Category: Approaches

0 DTE Option Trading

Many people are buying and selling options with zero days to expiration (0 DTE in option lingo). But is this a good idea? Are there strategies that actually work? Or is this just gambling? Well, like many things in options, it depends. There are strategies that have been successful with years of history, and we’ll dig in to discuss them.

In 2022, the option exchanges rolled out options on a few indexes that expire every day of the trading week. This has caused a frenzy of option trading by individuals who are trading a variety of expiration day strategies every day. Many people are buying and selling options with zero days to expiration (0 DTE in option lingo). But is this a good idea? Are there strategies that actually work? Or is this just gambling? Well, like many things in options, it depends. There are strategies that have been successful with years of history, and we’ll dig in to discuss them.

Over the past several years, the frequency of option expirations has increased dramatically, particularly for the major indexes, the S&P 500, the Nasdaq 100, and the Russell 2000. Initially, there were only monthly expirations that expired on the third Friday of the month. Options expiring every Friday were added several years ago, and Monday and Wednesday were added a few years back, and finally in 2022, Tuesday and Thursday expirations were added. Trading volume has grown exponentially, and trading on options expiring within the next few days are now the majority of option trades. Clearly, expiration day trading is very popular.

I’ve been exploring trading strategies for expiration day for several years, going back to when we started having expirations available for Monday, Wednesday, and Friday. I’ve discovered that 0 DTE is not for everyone, can have many elements of gambling for many, but has a few strategies that have a positive expectancy of profit.

Things to know about 0 DTE

First off, 0 DTE requires a different mindset than longer duration trading. Profits and losses explode in minutes, making the importance of having a plan critical. Options in general require strategies and planning, but 0 DTE is significantly more volatile. So, for traders that can’t handle huge swings in value over very short periods, 0 DTE may not be a good place to go.

For traders that do trade 0 DTE, I highly recommend keeping a log of all trades to be able to evaluate whether the strategy being used is actually working. Some trades have fairly high win rates, but have big losses when they lose- a log will help a trader determine if the wins outweigh the losses over the long run. Also, keeping note of what went well and what went wrong will help a trader learn from success and failure. I can tell you that most traders that fail do so by not sticking to their own rules for managing risk.

One key consideration is the Pattern Day Trade Rule that applies to accounts with less than $25,000. Federal regulations prevent small accounts from opening and closing the same position the same day more than three times in any 7 day period. Doing so will place severe limits on the traders account. If you have an account with $25,000 or less, or even just slightly more, you need to be very aware of this rule and how it works before even thinking about 0 DTE trading or any short duration in and out trading strategies.

There are a number of ways to trade 0 DTE. Some traders try to get in and out, while others hold a trade to expiration at the close of the day. Some are net buyers of options, what I will call debit trades, while other are net sellers, or credit traders. I say “net” because many strategies involve trading spreads, buying one option and selling another, generally the more expensive being hedged, protected, or partially financed by the cheaper option.

When options are expiring at the end of the trading day, all the characteristics of options are sped up. From a data driven standpoint, there are three key Greeks to consider. The two most obvious are Theta and Gamma which essentially battle it out for the day. But Vega also plays a key role, as big moves spike up Implied Volatility and option’s premium, and calmness can sap premium almost as fast. With hours or even minutes until the options expire, the Greeks’ calculations stop meaning as much as the concepts behind them.

Options sellers are banking on Theta eating away the premium as the day progresses. If the option ends out of the money at the end of the day, it is worthless. On the other hand, Delta will end the day at either 100 or zero and is likely to swing huge amounts during the day, which is the measure of Gamma, the change of Delta. So option buyers are looking for options to get in the money and run way up in value.

Since we are talking about expiration, it is important to understand the implications, which vary depending on what underlying the option is based on. Remember, there are four types of underlying securities, and at expiration the differences really stand out when an option expires in the money. For stock and ETF options, in the money options are settled with shares, which may not be the best outcome for day trading. In addition, while expiration option trading ends at the closing bell, expired stock and ETF options can be exercised until midnight, so even options that end trading out of the money still might be exercised if market conditions change after hours from news or earnings impact. Index options are much more straightforward. Index options are cash settled based on the price of the index at the closing bell. Because of this, index options, like SPX, are generally the preferred trading vehicle for traders holding options through the closing bell. Futures options settle with futures contracts unless the futures contract is also expiring the same day. However, futures options are assigned based on the price at the closing bell, not any after hours moves, so a trader knows at the bell whether there will be an assignment or not. So switching between underlying types for 0 DTE trades in not a trivial decision.

As mentioned before, because 0 DTE trades can rapidly change in value, having a mechanical trading plan becomes critical for consistent success. Most traders that trade short/selling strategies use stop losses to keep losses from getting out of hand, and long/buying strategies use some type of trailing stops or rolls to protect winning positions and keep upside unlimited. There are a few trades where holding to expiration (no matter what happens) could be considered, but I think 0 DTE are best managed by active trading based on market action.

So let’s get to it. Let’s discuss some typical strategies, both from the long and short side, considering what it takes to be successful.

Selling options with 0 DTE

Most 0 DTE option sellers I know actually sell spreads to define risk. Selling naked options on expiration day simply requires too much capital and carries too much risk for the average trader. The width of the spread can vary based on the strategy or capital available to the trader, but wider spreads tend to decay faster than narrower spreads. These trades are expected to win a high probability of the time, but to avoid severe losses, stop losses are also critical parts of the strategy.

While there are many variations of these strategies- different times to enter and exit, trading one side or both sides (puts and/or calls), entering or exiting all at once or legging in based on the market, the core of the strategy is the same. Sellers want to sell at a relatively high premium and buy it back for less or even let it expire worthless. I’m going to focus in on two common strategies that I have had success with and 0 DTE trading friends have done successfully- a wide Iron Condor and an Iron Fly. For discussion, let’s assume that we are selling spreads directly on the S&P 500 Index, ticker symbol SPX.

0 DTE Iron Condor

Iron Condors on expiration day seem to perform best way out of the money, selling options with 10 Delta or less and buying 30 to 100 points further out of the money. Greek calculations for 0 DTE can be flaky and vary widely, so many traders are more comfortable choosing strikes based on the premium available. For example, a trader may sell the lowest put strike that sells for over $1.00 or maybe over $1.50, and buy the put that sells for under $0.75 or $0.50. For perspective, you can estimate the expected move at any time in the day by adding the premium of the at the money put and at the money call. Generally, these strikes are between 1.5 and 2 times the expected move for the put being sold and another half expected move further for the put being bought as a hedge. So, it’s highly likely that the strikes will expire worthless.

Similarly, we do the same thing on the call side, selling a call and buying a higher strike call for less. If we choose similar Delta values, the premium for each call will be less, but the difference in premium may actually be more if we have the same width wings. It is a matter of preference as to whether to try to collect as much on the call side as the put side.

The risk vs reward for this set-up is the net premium difference between what was sold and what was bought and the difference between strikes. For example, if we sell a put for $1.50 and buy a put at a strike price 40 points lower for $0.70, we are risking 40 to make 0.80. Then, if our calls were sold for $1.20 and bought for $0.40, we have another 0.80 on another 35 wide spread. So in total we have 1.60, but still only 40 risk because the options can’t expire in the money on both sides. Actually, because the options are for a multiplier of 100, we risk $4000 to make $160. So, if all goes well, we make a 4% return on the capital needed in one day. Some traders sell slightly closer strikes to try to collect more premium, and others sell for less to improve probabilities.

While probabilities are fairly high that the strikes will end up out of the money, we never know for sure, so we have to protect our capital. Most traders I know use a 2x stop loss on each side. They limit their loss to twice the premium they collected on each side. So, if a put was sold for $1.50, losses are limited to $3.00 by entering a stop loss on the short put at $4.50. While a stop can be entered for the price of the spread, it isn’t recommended because during the day prices can vary in weird ways and stops can trigger on spreads when the price hasn’t really moved much. I’ve read numerous posts of traders who were frustrated by a stop that was executed when there position was in no danger because of a rogue quote. If possible, it’s best to have the stop trigger based on the bid price of the option if your broker allows it- for the same reason- to avoid bad quotes triggering a stop.

It can be frustrating when a stop triggers just as the underlying price hits the high or low of the day and reverses. A trader looks at this and thinks, “Gee, if I wouldn’t have triggered the stop, my option would have expired worthless. I took a 2x loss when I could have had a gain.” Unfortunately, a trader never knows when the price will reverse and when it will keep going. The goal is to stop our loss at 2x and not let it get to 10x or 20x. We can recover from small losses, losing all the capital of a spread trade can be devastating.

The Iron Condor is a 4 legged trade, so if one leg is stopped out, we still have three legs. On the side where the stop occurred, the long position will have gained value, although not as much as the short strike lost. We can hold the long strike in the event that price keeps moving, making the long strike more valuable. However, since the strike is likely still well out of the money, it is likely to expire worthless and probably is best to be closed out soon after the short strike stop occurs.

When we are stopped out on one side, it is even more likely that the opposite side will expire worthless. However, there is a small possibility that price action could reverse and move far enough to stop out the other side as well. For that reason, some traders will close out one side if the net premium has decayed 80 or 90% of the way while there is still a lot of time left in the day. The choice is take risk off the table, or hold out for that highly probable last 0.25%. Again, it’s personal preference.

So, let’s look at the various potential outcomes of our $1.60 Iron Condor:
1. most likely (~70%) both sides expire worthless $1.60 profit
2. sometimes (~25%) one side is stopped out and the other expires worthless ($3.00 loss on short stop, $0.20 gain on long, $0.80 profit on other side) $2.00 loss
3. rarely (~5%) both sides stopped out, assume no net gains from long strikes so $6.00 loss ($3.00 each side)
Adding all the probabilities together, we get an average return of 0.33 profit, or $33 on our $4000 capital. That’s just under 1% per day.

