Iron Condor Adjustments – A Detailed Explanation

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In this lesson we demonstrate a few adjustment ideas for the popular option spread known as the Iron Condor. In this conversation we explore the Vega and Vanna positioning of this trade and how the adjustments effect the Greeks when they are made.

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Iron Condor Adjustments   A Detailed Explanation

Video Transcript

Hello everybody! We’re getting down to the last class on the iron condor and before you finish I hope that you been able to pick up some new trading tips and have gained some insight from my experience with this particular trade and studying options in the Greeks from such a long time. I know everybody has a different perspective on the trade and I have mine and so. Hopefully, I’ve been able to help you in some way through watching this video series.

The last thing we’re going to talk about are some of the possible adjustments if you do choose to take on this task of trading the iron condor. The previous lesson, I did point out the risk and I showed you how the theta is there but it’s not really a very strong component in the trade and when this market really moves around, it can possibly override the facts of the delta or the vega. Being aware of that then make sure that you understand those risks entirely before you actually dive into this type of strategy. But we’ll talk about when we’ve, later to this earlier in the class but we’ll talk some of these adjustment possibilities. I’ll draw a couple up here for you.

Let’s say I have my own comfort zone, where I feel comfortable, it would be somewhere in that range. I don’t like to be in a trade where I’m actually losing more than I could possibly make. Once I’m within a range where I could actually lose 10%, which would be kind of like this point, but that means if I can lose 10% at this 970, that means the 950 I’m already within the range because the Russell could move 10 to 20 points easily in a day. You have to be aware so like, if I get to this point here, I’m already kind of on guard because I know that within 1 day I could be to my 10% loss. When I start to get into that zone, which is going to be the uncomfortable zone, so you have your comfort zone and your uncomfortable zone, then you have to start to consider some adjustments.

For the call side, what happens to the Russell at least normally, I think the statistic show it’s like over 80% correlation. As the Russell goes up, I’ll just use an up arrow, then volatility or the RVX drops. It’s again, somewhere; I read on, statistically it’s over 80% of the time. That means that this side where we have some hedging going on here, we’re a little bit benefited from the negative vega position. When we do an adjustment on this side, then I may be aware of the vega position that you have and how your adjustments may change your vega position.

You also have to think about your buying power effect. If you start the trade large, like if you’re all in from the beginning, then most likely you’ll have to start to buy back this side. Let’s say you started with 10 contracts, you might buy back 2 and start to change it so it looks kind of like this and more thing, that traded into an unbalanced condor. As you pick this side up, it’ll help flatten this out. Currently, you have this kind of slope and then when you buy a couple of those back it’ll get flatter. You can sort of change your, like, the location of your frown. Now you’re back at the top of the center of the founder. But then you can get with us. If it goes back you can start to lose and so on. Again, it’s not like an easy trade by all means.

These are things to think about with the call side; at least you have the vega, the negative vega position. It helps you a little bit. But one thing to note coming down here, notice as you move to the right, your negative vega is actually decaying on you. It’s changing. Again, I don’t want to confuse you with all of the second order Greeks but this has to do with your vana and we’ll get more into detail into our course. But this is your vana position to where you’re going this way and all of sudden your vega on this is actually becoming more positive and that’s not good for the trade because it gives, I pointed out over here, as the Russell goes up then your volatility drops and we’ll really benefit from having negative vega but the vana positioning in the trade is actually changing the vega to a negative, to a little bit more positive number ‘cause it’s starting at -216 and then it’s going to a -64. The vana position in the condor on the call side doesn’t help the position, it hurts it. Be aware of that, it’s way too complex to get into how to adjust your vana and all that in this series. But just be aware, just to be able to point out.

If we’re to close out some of these, it’s going to take what kind of trade? If you’re starting off you have a credit spread over here, you can actually have to buy in some of those debit spreads. When we do that, let’s take a look at how’s that going to affect the trade. I’ll come down here and I’ll adjust that, let’s say, to 5 and then we’ll look at the graph again. Let’s, again, theoretically, hypothetically, let’s say we’re over here. So we do that adjustment and now notice our vega position just dropped, in a way it rose, but it was -60 something and now it’s -40 something. You notice as you go this way and you buy those debit spreads or take off the credits that it’s actually helping your delta position over here making it a little bit more flat but it’s, at the same time, it’s also taking away your vega hedge. It’s something to be aware of: the more that you kind of chop that down, you chop this down or you take it off, you’re hurting your volatility hedge on the call side but you’re helping the delta.

