educational purposes only. It should not be construed as a recommendation or solicitation to buy or sell options. Many examples of options trades are presented in this presentation as illustrations of the principles being taught in this course. These examples are not recommendations or solicitations to buy or sell any stock or option. To simplify the calculations, commission costs have not been included in the examples in this presentation. Commission costs will affect the outcome of any stock or options trade and must be considered prior to entering the transaction. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed in this presentation. The past performance of any trading system or methodology is not necessarily indicative of future results. 2

3 Agenda Building the Iron Condor Spread Put the Probabilities On Your Side The Profit Engine of the Iron Condor Risk Management for the Iron Condor Spread Back testing the Adjustments Developing a Trading Plan

4 Building the Iron Condor Vertical spreads: the building blocks of more complex options strategies Created by buying one option and selling another option at a lower or higher strike price Credit vs. debit spreads Build the iron condor with: A bear call spread placed above the stock price, and A bull put spread placed under the stock price

5 Building the Iron Condor PCLN at $458 on 3/16/11 Note strong support and resistance levels at $443 and $475, respectively Establish the Apr 430/440 put spread for a credit of $2.55 Establish the Apr 475/485 call spread for a credit of $3.35 Maximum profit = $590/contract; maximum loss = $410

6 The Most Common Condor Strategies Two broad condor strategies are common: 1. The Opportunistic Model Look for a channeling pattern in a stock or index 2. The Insurance Model Trade every month to generate income Within each of these strategies are several possible variations: Strike price placement near or far? Time to expiration? Are spreads established simultaneously or by legging into the position? As is often the case in options trading, there isn t a best strategy. Each variation has its trade offs. Find what suits your style, risk tolerance, and time available to manage the position Parkwood Capital, LLC. All Rights Reserved. 6

7 The Opportunistic Model Look for stocks or indexes you expect to trade within a channel for the next 30 days Calculate one standard deviation (σ) for the underlying stock or index Look at the stock or index s price chart; has it moved > 1 σ in the past 2 3 months? A condor with a high probability of success (> 85%) will have short strike prices 1 σ from the current price Look for levels of support and resistance to position your short strikes Some software can screen for channeling stocks This is a directional trade, based on your sideways prediction 2010 Parkwood Capital, LLC. All Rights Reserved. 7

8 The Insurance Model Use the broad indexes, e.g., SPX, RUT, NDX, etc. Develop and consistently apply a probabilistic model to select strike prices Consistently use a similar time to expiration Settle on an adjustment methodology, including trigger criteria This is a non directional trade; you are reacting to what the market gives you 2010 Parkwood Capital, LLC. All Rights Reserved. 8

9 Put the Probabilities On Your Side Standard Deviation (σ) Gaussian distributions Blue shaded area = 84% probability of success for a credit spread one σ OTM Distinguish probability of closing vs. probability of touching

11 Risk Management for the Iron Condor A contingency stop loss order Adjustment technique An adjustment trigger A time stop A profit stop

12 Risk Management For The Iron Condor Contingency Order Triggers Here are some guidelines for selecting the contingency order trigger price: Watch the delta of the short option; when it reaches 35, I should be out of the trade. For example, on 12/15/09 with the RUT at $606, I establish an iron condor with the 510/520 puts and the 680/690 calls; the $580 put has delta = 33, so I set my contingency order to trigger at a value of $26 ( = 26) above my short put strike price. So my contingency stop loss order would trigger if the price of RUT drops below $546 ( ). Judgment Call: Set trigger farther down = greater risk of loss Set trigger closer = greater risk of being whipsawed out of the trade

13 Risk Management For The Iron Condor Adjustment Techniques 1. The 200% Rule: a) Monitor the debit required to close your spreads; when the debit to close is 200% of the original credit, close all of the spreads on that side 2. Closing Spreads: a) If the delta of either short option 18, close one third of the spreads on that side b) If the delta of either short option hits 30, close the remaining spreads on that side 3. The Buy Back: a) If the delta of either short option 18, buy back some of the short options b) If the delta of the short option returns to 15, sell options to recreate the spreads c) If the delta of either short option hits 30, close the spreads on that side and sell the extra long option(s) 4. The Long Hedge: a) If the delta of either short option 18, buy long options at the short strike in the next month b) If the delta of the short option returns to 15, sell the long option(s) c) If the delta of either short option hits 30, close the spreads on that side and sell the long option(s) 5. Rolling Spreads: a) When you close all of the spreads on a side, you may choose to roll up or down to continue the trade

14 Risk Management For The Iron Condor Adjustment Techniques The 200% Rule: Simple and easy to use A very conservative adjustment Downside is being frequently stopped out of trades The Closing Spreads Adjustment: Reduces one s potential loss Strong delta impact Minimal theta damage The Buy Back Adjustment: Flattens the R/R curve Requires less capital than the Long Hedge Smaller delta impact Worst theta damage The Long Hedge Adjustment: Flattens the R/R curve best Strong delta impact Moderate theta damage Increases the capital at risk

15 Risk Management For The Iron Condor Adjustment Techniques When making adjustments to your condor position, try to reduce delta without reducing theta too much. If the proposed adjustment causes theta to go negative, then close the position. If using the Buy Back or Long Hedge adjustments, watch the near term risk/reward curve; we want to flatten the slope so that additional movement of the index against us does not hurt us too much. When your adjustment has played out and you close the spreads on that side, you may roll those spreads up or down to continue the trade. You may also want to consider rolling the spreads on the good side. But this is increasing your risk. Some traders increase the number of contracts when they roll the spreads to recover the loss of closing; but beware of this tactic you are increasing the capital at risk. The key to success in trading the iron condor is managing your risk. If you are careful to minimize your losses, your gains will come.