Can some traders do better? Yes, there are lots of variations that some traders believe give them a better advantage. But lots of traders do worse. Why? Because managing trades while sticking to a plan isn’t easy for most traders.

How can the trade be varied? Some traders enter the trade at different times in the day. They may enter at market open and again a few hours into the day. They may open on just one side based on technical indicators predicting movement in a certain direction. They may add based on one side based on market movement. They may have plans to add new positions when an old one is stopped out. Which variations work and which ones don’t? The probabilities are essentially the same but can be tweaked by collecting a little more or less in each trade.

Some may wonder why we wouldn’t just look at stopping out the whole Iron Condor when it loses twice the premium collected instead of managing each side separately. While it could be done that way, the challenge is that each of the legs of the trade are very dynamic in their values and the relationship between them changes dramatically during the course of the day. If the trade is opened early in the day, it is likely that by the final hour of the day only one position will have any meaningful value. Also, managing puts and calls separately allows traders to add and take away positions on either side independent of how they treat the other side.

On an ideal day for this trade where the market doesn’t move much after the Iron Condor position is opened, all the legs will decay proportionately and have little value left by the afternoon period a few hours before expiration. This is because expectations of the remaining move for the day will decrease and the price distance that was 1.5 times the expected move will become 3 to 4 times the remaining expected move. Since the probabilities are exponentially smaller of being tested, the premiums simply evaporate. One doesn’t have to wait to the very end to see the result.

Other days Iron Condor traders may see the price creep around moving toward one of their short strikes. Big moves early in the day can quickly lead to executing a stop, but the nerve-wracking position is the one is close to stopping out all day as the price moves ever closer to a strike price but not close enough to trigger a stop. For some traders this is stressful, for others fascinating. To avoid stress, many traders set their stops and go on about their day knowing that the market will decide whether the trade wins or loses.

Iron Fly 0 DTE trades

A completely different approach to capturing decay on expiration day is selling an Iron Butterfly or Iron Fly as it is more commonly called. The Iron Fly is created by selling an at the money call and an at the money put and buying protective wings outside the expected move of the day. The trade simulates a straddle, but defines the risk as the width of the wings to keep buying power reasonable. Most traders try to open these trades soon after the market opens and get out fairly soon, taking advantage of early morning premium decay as the market settles in.

As discussed earlier, the at the money put and call premium imply an expected move for the remainder of the life of the option. How big the expectation is varies from day to day. For example, on days when the Federal Reserve announces interest rate policy, the expected move is much higher than other days. Other anticipated news events can also trigger uncertainty about pricing changes to expect later in the day, driving premium higher. Other days, little news is expected and low premiums reflect that. So setting up this trade requires a review of prices to pick wing strikes that are appropriate.

Generally, most traders look for Iron Fly wings that are 1.5 to 2 times the implied or expected move. For example, if the total premium of the at the money put and call is $30, one might choose to buy puts and calls $50 away from the money. These should be fairly cheap compared to the at the money strikes. The idea is that there isn’t much decay left, these long options are simply protection from a sudden outsized move. An alternative is to use a set price for one or both of the longs, like $1 for the long call and buying the equidistant long put, which may cost slightly more due to pricing skew.

The most common management strategy I’ve seen for this trade is to set a win target and an offsetting stop loss, and let the odds play out. Iron Fly sellers pick either a percentage target or a dollar target for profit and typically set the stop loss at twice the win target. For example, one trader may target a profit of 5% of the premium, while another may target $1.50 profit every day. There’s logic for either approach, big values may hold value until the news event that is expected to move price, while low values may decay slowly. The key is that the bigger the target, the longer a trader is in the trade.

Why not go for it all and let the position expire? First of all, one short strike will definitely be in the money at expiration while the other short strike will be worthless. The day to day variation in results would be huge, perhaps making 50% return one day and losing 140% the next day. In addition, most studies I’ve seen on this approach suggest that this is a net losing trade over time.

The idea of getting in and getting out is that there are periods of time during the day, primarily at the open, when the level of uncertainty drops significantly in a matter of minutes or a few hours. Even with price movement, expected moves drop faster and the premium of the Iron Fly decays for a win.

In practice, the Iron Fly can tolerate a move of a few strikes up or down initially without stopping out. Early in the day the market often moves around searching for a price to stabilize on. The Iron Fly seller expects that movement to be small enough most days that a stop isn’t triggered and the settling price is close enough to the price where the trade started that the profit target can be achieved.

Setting a stop order or profit limit order is trickier with an Iron Fly than with the Iron Condor. The issue is that with the Iron Fly, a price move of the underlying generally impacts three of the four legs. One short goes into the money and the long on that side starts increasing in value, while the other short starts decreasing in value. The long on the untested side goes from low value to nearly worthless and isn’t a factor. A set and forget stop strategy would be to set a stop for the whole four legs, but triggers and fills can be inconsistent. Another approach is to watch the direction of price and set a stop for the three legs that are most impacted. Another is to set a mental stop and manually close if the price goes beyond your mental stop.

For example, let’s say we open an Iron Fly for $30 credit and target $1.50 profit. We can enter a limit buy to close order to buy the whole position back for $28.50. We could alternatively place a stop loss order at $33. Some brokers allow a bracket order that combines the two orders into one for a situation like this. If we want to watch and mentally manage the order, we may choose to only close the three legs that have meaningful value.

Time in the trade can vary from minutes to hours. Some days the price sticks right where the Iron Fly was sold and the price decays in 5-10 minutes. Other days, the price may grind away varying premium between the profit and stop targets for hours. Many traders set a time limit- if the trade doesn’t hit a stop or profit target in 2 hours, close it and move on.

Time to enter is a bit of a personal preference as well. Some traders try to enter within seconds of the market open when there is the absolute most premium available. Others wait five to fifteen minutes for the initial big move to stop. Some do just one of these trades a day, while others open several at different points in the day. Some avoid Federal Reserve days while others embrace them. There are advantages and disadvantages to each way of entering, but often it comes down to comfort of the trader with a chosen approach, the probabilities are similar.

Over time, the math is fairly simple with this trade. We need to win more than twice as often as we lose. The studies I’ve seen show this as a net winner. The other key is stay mechanical and respect identified stop values. Most people who fail at this trade do so by getting sloppy with their stops and hoping for prices to reverse while the loss multiplies. Discipline can’t be overstated.

Long Strategies for 0 DTE

Buying an option on expiration day requires a strategy that can overcome the rapid time decay of the option purchased. Since there are huge volumes being bought each day, there must be some validity to this approach.

Buy 0 DTE Straddle

One simple approach is to buy a straddle and hope for an outsized move. This is essentially the strategy discussed in the post on the 1 DTE Straddle I’ve written about separately, just done on expiration day. The difference is that at 1 DTE, there is overnight movement that may impact pricing, while once the 0 DTE trading day has started, we only have the day’s price movement to consider.

This strategy is essentially the opposite of the Iron Fly strategy and counts on movement of price to exceed time decay. Since risk is limited to the premium paid, there isn’t much value in selling wings, which would limit the upside of any move.

When would one open a 0 DTE straddle? Perhaps right at the open, looking to capture a big early morning move. Or just before a big announcement, like the Federal Reserve interest rate announcement or press conference. Or maybe at a point in the day where there is time left but the straddle is just very cheap and a small move will make it profitable.

The biggest challenge is deciding when to get out both for winning and losing positions. The position won’t expire worthless, so should there be a stop loss? When a position wins, when is the profit enough to justify the strategy over time? Since the trade has theoretical unlimited profit, shouldn’t we preserve that potential? Tough choices, so thinking through a plan ahead of time for the situation is critical.

My go-to plan is usually to roll in the money puts toward the current strike price when I can collect a significant percentage of the roll distance. Early in the day, I might roll my strikes $10 when I can collect $7. Later in the day I may do it if I can collect $8. The idea is to take some of my winnings off the table while allowing for additional movement to make more. I protect myself from a reversal wiping out my profit. I find this approach reduces the volatility of my win and loss amounts.

Jump on the Trend with a Long Option

Many traders like to use Technical Analysis to predict future movements of the market. They detect when a trend in one direction is starting and determine how long they expect it to last. A great way to take advantage is to buy a call when the market is trending up and sell it at the top before it has time to decay, or buy a put on a downtrend and sell it at the bottom.

Generally, the idea is to get in opportunistically and get out. Time is ticking against the option buyer on expiration day, so the buyer has to be right on direction and right on timing. If the trend is small or slow moving, premium will decay faster than the underlying price can increase it.

A typical strategy on an uptrend is to buy a call a few strikes out of the money. For SPX, this might cost $10 premium or $1000 for the contract. The Delta value might be 30, so that a $10 price move would net $300.

If the strike ends up in the money and is above 50 Delta, a roll to a higher strike should net at least half the distance of the roll. For example, one might roll up $10 for a $5 credit. Or wait to get further in the money where a roll up could net a higher percentage. Or just close the trade when technical analysis says that the move is approaching the top of the range.

The same basic strategy would work with puts on a downtrend. In either case, the market needs to move decidedly in the buyers favor for there to be a profit.

Time of day impacts premium pricing as well. Early in the day there is obviously more premium than late in the day. Buys earlier in the day can follow long all-day trends and make up for the high premium to get in. Late day buys can pay off quickly with a fairly small move in the direction of the trade. A trader has to be aware of the time left and manage accordingly.

The Binary Event

Often, the option premium and price movement of a day is greatly influenced by a single scheduled event. A piece of news, like an economic report, or a Federal Reserve rate announcement is often anticipated by the market with high option premium before the event and much lower premium after. These events are referred to as “binary,” in other words true or false, 1 or 0, good or bad. The impact of these events really have three outcomes for option traders- the market goes up, the market goes down, or the market basically doesn’t move. A trader doesn’t really know what the market will do, so how can we play one of these events.

