Iron Condor
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Iron Condor: Following is an excerpt taken from the The Complete Iron Condor Strategy Guide E-Book …
IRON CONDOR: How To Know When It’s Time to Exit or Adjust
The Iron Condor Option Trading Strategy is a great trade.
Its simple to understand, easy to put on, has a high probability of success, kick off a great yield that can provide monthly income, and most of the time they work out beautifully.
MOST of the time.
The downside is that the Iron Condors Risk / Reward ratio is terrible - especially when compared with other option trading strategies.
Even though they DO work out just fine MOST of the time – all it takes is that ONE time to completely drain my account and put me out of the game for good.
That is, unless I know how and when to properly manage and adjust them.
There are different types of Iron Condors – each with their own different risk /reward ratios.
However, for illustration purposes, I will be using the main Iron Condor I use on a regular basis. Its what I call the ‘Plain Vanilla’ version of the Iron Condor.
Here it is:
10 point strike wings on an index vehicle, about one and a half standard deviations away from current price, between 30 and 50 days away from expiration. 80% or higher probability.
Now, using the above Iron Condor example – I could expect to take in a credit of around 1.00 on an average month. My risk would be 9.00.
Or, if I were to put on the above trade using 10 contracts, I would bring in a credit of around $1000.00 and be risking $9000.00
I am risking $9000.00 to make $1000.00
This risk to reward is terrible.
The above trade has around an 80% chance of success.
It should work out fine 8 times out of 10.
It’s the OTHER 2 times I need to be worried about.
Lets say I did the above iron condor for a total of 10 months – and I did absolutely NOTHING to manage or adjust. I just let the probabilities play out.
Heres what could happen…
I profit $1000.00 for 8 months.
$1000.00 X 8 = $8000.00 PROFIT.
Not bad. That’s almost a 100% return.
But then the other 2 months lets say I lose my max risk: $9000.00.
$9000.00 X 2 = 18000.00 LOSS
$8000.00 PROFIT – $18000.00 LOSS = 10,000.00 LOSS
Ouch!
Okay – lets say I don’t lose my max risk. Lets cut it in half.
Lose $4500.00 X 2 = $9000.00 LOSS
$8000.00 PROFIT – $9000.00 LOSS = 1,000.00 LOSS
Obviously – in order for this option trading strategy to work, I need to have a plan to protect – and keep – the profits I generate during the 8 good months – from the losses that will occur (and they WILL occur, believe me) during the 2 months that will be bad.
So what is that plan?
I need to know how to properly manage / adjust.
But� FIRST – I need to know WHEN to adjust.
So when do I adjust?
Lets go back to those numbers…
If I win $1000.00 8 times out of ten – HOW MUCH can I afford to LOSE 2 times out of ten?
If I can afford – both financially and psychologically – to just go back to break even at the end of ten months of trading, then my answer would be around $4000.00 per trade.
I could afford to absorb a loss of $4000.00, 2 trades out of 10.
At the end of ten months, I could be back at square one.
I win $1000.00 8 times, I lose $4000.00 2 times = $0 PROFIT.
On the other hand, lets say I dont want to make any less then $5000.00 during a 10 month span – then the most I can afford to lose on a trade would be around $1500.00
I win $1000.00 8 times, I lose $1500.00 2 times = $5000.00 PROFIT
THIS makes much more sense to me.
In the above example, $1500.00 equals about 1 and 1/2� times my original credit – or my expected monthly profit for the 8 good months.
I find this a good gauge to work off of.
I may even tighten it up to 1 times my original credit. But NEVER more than 2 times my original credit.
Anything more than 2 times would cause me to risk losing too much for my total income goal - AND it would wind up taking me MORE than 2 winning months just to make up for the loss - which could be hard to deal with emotionally.
Anything less than 1 times my original credit, I feel I am not giving the trade enough room to breathe and do its thing.
What this does is change the Iron Condors terrible 9 to 1 Risk / Reward Ratio to a much more acceptable 2 to 1 – or 1 to 1 Ratio.
So – before I ever even put a trade on - I decide what that ratio - or max acceptable dollar loss number - will be.
I’ll call this my ‘Maximum Pain Number’. It’s the maximum amount of dollars I am willing to lose while in the trade. In the above example it was 1 1/2 of my orginal / average monthly credit intake - or $1500.00 Loss.
I believe most times this number wont be hit.
But when it does (and it eventually WILL, believe me) – that’s my cue its time to either get out of the trade entirely - or adjust.
AND ACTUALLY - if I’m going to adjust, I need to begin doing so BEFORE my maximum pain number is hit - to take into account slippage and in order to give the new ‘adjustment’ position some room to breathe. If I am going to adjust, I usually begin planning/doing so when I am just over 3/4 of the way to hitting my maximum pain number.
This way, by not letting my losses get out of control, I always know that worst case scenario (I take my Maximum Pain Number LOSS) - based on the probabilities - I should still be profitable at the end of ten months.
AND best case scenario (I successfully adjust) - I could pull out of a losing trade and make it profitable once more.
I feel this concept might be the MOST IMPORTANT part of the Iron Condor strategy to fully understand and follow - religiously.
I believe in a poor risk to reward yet high probability trade - like the 80% probability Iron Condor I do - if I can just keep my losses under control and NEVER allow them to exceed my Maximum Pain Number (in this example 1 to 2 times my average monthly credit intake) - in the long run I will be profitable.
I NEVER allow an Iron Condor Loss to exceed my predetermined MAXIMUM PAIN NUMBER!
Until next time, Good Trading!
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