16 Risk Management For The Iron Condor Using the Greeks Delta measures the risk of your position to a price move, e.g., if my position delta = $125 and the index increases by $12 tomorrow, my position will lose $1,500. Therefore, keep delta small; I watch the theta/delta ratio more than the absolute value of delta. Your adjustment criteria will function to keep you within some delta limits, or could use position delta as our adjustment trigger. The positive theta value measures the beneficial effect of time decay on our position. Be careful that your adjustments do not remove too much theta. If theta ever goes negative, close the trade. Watch the ratio of theta to delta. Ratios > 2:1 are good (the higher, the better). When the theta/delta ratio is approximately 1:1, this is dangerous ground. May have to close or roll spreads soon.

17 Back-Testing Adjustment Techniques 2/5/10: Mar RUT 510/520 and 650/660 iron condor with credit = $2,800 on 20 contracts Adjustment trigger: when the delta of either short option > 16 2/12/10: delta of the 650 call = 17; closing spreads, buy back and long hedge adjustments triggered 2/16/10: 200% rule triggered 3/1/10: all call spreads closed; puts allowed to expire worthless. All adjustments held loss to one month s gains Date Adjustment New Delta 2/12/1 0 2/12/1 0 2/12/1 0 2/16/1 0 Closing Spreads % Change New Theta %Change Net G/L $54 44% +$78 26% $2,080 Buy Back $62 35% +$76 28% $2,750 Long Hedge $45 53% +$77 27% $2, % Rule n/a n/a $700

18 Back-Testing Adjustment Techniques 7/8/09: Aug RUT 390/400 and 550/560 iron condor with credit = $2,960 on 20 contracts Adjustment trigger: when the delta of either short option > 16 7/15/09: delta of the 550 call = 22; closing spreads, buy back and long hedge adjustments triggered 7/15/09: 200% rule triggered 7/23/09: all call spreads closed; puts allowed to expire worthless. All adjustments held loss to one month s gains (on average) Date Adjustment New Delta 7/15/0 9 7/15/0 9 7/15/0 9 7/15/0 9 Closing Spreads % Change New Theta %Change Net G/L $71 39% +$64 26% $3,400 Buy Back $72 38% +$53 39% $3,270 Long Hedge $56 52% +$57 34% $2, % Rule n/a n/a $560

19 Back-Testing Adjustment Techniques 9/2/08: Oct RUT 660/670 and 810/820 iron condor with credit = $5,200 on 20 contracts Adjustment trigger: when the delta of either short option > 16 9/4/08: delta of the 670 put = 23; closing spreads, buy back and long hedge adjustments triggered 9/15/08: 200% rule triggered 9/15/08: all put spreads closed; calls allowed to expire worthless. All adjustments held loss to one month s gains Date Adjustment New Delta 9/4/08 Closing Spreads % Change New Theta %Change Net G/L +$9 75% +$75 18% $1,301 9/4/08 Buy Back $10 128% +$39 58% +$580 9/4/08 Long Hedge $20 156% +$48 48% +$920 9/15/ % Rule n/a n/a $1,000

20 Back-Testing Adjustment Techniques 3/23/11: May RUT 680/690 and 890/900 iron condor with credit = $3,240 on 20 contracts Adjustment trigger: when the delta of either short option > 16 3/30/11: delta of the 890 call = 20; closing spreads, buy back and long hedge adjustments triggered 3/31/11: 200% rule triggered 4/11/11: delta of the 890 calls = 13; 890/900 call spreads re established in buy back; long hedge options sold. 5/21/11: all remaining options expire worthless. When the market runs and then pulls back, the 200% Rule gets us out early, but without a salvage opportunity. Date Adjustment New Delta 3/30/1 1 3/30/1 1 3/30/1 1 3/31/1 1 Closing Spreads % Change New Theta %Change Net G/L $60 34% +$63 23% +$2,070 Buy Back $51 44% +$51 38% +$2,700 Long Hedge $37 55% +$50 39% +$2, % Rule n/a n/a $860

21 Back-Testing Adjustment Techniques RUT May 680/690 and 890/900 Iron Condor on 4/5/11 Adjusted Here Results of flattened R/R curve On 3/30: $1,260 On 4/5: $1,660 Long hedge buys us time for a possible pull back

22 Back-Testing Adjustment Techniques The 200% rule is simple and usually gets you out of the trade early for a minimum loss. The Long Hedge decreases delta the most with less theta damage. The Buy Back causes the most theta damage. The Buy Back and Long Hedge adjustments allow you to salvage a trade. The Long Hedge requires more capital to be put at risk. All of these adjustments accomplish the key objective: minimize the losses in the bad months so you can be profitable in the long term.

23 Develop the Iron Condor Trading Plan 1. Develop and follow a consistent trade entry process. 2. Immediately after establishing the position, enter the stop loss order with the broker. 3. Write down the key points of your trading plan: What is the stop loss price trigger? I will adjust at what point? What is the specific measure? What adjustment will I use? Is there a time stop? Is there a profit level at which I will close the position? If I close the spreads on one side: a) Will I roll those spreads up or down? b) Will I increase the number of contracts to cover the debit? c) Will I roll the good spreads at the same time?

24 Summary The iron condor: Is an excellent income generating trading strategy Doesn t require you to predict where the market is going But risk management is crucial for long term success

25 Would You Like To Learn More? Dr. Duke s Daily Blog (free) Private and Group Coaching Classes Dr. Duke s Trading Group, $49/mo Flying With The Condor Trading Service, $149/mo Auto Trading also available For more information: Dr.Duke@DrDukeOptions.com 25