A starting point might be to look at how much premium is elevated. Sometimes the market is expecting a big impact and sometimes a small one, and it often pays to be contrarian in regards to expected impact. How do we know if the premium is high or low? It takes only a few weeks of watching premium prices to grasp whether premium is higher or lower than normal, and if the high premium for a binary event is extra high, or actually a bargain. If premium is lower than normal, it might be a good time to buy options, either a straddle, or an out of the money call or put in the direction that the market is most susceptible to a big move. If premium is extra high, selling an Iron Fly or Iron Condor might make more sense.

Binary events tend to behave in crazy ways. When the initial news comes out the market may rocket in one direction for a few minutes and then reverse back to where it started or even switch from a big move in one direction to another. Most market observers explain this by noting that the very first reaction is from robot traders that look for certain numbers or words in a statement and interpret them as bullish or bearish, triggering large buys or sells. Then a combination of cooler heads prevail, as the market digests the information and puts things in context. After a while, the market decides whether to take the event as a positive, negative or neutral for the near-term future.

I know many traders avoid binary events because of the unpredictability of market behavior. There simply isn’t a built in probability advantage to any specific trade, and big losses are a distinct possibility. For traders that do like these trades, a plan for managing the trade is critical, when to get in, and a plan to hold, fold, or roll depending on the behavior of the market.

Conclusion

0 DTE trades are extremely popular now that they are available every trading day. However, that doesn’t mean that they are an easy way to make money. In many ways, they are the closest option trade to gambling that there is available. Gaining an edge requires developing and following a plan that accounts for both the potential movement of the market and decay of options. For traders that regularly trade 0 DTE options, it is critical to track all trades to make sure that the strategies used actually average a positive return over time.

I’m actually not a big fan of 0 DTE. For me it is too much drama with too little edge. The rest of this site is dedicated to other strategies that I prefer. But for traders that have the wits and discipline to trade 0 DTE, all I can say is “best wishes!”

2022 Learnings

In 2022 I had a rough year in many ways, but also had many successes, and need to take away some lessons from it.

Moving into a new year, it is always good to review trading in the past year to see what can be learned. 2022 is no exception. I had a rough year in many ways, but also had many successes, and need to take away some lessons from it.

Overview

2022 was a bear market year. Coming into the year, I was trading some very aggressive, short-duration bullish options positions, despite lots of warnings of troubles on the horizon. This resulted in a big loss in January and February, until I adjusted to a more neutral approach. However, I got away from many core philosophies and still didn’t recover as well as I could have.

What didn’t work and why

My biggest losses came from three main strategic mistakes, one that was new to me, and two that I should have know better. The new one was selling short duration without an appropriate exit strategy. The old should have known better losers were trading options on individual stocks and selling calls too close to the money.

Short duration trades

In 2021 I rode the bull market with a trade that was perfect for an almost straight up market, the 7 DTE rolling put spread. I’ve written about it, and you can read about how great it worked. However, when the S&P 500 went down over 400 points in a month at the beginning of 2022, there was no defense with the strategy of rolling. Because I had so much success with selling 7 DTE put spreads, I was reluctant to admit that the strategy wouldn’t work. I wasn’t prepared for a move down that didn’t bounce back. We had plenty of warning that the Federal Reserve was going to stop pumping money into the economy and instead raise interest rates and reduce the money supply. But, I left myself exposed with lots of short duration put spreads as the year began.

I tried to fight the down moves with rolls and a variety of other tricks I’ve used over the years, but there really was no defense for short puts close to expiration in a plummeting market. As I’ve come to learn, in down markets puts can be underpriced for the risk, and short duration puts can actually be a good buy. The book “The Second Leg Down: Strategies for Profiting after a Market Sell-Off” by Hari Krishman details a number of studies to back this up.

I’ve heard from a number of people that they had success with short duration options even in 2022 by going a little further away from the current price and either holding or using stop losses to keep losses from getting too big. But, I didn’t do that. Later in the year I tried to get back into selling some short duration options and got burned again. My style of rolling is just not a good fit for short duration options.

So, as expiration approaches, there is a lot of time decay that is very tempting to take advantage of. The flip side is that to get that decay, options must be sold quite close to the current price making them susceptible to a sharp move. Short term move of several times the expected move are not uncommon, especially in a bear market. For me, the returns are not worth the risk. My temperament is just not set up for this kind of trade.

More time gives more forgiveness. Looking to reduce risk from short duration options, I’ve focused studying ways to get the most out of longer duration options. I’ve done additional research on optimal Delta for selling put spreads at different time durations to maximize Theta. I’ve also gotten back to waiting for down days to sell bullish put strategies.

The only short duration trade I’m currently doing is an opposite trade to most of my other strategies. I’m buying 1 DTE straddles, as I’ve written about in a previous post. So far, so good with that.

Selling Calls too Close to the Money

Even in a bear market, selling calls can be painful. In a bear market there are often large counter-trend rallies where calls with strike prices close to the money quickly end up in the money. Implied volatility on index options is almost always significant skewed to the downside, making calls cheaper than puts. Selling the lesser call premium tends to not be adequate for the risk of a big rally. When I combine selling calls close to the money and with fairly short duration, I set myself up to be whip-sawed back and forth, reacting to each move in ways that locks in losses each way.

Ideally, I want to have positions outside of the market moves, far enough away in time and price distance that day to day price changes have little impact on me and I can just wait for time decay to work my option prices down over time. Puts tend to have more strategies that can be profitable when selling than calls. If you don’t believe this, just try back testing short option strategies and see if you can find one where calls beat puts- I haven’t found one.

Selling Options on Individual Stocks

I’ve written a number of times about how indexes are much less likely to have extreme outsized moves than individual stocks. 2022 is a great reminder of that. Many formerly valuable stocks lost well over half their value during the year, and a number of them lost over 90% of their value. I was exposed to some of this mayhem when I sold puts well out of the money on a few that seemed like they couldn’t miss, but then did.

I completely botched a trade on a company that I really like. Generac makes back-up generators as well as systems that store and manage electricity generated from solar panels. With the electrical grid getting less reliable, people are in need of their products. So, to mix it up a bit, I sold at $20 wide put spread in the low 200s early in the year after the stock had fallen significantly and seemed to be on an upward trajectory. Despite all their success in the market, the stock slowly declined, and I found myself rolling my position down and out a few times. Then, I made the fateful decision to sell my long put of the spread and switch from a put spread with $20 risk, to a naked put with a strike price of $200, cash secured. I figured that the stock was surely at the bottom of its range, and I wouldn’t mind owning it if it dropped a little more. Then Generac announced that they were going to miss earnings substantially because of a lack of installers available to deliver and install their equipment at residences. Overnight the stock dropped 30% after previously losing over 20%. Before I knew it, I was stuck obligated to buy a $100 stock for $200. I tried to roll out, but there were no takers to make a trade. I was assigned the shares, losing $10,000 per contract on a trade that originally had a max loss of $2,000 per contract. Multiple bad ideas- individual stock risk, getting cute when tested, not accepting a loss and moving on.

I also sold puts on ARKK, the Ark Innovation ETF. It’s not an individual stock, but it is a volatile managed fund of a relatively small number of innovative companies. Again, I thought that we had seen the worst of the market drop, especially for this fund, and I sold cash secured puts in the middle of the year. Since then, the stock has fallen by half- I had about a 10% cushion to start, but that is long gone and now I have shares.

There are some others that weren’t that bad, but the conclusion is the same. Options on major indexes are much less likely to be hit by outsized moves, particularly if there is a decent amount of time until expiration and the strikes are well out of the money. That is one of my core mantras and I strayed at my own peril.

What went well

Fortunately, not everything went as badly as the trades described above. I re-discovered some strategies that I had stopped using that worked well, and started using some new strategies that I was either skeptical of or unaware of prior to putting them into practice.

Selling Long Duration Puts

I’ve sold puts well out of the money well out in time many times in the past, but the allure of big Theta from short duration started getting the best of me. Why sell at 6 weeks or 12 weeks when we can make bigger returns selling at one week? Well, lots of reasons. Short duration takes lots of effort and is much more stressful. It doesn’t take a big move to blow past strikes that have value less than a week until expiration, while positions outside of the expected move a month or more out in time are much less impacted.

With positions 4 to 6 weeks out or even more, we get more consistent results and can reduce volatility of the portfolio. When a big move happens, we can wait a few days to see if the move reverses before making any adjustments. Often it does and there is no reason to intervene.

I’ve found that I can still sell spreads with Delta values in the teens that are in their maximum percentage of decay weeks or even months before expiration. While the percentage return isn’t as high as short duration, it is more consistent and higher probability of being positive. It isn’t exciting, but that’s okay.

Put Ratio Trades

The most popular page on my site every month is my explanation of how I trade broken wing butterflies. For a while I got away from trading this, chasing some other “shiny object.” I re-started trading the strategy and got back to winning. I have been a little more opportunistic with this strategy, opening on down days to get my strikes lower with higher IV, but the trade is high probability with rapid decay. The way I trade it seems to be just far enough out in time to buffer it from the volatile weeks that have come along regularly in 2022.

I’ve also had good success with the other put ratio cousins of this trade, the broken wing condor (or 1-1-1-1), and the 1-1-2-2 trade. The common thread to each of these is that there are two competing spreads in each case. I start with a debit put spread, typically where I buy a 25 Delta put and sell a 20 Delta call which acts as protection for a higher priced and wider credit put spread at lower delta values. The wider and lower Delta valued credit spreads decay faster than the narrow debit spread, and often switch from a negative value overall position when sold to a positive value position that I can sell to close prior to expiration. This happens when the wide credit spread decays to the point that it has less value than the narrower debit spread. So, I often collect cash when I open and collect cash when I close these.