That’s a very common adjustment and in this class, it’s as Far as we’re going to get. I’ll just tell you, you know, I’m giving you insights so you can experiment on your own and try to figure out better ways. The pros to that is it’s definitely helping your delta. You’re getting this flatter, again, we’re talking like if we move over here we’re starting to get out of our comfort zone so we’re getting a little bit better delta position. We still may have a little bit of credit here at the top but we’re giving some back. At the same tie, it’s hurting your vega position a little bit because, again as I already told you, the RVX is going to drop about 80% of the time. The trade really benefits to have that negative vega over there but you’re starting to actually lose some of that hedge. It helps the delta but it hurts the vega. But overall, you know, you’re taking off the risk. You’re taking off some of the risk over here as it moves that way and that’s a very simple adjustment process that you can really consider.

Now, let’s talk about the other side of the trade. Of course, you could do the same thing on that side. Let’s first look at the same adjustment. Here’s a similar adjustment here and you can see same type of thing. As you’re getting in this area, you can start to take off the risk by buying back those credits and raising this side of the graph. When you do that, it’s going to lower this part down o you’re going to lose a little bit of your initial credit but at the same time, at least this way, because remember the discussion about thee volatility here. You have a little bit of a benefit on this side. So you have your puts over here and, again, it’s the Russell and it’ll be similar for the SPX and the NDX or IWM spy diamonds. As they go down, so Russell drops, then there’s an extremely high correlation that the IV or the RVX or the VIX, whatever, is going to rise. It’s actually a 100% correlation if it’s a pretty large move. If it’s like a 2% move in one day or a 3%, something like that, it’s like pretty much always, it’s really close to 100%. Any large move is definitely 100% but I’m not sure what the threshold is.

As we go this way, then it definitely moves us to raise up our vega to have a little bit more of positive vega and get rid of that negative vega. When you buy back the credits, you’re actually placing an order for a debit spread. Then it can help your vega position and in this case it’s okay. It doesn’t hurt your vega position like it does in the call side because of the directional, the inverse relationship between the Russell and the volatility. That’s how you can work on the put side. Again, if it continues down this way, you need to find your comfort zone. And then you can just keep chopping it down or taking it off and then if you go back this way, well you can always put them back down but as you’re making all of that adjustments then you’re usually losing some money and you’re moving the bar down lower and lower. And that’s typically what happens with this trade.

I’ll show you another, one other simple adjustment that will help you increase the vega a little bit more. Another thing you could do on the put side is you can buy some of the, instead of doing the whole debit spread, you could actually just buy some long contracts. So let’s look at maybe buying one extra put here and then we can look at the difference. Notice in this situation, and let’s look at maybe two. We showed the graph on the other one but let’s look at this one for a moment. Notice this one, if you just buy some of these extra puts, like out of the money, you could always but the inside but if you buy the outside, you’re adding some more positive van. Notice if you do this, then your leg here started to actually go up instead of flat like it is on this side. Then you’re creating an immediate risk curve that actually starts to curve up. You see the difference there between just buying some extra puts instead of the whole debit spread. it’s a little different reaction that you can have. But also notice how it affects the vega a little bit better. The other one, you can keep holding on your theta a little bit stronger. But this adjustment, it can actually shift your vegas into actually positive.

Depending on the market, like when you’re in a low volatility market like today and we’re at March of 2013. When the vols are so low, this could be a decent type of adjustment compared to the debit spread because you’re starting to create yourself a back ratio spread over here and there’s just a higher chance right now the volatility could go up. This would be an adjustment that would be more protective in nature in giving away some of the theta but going after a little bit more of the protection to the downside. That’s definitely another alternative. For the call side, you could do a similar thing but you would be adding a lot of the positive vega to the call side that’s why I was pretty much just showing the credit or the debit spread on the call side.

That’s about it for now. I hope you were able to pick up some new insight on trading the iron condor. If you do trade this, then I definitely wish you a lot of luck. It’s a pretty tough trade. Sometimes it works out really nicely and everything is great but it seems like by the time you get comfortable with it, then you find yourself kind of glued to the computer and then you get to the point where you want to learn something different and that’s really what I went through. So I tried this strategy for a few years and then I just kind of outgrew it and I developed the newer strategies that we teach in our course that really help free up my time and allow me to focus on actually developing this software and things like that so I don’t have to monitor all my positions all day long. But this is a great conversation and an excellent trade to learn from. To practice, I certainly recommend to paper trade it. I can’t really recommend to do the trade with real money but still great conversation and there’s so much to learn from this trade. I highly recommend paper trading it, trying out some of the knowledge you’ve learned in these lessons, doing some back testing and see if you can further your knowledge no this particular spread as well as others.

Thank you very much for watching the video series and I guess I’ll be signing off so this is Morris with San Jose Options. Thanks once again!