Finally, I’m seeing success in the naked versions of these trades as well. Instead of having two spreads, I sometimes skip using the low long leg of the credit spread and go with selling a naked put. This leaves me with a debit spread protecting a naked put or two below it. So I end up with 1-1-1 or 1-1-2 versions of the above trades- true ratio spreads. These have undefined risk to the downside unless cash secured, and I trade them on margin. That ties in nicely with some of my other take-aways.

Using Futures Options to Pump Up Returns

After avoiding futures for many years, I’ve really become fond of them. I avoided them because I didn’t see the strategic value of buying or selling futures contracts on an index or commodity. I was also scared by the risk of aggressive use of SPAN margin. But what I’ve found is that futures options in particular allow me to sell high probability positions for very low amounts of capital, and then allow me to buy or sell actual futures contracts to use as a hedge and neutralize overall Delta. It can get complex very quickly and a trader has to be avoid building a house of cards that could collapse in a outsized market event. But when used with care, futures options and futures themselves provide valuable tools to increase returns.

I haven’t written much about the use of futures strategies on this site because I’m still working to distil the approaches into content that can be readily applied. Risk vs reward becomes much more significant with futures options, so risk management becomes a primary consideration in every trade and isn’t something to jump into without a comprehensive understanding.

All that said, I’m finding futures options allow me ways to magnify returns and also hedge my risks. I’ll be writing more in subsequent strategy discussions, but if you look at pages on four different underlying types and four levels of risk, there’s some initial content to consider. One specific hedge trade I’ve started using, the 1 DTE Straddle, came from my futures experience.

Selling Naked Futures Options

One place where I’ve found success with futures options is selling naked options well out of the money well out in time. Because of SPAN margin, these trades don’t require much capital. They also don’t move that much because of the long duration. I’m finding trades with lots of decay and really seeing the appeal of naked options. Long duration and low deltas cushion the positions from big day to day moves and give me plenty of warning to adjust when needed. While spreads have windows where they can be rolled for credit and other Delta values where they can’t, naked options can always be rolled out in time for credit. The issue is that some rolls are more lucrative than others.

So I finally see the flexibility and adjustability that naked options provide in defending against big price movements. The key is to manage size to keep risk reasonable.

Naked to me involves a variety of strategies from selling a single option, to selling the naked put ratio trades mentioned above. As I better define consistent management and hedging approaches to these trades, I’ll explain my naked strategies in more detail.

Using Research to Test Strategies

Finally, I’ve re-discovered the importance of doing my own research to understand trades I’m doing. I’ve shared many of my insights on this website, but I always have new ways to look at trade set-ups, impact of management, and understanding risk. I’ve written about the sources I use to research the market, and I still use the same primary approaches. I use current option tables, I do backtests, I analyze historic trends, and I model potential outcomes.

Sometimes it is easy to get caught up in what I’m doing every day and not stop and ask if the approaches I’m using at the moment are really valid. I don’t look to see if there is a better way. Research keeps me fresh, and often validates findings I’ve observed in the past, but strayed away from in my current trading. So, constantly looking at data from different strategies in different ways actually keeps my trading focused on approaches that work.

I also find that the biggest beneficiary of the studies I share is me. Writing things down to share makes me double check my work and get clearer as to what I’m doing. Sometimes in the course of providing data for a trading approach I’m doing; I realize that I could do better, and revise based on what the data says.

I also get a lot of inspiration from other sources- groups I’m a part of and sites I follow. My favorite source of inspiration continues to be TastyLive, which I often have playing in the background while I trade. I interact with a lot of other traders which also helps. I’ve written about the value of community in the past.

So my final thought is that I need to challenge myself to always keep learning and base my trading strategies focused on proven approaches with high probability of success and manageable risk.

Buy 1 DTE Straddle

I buy a 1 DTE straddle on indexes for two reasons. 1, It has a positive expectancy over time. 2. It is a hedge against short option positions

I’ve started buying 1 DTE straddles on the S&P 500 for two reasons. First, this straddle trade has a positive expectancy- over time it has made more than it has lost. Second, and perhaps more importantly, the straddle is a great hedge against my many short option positions further out in time. How I came to these observations and how I manage this trade are the topics of this discussion.

A straddle is buying a call and a put at the same strike price and same expiration. When traded at the money, it roughly represents the expected move of the underlying for that time period. So, buying a 1 DTE straddle for $30 would mean that the market expects the SPX index to move around $30 plus or minus the next day. Buying a straddle means the buyer is hoping the market will move more than expected, and the seller is hoping the market will move less than expected.

Normally, I only sell options or spreads for a net credit and wait for the value to decay away for a profit. I mostly sell options with expiration dates weeks or even months out and a decent distance out of the money. Those trades have a high probability of profit. However, they also carry the risk that an extended big move in the market could result in a big loss.

Profiting from the trade outright

With 2022 being a bear market year, I have studied more about ways to manage positions in downturns. One interesting book on the topic is “The Second Leg Down: Strategies for Profitting after a Market Sell-Off” by Hari P. Krishnan. One observation in the book is that options under 7 DTE tend to be undervalued and have good potential to make money or protect a portfolio in the midst of a downturn. The book has numerous interesting strategies to help navigate downturns. I’ve toyed with a few of these, but I couldn’t find a trade strategy that achieved the type of positive outcome I was looking for.

As I’ve noted elsewhere, I’m a big fan of the TastyLive.com broadcast site. Just before Christmas at the end of 2022, Jermal Chandler interviewed Dr. Russell Rhoads on his Engineering the Trade show. The topic was short duration options that are now quite prevalent. One key point is how very short duration at the money (ATM) straddles on SPX (S&P 500 Index) and NDX (Nasdaq 100 Index) are actually underpriced. If you buy a 1 DTE straddle at the end of the day and hold to expiration the next, it has averaged a positive return in the past year, which says these options are actually undervalued, counter to what we would normally expect.

I’ve added the presentation, which is broad ranging on the topic here:
(Press the red play button to watch)

Starting at about 8:00 into this video, the discussion starts on how 1 DTE premium has been underpriced for the past year.

I decided to try buying these as a one lot and so far I’m seeing this work out with a positive return. And this has been during a few mild weeks with little movement. The straddle never expires worthless as one side is always in the money- it’s just a matter of how much. I have generally closed these early, selling the side that is in the money when I can for more than I paid for the straddle. So far, this has worked better than holding to expiration because we have been range-bound. When we get into a trending market one way or the other, it will likely make more sense to hold.

The hedging benefit

However, I found a second benefit that may be much bigger. I decided to switch over and buy a 1 DTE /ES (S&P 500 mini futures) option straddle in an account with a lot of short futures options for a 1 DTE straddle- not sure why I even decided to other than the size is half as much. Anyway, I noticed that buying one straddle greatly increased my buying power by over $27K, which didn’t make sense initially because I was paying a debit and I thought that would reduce buying power by what I paid-about $1500 ($30 x 50 multiplier).

It turns out that the futures SPAN margin saw this as a big risk reduction. (For more on futures options and margin, see the webpage on different option underlyings.) Buying the /ES straddle gives me 500 equivalent shares of SPY notional in either direction of price movement. This will counter several short options out in time and out of the money. So essentially it is a shock absorber for my futures positions.

Many traders are nervous about the overnight risk of holding short options, due the possibility of a big gap in price overnight. Having a hedge like this can help mitigate that risk.

The biggest question is how big of a position is appropriate? Well, keep in mind that if the market doesn’t move at all and closes very close to the strikes of the straddle, the straddle will be nearly a complete loss. So the size of the trade should be a very small portion of a portfolio, as this trade will be very volatile, going from losing nearly 100% some days to returning several multiples of the initial value others. Think of it as a volatile side trade that can reduce volatility of a much larger set of positions. Kind of a contradiction.

Futures make this obvious, but the same logic applies to any portfolio full of short option premium. The S&P 500 and Nasdaq 100 indexes have a variety of options underlyings at different costs to allow traders of virtually all account sizes to utilize this kind of trading strategy.

So, I think there are a number of angles to pursue this from a trading and portfolio management tool. I thought it might make a good topic to discuss with this group- the gamma of this trade provides a lot of protection at a low cost, essentially free over time, although likely to have periods of loss.

Essentially, I look at it as a great hedge that can still make money on its own. If I have out of the money longer-dated short options in a portfolio, they will make money on calm days, and the 1 DTE straddle will make money on turbulent days. And if I manage each correctly, each should make money over time.

Managing the Straddle

I tend to buy these straddles right at the close the day before expiration. On Fridays, I buy Monday’s expiration, which surprisingly often is about the same price as other days. I’ve tried buying two days out and laddering, but that gets to be a lot to keep track of if I try to manage early, so I prefer to buy at the money at the close for just one day.

A 1 DTE straddle benefits from big moves on expiration day
Big moves by the end of the day can be very profitable for a 1 DTE straddle, so so can smaller moves overnight or early in the day that allow a trader to manage the trade or take some risk off the table.

Like all option trades, there’s always a management choice of hold, fold, or roll. This trade has all those elements to choose from.

As mentioned earlier, probably the simplest choice is to just hold to expiration. The odds are that over time, the trade will win more than lose. However, this may mean that we have a day where a trade is profitable at some point in the day, but then moves back toward the strike price and loses money. Finding a way to beat simple holding takes a lot of effort and since we know the worst case scenario is losing all the premium we paid, we may want to just let it ride. On days where the market is on the move, this can be very lucrative, as the max move may be at the close of the day. Think of holding as the default way to manage the long straddle.

I’ve found that calm days in a range-bound environment are ones where prices explore support and resistance levels before returning to a point closer the strike price. As the day goes on and price stays constrained, I look for a chance to sell one side of the straddle for a price more than I paid for the total. Earlier in the day, I feel like I can be greedy and wait for a big profit, but as the day goes on, I’m happy to get out for any profit. So, I’ll fold one side of the straddle for a profit when it doesn’t look like we are going to close at an extreme move. Occasionally, I might get to sell the other side if there is a late move in price to the other side of the strike price.

So, that’s hold and fold. How/why would I roll? Let’s say the market has moved a significant amount from the strike price, and I’d like to take a profit but still have the possibility of taking advantage of additional movement. I can roll my in the money option toward the current price for most of the distance rolled. For example, let’s say the price of SPX is down 40 points midway through the day and I’m worried it might come back up, but want to also benefit if it keeps going down. I could roll down my put 20 points and maybe collect $18, locking in 90% of the move. If the price keeps moving, I could keep rolling. The downside of this is that I don’t get 100% of the move, and I’m paying commissions on each roll, and these trades will be pattern day trades if I close the new position before the end of the day. I also will have a hard time locking into a profit that is beyond my purchase price, unless I have a really big move. But rolling is a choice to consider for some traders and some accounts.

Conclusion

So, there you have it. A volatile option buying strategy one day before expiration that averages a profit and can hedge other positions in a portfolio. I have found expiration trades stressful in the past, but this one has been much less stressful to me despite the volatile nature of it.

Best Delta for Rolling Put Spreads

I’ve noticed some put spread rolls collect more credit than others. This study shows that there is an ideal Delta for rolling put spreads

After trading put spreads for several years, I’ve noticed that some rolls collect a lot of premium credit, and others are a struggle to collect any credit at all. I decided to study this to see if I could find if there is a “sweet spot” for rolling put spreads based on Delta values. I’m happy to report that there is.

It’s no secret that if a put spread gets fully in the money, it is impossible to roll to the same strikes in a later expiration for a credit. But when a spread is out of the money, I’ve seen a wide variation in credit when I roll, and I’ve often thought that there must be a best place to make a roll to get the most credit. If there is, I could devise a strategy to take advantage. So, I copied some option tables into Excel and pivoted the data a few different ways to figure out how premium from rolls vary.

Before jumping into the study, let’s discuss what rolling option spreads involves and why we might do it when a spread is out of the money. Rolling is one three ways to manage an exisitng trade- I covered the three ways in the page on managing by holding, folding, or rolling. One of my common management techniques is to continuously roll a position- I let the short spread decay in value, then roll it out in time to get more premium, and then let it decay all over again. Just repeat over and over. For those not familiar with the roll concept, rolling means executing a trade where an existing position is closed and a new position is opened all at once in one trade. The new options may be at the same strikes, which would be rolling “out,” or the strikes may be higher, which would be rolling “up and out,” or we could also roll “down and out.” Rolling a credit put spread that is out of the money out to the same strikes, will almost certainly generate a credit, which is the goal of this strategy. I’ve discussed this -approach in detail in other pages of this website, including roll for 6 percent a week, goals for rolling Iron Condors, the power of rolling Iron Condors, and rolling losing positions.

Rolling Spreads in the Study

I looked at a lot of different combinations of rolls, different durations, different times between durations, and I saw similar results. In the interest of keeping this write-up from getting lengthy, I’m choosing to just show a few examples.

7-10 DTE Roll

While I don’t trade a lot of options with durations of a week or less, I thought it would be good to look at this timeframe as the lower end of timeframes where we get outside of current week expirations. The following chart shows all the available combinations of 40 wide 7 days to expiration (DTE) SPX credit spreads rolling to the same strikes at 10 DTE.

Rolling out from 7 DTE to 10 DTE has the best credit when the 7 DTE short strike is between 10 and 20 Delta. Note that the Theta peaks at a slightly higher Delta.
Rolling out from 7 DTE to 10 DTE has the best credit when the 7 DTE short strike is between 10 and 20 Delta. Note that the Theta peaks at a slightly higher Delta.

I’ve shown the net credit for each roll combination, as well as the raw Theta difference for each existing 7 DTE 40 point wide spread. The x-axis is the Delta of each 7 DTE spread. The roll credit is shown on the left axis, and the net Theta is shown on the right axis. Looking at a peak value of approximately $1.20 per roll, we would collect 3% of the 40 wide spread. Meanwhile, the peak Theta of around $0.45 per day would equate to 1.1% of the width. So, holding might get a similar daily return, but with increasing risk as expiration approaches, but a roll would allow us to collect 3% and still collect additional Theta over again. Actually, that’s double counting. The Theta would just be the decay of the premium we are collecting. Just a few ways to think about the transaction. We can also look at actual strike prices and look at a few other values.

This graph shows roll credit plus Delta and Theta values for the positions
This graph shows roll credit plus Delta and Theta values for the positions

On this next chart, I’ve shown the x-axis as the strike price of the short put of the credit put spread. I’ve also added the Delta values of each of the puts for the 7 DTE spread as well as the Delta of spread position. In addition to the net Theta of the 7 DTE spread, I added the net Theta of the 10 DTE spread that we would roll to. So, each strike price on the x-axis is tied to six different pieces of data for a potential spread roll. While the roll premium and net Theta of the 7 DTE spread is the same information as the previous graph, the additional data can add more context.

Note that the Theta values of the longer duration spreads are generally lower than shorter. That should be expected. More time means slower decay. But the new spread will have a slightly higher Delta, which moves the peak of the Theta curve down in strike prices, because as we have seen in our study on maximizing Theta for a put spread, Theta tends to max out at short Deltas around 20, which will be further down after a roll. So, note from the chart that the maximum roll premium lines up for the most part with the maximum Theta of the spread we are rolling to.

The take-away from the Delta information on the chart is that as we get closer to the current price and have higher Deltas, the net Delta goes up, and the value of rolls goes down. Also, if Delta gets too low, there isn’t as much premium available in a roll to the same strike prices. I picked out the Delta values of the spread with the highest roll value, and it is approximately 14 Delta on the short strike and 8 Delta on the long strike.

So, the ideal scenario is to start with Deltas of around 20/13 and see the positions decay and Deltas to decline to 14/8, and then roll out to new strikes with Deltas of 20/13. If only the market would cooperate with our plan and let us do this all the time. Obviously, the market isn’t that consistent, so we have to manage in other ways.

Sometimes, we may want to roll down and out. Let’s look at the premium for 40 wide spreads and see what is possible if we want to collect a credit.

Looking at the premium differences, we can see opportunity to roll down at some strikes more than others.
Looking at the premium differences, we can see opportunity to roll down at some strikes more than others.

On the above chart, I have plotted the premium value of 40 wide put spreads at 7 and 10 DTE, along with the premium collected to roll out to the same strikes. I’ve also highlighted possible rolls down and out. The highest strike where it is possible to roll down a strike and collect a credit is to go from 3920/3880 at 7 DTE to 3915/3875 for a 10 cent credit. When a spread is being tested, every bit helps, but clearly this roll doesn’t give the position much more breathing room. On the other hand, if we had the 3800/3760 spread, we could roll down 25 points to 3775/3735 for no cost. So, again it pays to stay away from being tested. But at this short of timeframe, it doesn’t take much of a move to get a spread in trouble, so let’s look at how a little longer duration would fare.

21-42 DTE

Let’s look at an example that generally matches up with the common strategy often associated with TastyLive.com. Interestingly, values peak out at about the same place based on Delta.

This example shows rolling from 21 DTE to 42 DTE, essentially doubling the time until expiration.
This example shows rolling from 21 DTE to 42 DTE, essentially doubling the time until expiration.

Again, the best premium for a roll is in the mid to low teen values of the Delta value of the short strike of the 21 DTE spread. Here we are collecting just over $6.00 to roll our 100-wide put spread out to 42 DTE. In that case, we would be collecting an additional 6% of the width of the spread. The 21 DTE spread would be decaying about $0.30 per day, so the roll allows us to collect around 21 days of decay in cash.

Notice that the observations we made on the 7-10 DTE roll hold almost exactly the same on the 21-42 DTE roll, even though we have much higher time to expiration, wider spreads, and proportionally longer rolls. One difference to note is that amount of premium and Theta are much less on a daily basis, but that should be expected as daily decay for similar Deltas gets higher as expiration approaches.

This graph shows the premium levels of 100 point wide spreads at 21 and 42 DTE, as well as the premium collected to roll out at the same strikes.

Another key difference is the distance that our strikes can be from the current price, giving the position more wiggle room for price changes. The above chart shows the premium of the various spreads available at 21 and 42 DTE. Notice that the lower strikes approach zero value while the spreads at higher strikes approach 100, which is the width of the spread and would be maximum loss for a credit spread at expiration. With spreads, the closer expiration gets the more of an S-shape we get when charting the premium. Since we are selling the spread, we’d like to see the value decay, either by staying out of the money as time goes by, or seeing the price go up, which would shift all the lines to the right on the chart.

What if we want to roll down to lower strikes when rolling out from 21 to 42 days? Let’s look at what would be available by zooming in a bit to the chart above to the area where there is credit available to roll out.

In this chart, we can see that the further we are out of the money, the more we can roll down for a credit. Once a spread is in the money, the opportunity to collect a credit is gone.
In this chart, we can see that the further we are out of the money, the more we can roll down for a credit. Once a spread is in the money, the opportunity to collect a credit is gone.

With plenty of time to expiration, we can roll out for nice credit or roll down quite a ways for some credit. For example, in the chart above, the 3700/3600 spread could be rolled down 150 points to 3550/3450 for 20 cents credit or rolled to the same strikes for $7.50 credit. The closer our strikes are to the money, the less credit we get to roll and the less we can roll down for a credit. And as we’ve seen, if our strikes are in the money, we would have to pay a debit to roll out. Having more time allows us to sell spreads that are much further away from the money and be able to roll out and away much easier than spreads that are closer to expiration.

42-49 DTE

One last example for contrast, we will roll out a relatively short amount of time from a 42 DTE put spread.

Again, we compare rolls at different Delta values, along with the net Theta of our current position.
Again, we compare rolls at different Delta values, along with the net Theta of our current position.

So, this roll is from 6 weeks to 7 weeks until duration. However, our previous observations generally hold. The peak premium is at a bit higher Delta, in the high teens. This makes sense if we consider that we are only rolling out for about 16% more time, so our new spreads will have peak Theta much closer to our old spreads. This would point to the idea that the best roll is the roll that gets us to a new spread with a short strike Delta of around 20.

Again, our max roll amount equates roughly to the daily Theta multiplied by the number of days we are rolling out.

How to Use This Information

Readers may wonder, what good is this? A trader can’t really control where prices move to, so the Delta value is not really controllable by a trader. This is somewhat true, but prices do move up and down all the time, and so if I’m looking to roll out to get to a timeframe that has less volatility, I might be able to enter a limit order that seeks to collect close to the maximum roll credit possible. Often, I’m not in a big hurry to roll, so I can check out where the maximum should be and set up an order for 90% of that amount and go about my business. If it doesn’t execute after a day or maybe even a week depending on the timeframe of the position, I could change the order to something less lucrative.

Another way to look at this data is to realize that if my position has both strikes down in the single digits of Delta, I’ll likely want to roll up my strikes when I roll out to get to optimal Theta. On the other hand, if my position has strikes with Deltas in the twenties or thirties, I may want to try to roll down and out, and hopefully still collect a credit.

If my position has gotten even closer to the money or even into the money, I’m going to have trouble rolling for a credit, and I have some tough decisions to make. I need to consider all my choices: holding, folding, or rolling. If I’m deep in the money I might consider taking desperate measures. It all comes down to risk appetite and an overall plan of action. It’s best to have a plan for all possibilities ahead of time, and not try to figure it out when times get tough.

Final Take-aways on rolling put spreads

My thought process for looking into this was to find optimal credits for rolling spreads, so I could devise strategies to improve my results. After studying this, I was excited to find an answer that makes sense. Deltas in the teens for the short strike of the spread are ideal for rolling. The further out in time the roll is as a ratio of current DTE to future DTE, the lower the delta of the current spread for best credit from the roll.

A good starting point for estimating the best credit is to take current Theta of the spread and multiply by the number of days that are being rolled out. So, if Theta is 20 cents and the roll is going out 5 days beyond the existing spread, the best credit will be around $1.00.

Finally, realize that this study was for put spreads, not call spreads, iron condors, or naked options. Spreads have unique characteristics compared to naked positions, and their behavior does not translate over. So, I only apply this information to rolling put spreads.

I am studying how naked puts best roll as well and plan to do a write up in the future on the topic.

Best Delta for Put Spreads?

Selling put spreads is a fairly simple trade that can generate one of the highest returns on capital of all option trades. The trade is fairly flexible to adjust for higher returns with higher risk, or more consistent, but lower returns with lower risk based on choice of duration until expiration. While I’ve written about put spreads in detail before, I recently did some additional studies to see if my earlier conclusions on best Delta values for entry were still accurate.

I’ve noticed from Google Analytics that many traders are searching for the answer to “What are the best Delta values to use for selling put spreads?” or some variation. While I think my earlier webpage on put spreads covers that fairly well, there have been enough people question me, and enough questions pop up from my own trading to cause me to go back and dig into the data a little deeper. The quick answer that I usually give to anyone on Delta values for a put spread is to sell the put strike with a 20 Delta value and buy the strike with a 13 Delta value. This optimizes position Theta, and also provides a nice, relatively high probability of profit. But is that answer true if the expiration timeframe is short, like just a few days, or really long, like several months?

Readers likely have a hint at results from the featured chart image at the top of this post. I decided to look at all the possible Theta values of short put spreads at different strikes. For the first example, I looked at 7 days to expiration (DTE), and chose 40 point wide spreads on SPX, the S&P 500 index. SPX is generally my go to choice for options on the S&P 500, but as I wrote in another post, there are lots of different ways to trade options on the S&P 500. So, the graph shows the Theta value relative to the Delta value of the short put of the spread of all possible 40 wide put spreads, expiring 7 days from November 18, 2022. The chart shows a very smooth curve peaking around 22 Delta.

7 DTE Theta values of put spreads
This chart shows all possible short put spread combinations around the peak Theta values as a percentage of the spread width.

Here’s a slightly different way to look at the different Theta possibilities of 7 DTE put spreads. The horizontal axis is the long strike value, and the vertical axis is the short strike. The various values are color-coded, where the greener the cell, the higher the Theta value is as a percentage of the spread width, while yellow means lower Theta. As I’ve written elsewhere, this is one of my favorite ways to evaluate decay of a spread. I also drew boxes around all the values where the spread is 40 points wide- the points that are plotted on the earlier chart at the top of this post. If you zoom in on this green-yellow table, you can see that each cell is a percentage value, while the left and top lines show the strike prices and Delta values of each strike price. This table goes out much further than what I’m showing, but this is the part of the table where values are highest, and you can see the values are lower at the edges of this chart.

Note that delta values of between 5 and zero for the long put tend to have lower Theta values. And when the short puts get into the mid-twenties to thirty, Theta drops off. There are a number of combinations in between that have good Theta, and one could make an argument for many different ones.

On this chart each line represents the Theta values of different spread widths at different strike prices.
On this chart each line represents the Theta values of different spread widths at different strike prices.

One more way to look at this is to look at a graph with each line representing a different spread width. Notice that the most narrow width of 5 points has a lot of variation- this is because the Theta difference is so small, yet divided by a small width and a few nickels change in the difference in Thetas doesn’t scale smoothly. I’ve highlighted the 40 wide line that I’ve used earlier. One could argue that another line might be a better choice, but as we go wider, the peak gets closer to the current price which makes the probability of expiring in the money higher and higher.

Since the chart is made based on the short put strike, the curves move higher and higher as the spreads widen. Notice that as the spreads get wider, the peak Theta percentage gets smaller.

Longer Duration put spreads

Let’s go a little further out in time and see if the data is different. At 42 days to expiration, we get somewhat similar results.

For 42 DTE on SPX. I chose 100 wide spreads and Theta peaked right at the 20 Delta short strike.
For 42 DTE on SPX. I chose 100 wide spreads and Theta peaked right at the 20 Delta short strike.

I also did a similar thing with a table of percentage Theta values, highlighting the 100 wide spreads.

This table shows the Theta as a percentage of the spread width, and is color coded with more green meaning more Theta return. Lines on the chart mark key Delta values.
This table shows the Theta as a percentage of the spread width, and is color coded with more green meaning more Theta return. Lines on the chart mark key Delta values.

Even longer duration put spreads?

Let’s look at 90 DTE for an even longer duration.

At 90 DTE, Theta peaks out just under 20 Delta
At 90 DTE, Theta peaks out just under 20 Delta

We can also look at a table of Theta values as well for 90 days to expiration.

The boxed values are 200 point wide spreads.
The boxed values are 200 point wide spreads.

Again, the highest values have short strikes in the teens and low twenties for Delta. However, it probably is worth noting that the values shown are not that different between the yellow and green cells. So, maybe we should look at different spread widths to see it graphically.

Virtually all spread widths have a lot of combinations of strikes with values over 0.06% Theta per day. Compared to shorter durations, these Theta values are fairly low.
Virtually all spread widths have a lot of combinations of strikes with values over 0.06% Theta per day. Compared to shorter durations, these Theta values are fairly low.

When selling spreads this far out in time, the idea is to have a large buffer from the current price and get much of the premium to decay well before expiration is even close. Let’s look at an example of how this might work.

This chart shows how the premium of a 200 point wide spread is likely to decay over 90 days, assuming no change in underlying price or volatility. The small triangles represent the Delta values of each of the strikes in the spread as time passes.
This chart shows how the premium of a 200 point wide spread is likely to decay over 90 days, assuming no change in underlying price or volatility. The small triangles represent the Delta values of each of the strikes in the spread as time passes.

Starting with low deltas below 20, we can see that much of the decay of this spread happens well before expiration is even close. In fact, the last 20 days have virtually no premium left, which would suggest closing early and moving on. I plan to do a lot more studies on the decay curves of different spread widths and strikes to help identify the pros and cons of different entry points.

Conclusion

I think it is safe to say that the original study on spread width still stands. However, the data shows that there is some wiggle room around our old ideal of 20 Delta short and 13 Delta long strikes. We just need to be in the neighborhood. We don’t have to be exact.

Where’d the data come from?

Readers may wonder the source of the data for all these charts and tables. Actually, it’s a source that anyone can access and replicate. I simply copied an option table from my broker’s site and pasted it into Excel. Then I used a pivot table to organize the data so that it was friendly for the analysis I wanted to do. The option table had Delta and Theta values for each option contract available, and I had to use some formulas to figure out percentages of spread widths, but it wasn’t any really difficult challenge.

I do worry that my broker is changing the format of the option tables it presents, and copying every contract may be a bigger challenge in the future, but for now, I can display all contracts and select all with Control-A, then paste as text in Excel. In the future, I may have to paste a smaller amount of data each time. Readers trying to replicate these studies may face the same problem.

Goals for Rolling Iron Condors

The goals of rolling are to neutralize delta, harvest profits, collect credits, and widen body width of the Iron Condor.

I see four ideal goals for executing a roll of any position, but specifically Iron Condors. First, I want to neutralize the position delta. Next, I want to harvest profits from the existing position. I also want to collect a net credit with the roll from the old position to the new. And finally, I want to improve probabilities of success by widening the body of the Iron Condor. If I can achieve all four, that’s the quadruple crown of rolling.

Often I see posts in social media lambasting rolling positions as a way to lock in losses and having no point. While that can be a possible scenario, I’d like to take a moment to discuss the ideal outcome of a roll, and share a recent example of what we are striving for with a rolling strategy.

For more information on the initial setup of Iron Condors, refer to my earlier post on the subject. This post is meant to build on that earlier post.

Example Iron Condor Roll

Earlier today I rolled an Iron Condor from 36 days to expiration out to 43 days to expiration. I opened the old position 10 days ago when the market was a little higher. Today, I wanted to better center my position to bring in my position Delta, and be less at risk for a move up. So, I rolled both sides up, rolling the calls up 20 points and rolling the puts up 10 points, which widened the body of the Iron Condor from 120 points to 130 points. Here is a summary of the old and new positions, with key points highlighted for further discussion.

Iron Condor Roll
Here is the key data from my tracking sheet for the old and new positions involved in this roll.

Let’s look at each goal and see how I did.

1. Neutralize Delta

While I don’t track Delta in my trade records, I do look at it for my open positions every day. For background on what Delta is for an option, a position, or a portfolio, see my posts on the topic. The account with this position was showing a lot of negative Delta, so I wanted to bring that in to a more neutral amount. Specifically, this position had a position Delta of -4.7, which equates to a Beta-weighted Delta of -47. This would be the equivalent of being short 47 shares of SPY. With my short call strikes slightly in the money, I wanted to reduce delta, get out of the money, and get more time. Rolling out a week accomplished all of that.

By rolling up 20 points, I got my short call out of the money. I rolled out a week, so I have more time. But most importantly, I cut my Delta almost in half from -4.7 to -2.5. I’m not zero delta or completely neutral, but it is a move in the right direction. I try not to over-adjust and chase being neutral too much or I can get whipsawed back and forth. So, now my premium value will be less volatile as the market moves up and down. Goal 1 accomplished.

2. Harvest profits from old position

The market has moved the direction I was positioned for, and today seemed like a good time to roll and recognize some profit. I’ve been in this position for 10 days, just over 20% of the life of the option. I’ve had some help from all the main pricing factors- price has moved down while I had negative Delta, time has passed while I had positive Theta, and volatility has come down slightly while I have negative Vega. All good for me. Notice that my put side lost money and my calls made money. I track them separately which helps me see trends, but the goal is for the net profit to be positive. And this position made $611 over 10 days. That’s around 8% return on capital. Goal 2 accomplished.

3. Collect a net credit from the roll

With a roll up on both sides, I had to pay a debit to roll up the calls, but I collected a bigger credit to roll up the puts. So, the net of the transaction is that I collected $0.35 per unit, or $35 overall. I try to collect credits in every roll because this is cash going into my account, while debits are cash leaving my account.

This old position wasn’t centered, and I widened the position while rolling out, factors that limited my net credit. However, I was able to find strikes that accomplished my other goals while still collecting a net credit. My new position isn’t ideal, but it is better than where I was and I got paid to make the change. Setting up a roll is an exercise in balancing many different desires, and I focus on collecting a credit as a way to determine how far I can go with my other desires. It isn’t a lot, but I collected a credit, so Goal 3 is accomplished.

4. Widen the body of the Iron Condor

The body of my Iron Condor is pretty narrow. How do I know? Look at the profit profile and it is clear that the whole position is inside of one expected move either way. Ideally, I’d like to get the expected moves inside my short strikes, but I’m managing a trade that is much tighter. So, every chance I get, I want to widen the body, the distance between the short strikes. Why do I want to do that? Because wider strikes have faster decay, up to a point, and we aren’t near that point. This position has strikes close to the money and the Theta values of the longs tend to cancel out the Theta of the short strikes more than I’d like. And the wider the distance between short strikes, the higher the probability of the price staying out of the money. Over several rolls, I want to get wider to where the position can tolerate moves without getting into the money as often. I went from 120 points between short strikes to 130 points, so Goal 4 is accomplished.

Quadruple Crown!

This roll accomplished all four of my goals for an Iron Condor roll. As I mentioned, I had to make some trade-offs along the way to accomplish all four goals, but this is an example of how I use all the data at my disposal to pick the trade that best suits the current situation.

Not every roll can be hit all four goals. If the current trade is a loser, the best you can do is meet the other three goals. Sometimes, I have to miss one goal to make another. In those cases, I choose based on what goal I’m most concerned with- do I need to neutralize delta more than I need a credit, or do I need to maintain body width more than I need a credit? Generally, I have a good shot to meet most of my goals if the current underlying price is inside the short strikes. As short strikes go deeper into the money, it becomes more and more likely that a roll will miss many of my goals.

This mindset of positive goals for trades isn’t exclusive to Iron Condors, but I thought today’s example would be a good way to illustrate the thought process involved in rolling for positive outcomes.

The 1-1-2-2 Put Ratio Trade

Like all the front ratio type trades I have shared, this trade is a defined risk version of a very similar front ratio trade featuring naked short puts. My versions hedge the trade with long puts to limit the risk. However, in this trade, I will also discuss the unlimited risk version of the trade, the 1-1-2, because the additional risk isn’t that much from a practical standpoint.

I’m a big fan of front ratio type trades. I’ve written about my success with Broken Wing Butterflies and Broken Wing Put Condors. Another trade that fits in the group is the 1-1-2-2 Put Ratio. I don’t know of a named reference to a bird or insect for this trade, so I’m going with 1-1-2-2. Like all the front ratio type trades I have shared, this trade is a defined risk version of a very similar front ratio trade featuring naked short puts. My versions hedge the trade with long puts to limit the risk. However, in this trade, I will also discuss the unlimited risk version of the trade, the 1-1-2, because the additional risk isn’t that much from a practical standpoint.

I picked up the concept of this trade from one of my favorite traders, “Sweet Bobby” Gaines, who I have mentioned previously in at least one other page on this site. Bobby is a big proponent of the 1-1-2 trade, and has posted numerous videos on it on his YouTube channel, including his recent rising star appearance on Tasty Trade. But really, the trade is the next level of evolution moving from broken wing butterfly to broken wing condor to “one louder” as they say in the mythical group Spinal Tap.

What all these trades have in common is selling an out of the money debit put spread, and financing by selling further out of the money puts or wider credit put spreads. The combination delivers a net credit, but also sets up an interesting dynamic of extra rapid decay of the premium involved. The farther out puts or put spreads decay faster than the closer debit spread, and often lead to the debit spread having more value than the credit spread. These trades take in a credit to open, and often can take in a credit to close. At least that’s how I set them up and manage them.

All these trades are a variation of a front ratio spread, where more options are sold than bought with hedges added to define risk. I’ve also written about back ratio spreads where more options are bought than sold. Front ratios are designed for maximizing decay, while back ratios set up multiple long positions paid for by a costly short position.

The previously discussed broken wing condor could also be called a 1-1-1-1 trade. In that trade we buy a put spread and then sell another put spread further out for more money, collecting a net credit. Four different strikes, 1 contract each. So what is a 1-1-2-2?

1-1-2-2 Basic trade setup

The 1-1-2-2 takes this a step farther, because we use two credit spreads very far out of the money to pay for the debit spread. The 1-1 part is buying a put around 25 delta and selling a put around 20 delta. The 2-2 part is selling two puts at around 5 delta and buying two puts around 1 delta. The goal is for the 2-2 to sell for about twice what the 1-1 cost. I like to set these up with 45-55 days remaining to expiration, quite a bit longer than the other ratio trades I’ve discussed.

What is the advantage of this? Well, because each of the two short strikes are further out, we greatly improve the odds of being profitable, and increase the initial rate of decay of the total position. We end up with a big gap between the debit spread strikes and the two short put strikes. Lots of good things happen with this setup. The biggest upside is that there is no upside risk- if price goes up, the trade makes money. The downside of this trade is that it can consume a lot of capital and has significant tail risk, which we will get into before we are done. Let’s look at a typical example.

Pricing and Greeks for the 1-1-2-2 position
In this example, each of the two low delta puts collect about what the debit spread costs (~$10).

The first thing I want to point out in this example is that the 3100 short put is 900 points below the current price of $4000. For that strike to get in the money, it would take a 22.5% decline in the market in 55 days. That won’t happen very often. To be fair, this example uses values with VIX at 25, a historically higher than average value, but for the timeframe of 2020-2022, a fairly middle of the road level. The higher that implied volatility is, the farther away the short strikes can be and still collect meaningful premium.

The next thing to point out in the setup numbers is the Greeks. Delta is fairly flat at +3. For a credit trade, that isn’t much and means that the position can handle some movement in price. Theta is $69/day, and we collected $805. So, the position is expected to lose 1/12 of its value each day. But we have 55 days, so how does that work? Quite well, I’d say.

Finally, we can’t ignore the capital risk of $115,000. How can this be? If the price drops below $2500 at expiration, a 47.5% drop, the loss would be $115,000. While extremely unlikely (we didn’t lose that much in the Covid crash of 2020), it is possible in some disastrous scenarios. We’ll discuss this later as it impacts capital requirements and how one perceives risk. At the end of this post, I’ll explain how we can get into this trade for a fraction of this buying power.

Numbers are one thing. A picture or three might help make this all more clear.

overall profit profile chart
The dotted lines represent expected moves. This trade is profitable at expiration if the market doesn’t go down more than two expected moves.

This chart shows how changes in the underlying price will impact the profit and loss of the trade. We evaluate at four points in time. The green diamond shows our initial position at 55 DTE, underlying price is $4000, and the P/L is zero. The curvy lavender line shows how price would likely impact the position with 35 DTE. The green curve shows the likely profit at 14 DTE, and the sharp purple lines are the expiration values. We know exactly what expiration values will be at any price, but the curves are estimates based on likely impact to implied volatility as time passes and prices change.

I’ve put in dotted lines to show the expected move and multiple expected moves down. If you need a refresher, check my earlier post on expected moves. It is likely that price will end up inside of one expected move, the dotted lines on either side of the current price of $4000. There is approximately a 2% chance that price will move two expected moves to the second dotted line below the current price, which would still be max profit for this trade at expiration. And there is approximately a 0.3% chance of moving three expected moves to the far left dotted line. We can go further, but the odds keep dropping as we go to lower levels. However, as history has shown, moves down tend to have somewhat higher probability than theoretic probabilities once we get beyond two expected moves. The bottom long puts are a final defense to limit losses for going even more extreme in a rapid crash. The point is that this trade is very likely to end up profitable, but there is risk that an extremely big move down could lead to an extremely big loss. We’ll talk about ways to reduce exposure later.

Now that we’ve talked a bit about the very unlikely outcomes, let’s zoom in and discuss the most likely scenarios. Here’s the profit chart showing prices down to 25% below the current price with profit and loss zones highlighted.

This chart shows the profit and loss compared to most likely underlying price levels.

Zooming in allows us to see the profit levels in the timeframes referenced above. Notice that down moves initially can drive the position to a loss, but if the move doesn’t go below the two short puts at 3100, the position will be highly profitable at expiration. In fact, this trade does best in the very wide range of a price drop between 6 and 22 percent, bringing in up to $5000 additional credit.

If price goes up or drops less than 200 points, we can keep our initial premium at expiration. We may be able to collect more. The profit curve at 14 DTE is actually above the expiration profit if the price remains the same. How is this possible? Because the 1-1 debit put spread decays slower than the 2-2 credit spread, eventually the 1-1 part is worth more than the 2-2 part, even though the 2-2 part started out worth twice as much as the 1-1.

Let’s look at this another way. Prices don’t generally move immediately to a new level, but have probabilities of moves that get bigger over time. Again, going back to expected moves, let’s compare how we might expect price to move during the duration of the trade.

Price expected moves
This chart shows expected moves day by day from initiating the trade until expiration, and compares to the put strike prices.

In this chart I’ve shown several outcomes. The zero move is if price doesn’t change at all, a baseline. I’ve shown a +1% move which is in line with the positive drift of the market. There’s also a line for the positive expected move and the negative expected move, where price is likely to be within at any point in time. And finally I’ve shown a curve for a price move of two times the expected move down. Notice where the strikes are relative to the price curves are. The negative curves take time to get below the upper 1-1 put strikes, and never reach even the short put of the 2-2 credit spread.

Now let’s look at what happens to the value of our premium if price were to follow each of these curves. This is a view that you don’t see much because it is based on lots of assumptions for the pricing models. Since implied volatility is not predictable in the future, the chart makes assumptions for how price and time will most likely impact volatility and premium value.

option premium vs time
This chart shows how different underlying price trends would likely impact option premium over time.

Initially, this position collected $8.05 in premium, so we start with a negative or short value of -8.05. From there the price moves shown in the previous chart drive the premium up or down along with time decay. If price is flat or going up, premium decays and moves quickly toward zero premium. If the price goes down, the positive Delta pushes premium to more negative values. The price move of negative two expected moves really does a number on our premium initially, driving it down to below -30.

But, remember our profit chart at expiration? The flat and positive moves end up with a profit of our initial premium (all the puts have zero value at expiration, and the negative expected move and negative double expected move end up at maximum profit. Since our debit spread is 50 points wide, the negative moves would leave it fully in the money for a premium value of +50 points. And that’s in addition to the initial premium collected to open the trade. The challenge is that to get that max profit, we likely will have points in time where our position loses money.

The probability of getting to max profit is low because it would require a price drop between 6 and 22%. Based on our put strike Deltas we can estimate that we have about a 20% chance of that. Most of the other 80% is expiring with all strikes out of the money. So, it might be wise to zoom in and understand what happens with the vast majority of trades.

1-1-2-2 value vs. time chart
In most situations, the premium of the 1-1-2-2 front ration decays quickly, maxes out, and then levels off before losing value.

I used this chart as the featured image of this post because I thought it best illustrates how this trade plays out most of the time. If you remember when we discussed the Greeks, I pointed out that Theta is very high compared to the premium. From this chart we see that if price stays the same or is slightly up, premium will decay to zero by 35 DTE, or just 20 days into the trade. This is an example that Theta isn’t 100% accurate by itself as it looked like 12 days of Theta should move us to zero value. It could be that IV modeling is slightly off or the Theta was off, but still we have very rapid decay that I don’t think anyone can complain about.

Like all ratio style trades we have discussed, this trade has the possibility of switching from negative to positive premium. The difference with this trade is that it is actually quite likely, and as such we need to plan for it and manage our profit accordingly.

I’ve colored in the area under our three flat-to-positive curves with three zones each. There is a green zone where positive premium is growing, a yellow zone where premium is topping out, and a red zone where positive premium is being lost. Notice that the curve of the 1% up move and no price move are fairly close together, and that’s because the price movement is relatively close to the same compared to the other moves we are analyzing.

Let’s review how this happens. This trade essentially has two spreads, a slow decaying debit spread (1-1), and a fast decaying credit spread (2-2). The credit spread decays faster because it is farther out from the money, is much wider, and has twice the value to start with. All these factors help decay happen more quickly. As long as the price stays fairly stable, this relationship will hold. Theta will be the primary driver of the premium value, and the wide credit spread will get to be worth less than the narrow debit spread.

The most likely scenario is that we stay inside the expected move and travel somewhere close to the no price move or 1% up move. Let’s realize that the market doesn’t move in equal amounts every day like this chart, so think of it as a smoothed out version of what premium would do. In the real world, premium would bounce up and down with price. However, if our price is close to where we started with 20 days until expiration, we would expect that the premium switch to positive has about maxed out, and it is probably a good time to close out the trade. Hopefully,your trading platform has a analysis feature that lets you look at your position and see how profits are changing day by day to help determine when the position is as high as it can go.

Without a chart, another way to determine how close the trade is to switching direction is to watch the position Theta. At the beginning of this trade, Theta was 0.688, or $68.80 for the full contract per day. As the trade progresses, Theta will decrease and at some point when the premium goes positive, Theta will turn from positive to negative. As it gets close to zero, that is the peak premium value. I generally try to exit the trade a few days before Theta is projected to turn negative. A big up day for the market could quickly change my very positive premium to not as positive premium, so it isn’t a time to get greedy.

So that brings us to the curve for the positive expected move. This is the curve that assumes that the price follows the one standard deviation move up. The good news when this happens is that premium decays very quickly because Delta and Theta team up. The not so good news is because the price move gets so far away from the strikes, the total position won’t get to a very high positive value. This is because all the options will drop in value quickly, approaching zero, and the upper debit spread won’t have much value. A big move up means that the probability of any of the strikes going into the money will be very low, so there is very little premium. As a result, it is likely we won’t be able to get out for much positive premium if any at all, but we will be able to keep most, if not all the premium from the opening trade. This is the least stressful outcome of the trade. If the price moves up faster than the expected move, premium will likely drop to very close to zero and may not ever go positive. So, if price is up a lot and the trade can be closed for a credit, I take the money and run. I’m happy to have a quick, winning trade.

The risky outcomes

Looking at the position vs time value chart, there are two lines that represent what happens if price goes down. One is the move down one expected move and the other is down two expected moves. Interestingly, in this example, both end up at max profit by the end of the trade. So, it would appear that the trade can’t lose, which is far from true. Notice that these premium values may go very negative if prices drop quickly after opening the trade. This is because the narrow debit spread doesn’t pick up as much value from increasing delta as the wide credit spread does in a down move. We know that if price stays above our credit spread short strike at expiration, we will make money, but when price moves quickly down, it isn’t clear that price will level off.

So, as a trader, we are left with a choice when the market drops, We can take a loss and get out of the trade, or wait to see if the market quits dropping before it tests or violates the credit spread strikes. If we are a week or two into the trade, a decent down move will not make a huge impact, but initially the trade can take a big hit from a down move. The longer we are into the trade without a big down move in price, the less the risk is of a loss. On the flip side, a big move down opens the possibility of additional big down moves that can lead to a very big loss. We reviewed the odds earlier- about 4% of the time the trade will lose based on the far short puts having an initial Delta of 4. If this trade is done enough times, there will be some losses. Let’s look at some management actions that could be taken.

1. Set a stop based on premium price. In this example, we collected just over $8 premium to open the trade. So, we could set a stop to avoid losing twice ($16) or maybe even three times ($24) our initial premium. This would mean a stop loss if premium climbs to $24 or $32, given that $8 premium is our starting break-even point. This is the simplest risk mitigation strategy. Using this will lower the overall win rate as many negative scenarios would end up fine if not closed, but this management technique will prevent huge losses that might impact the account dramatically.

2. Close the trade if the underlying price goes below a trigger point. We know this trade has a lot of cushion. We can handle much more than one expected move and be profitable. But if the move is much more than expected, we have to consider that the move is very unusual and dangerous for us. Perhaps our point to get out is when the debit spread is in the money, or when we are half-way between the debit spread and credit spread. Or maybe it is the short strike of the credit spread that is the final trigger to get out. The further down we allow price to go down, the more we stand to lose. Pick the underlying price where it gets too uncomfortable and use that as the trigger point to get out of the trade.

3. Roll out in time if premium or price triggers are hit. If the position is rolled before the credit spread is in the money, it can be rolled out for a credit. This gives more time for the market to turn around. However, it gives more time for a losing trader to lose more, because we likely can’t roll down that far and still get a credit, and we will likely have to pay to roll the debit spread or narrow the distance between spreads, making the trade less attractive. If the price move continues down, there will be much less room to maneuver going forward.

4. Simply hold on and hope the probabilities play out. With 55 days in the trade, we just need to move down less that two expected moves by expiration. If the capital is available, and the conviction is there, holding can bring max profit with a big down move. Note that as time passes and the credit spread stays out of the money, the premium has to go away, so the value can evaporate very quickly with very high Theta as expiration approaches. This can be observed in the value vs time graph for the -2 EM curve. It can also result in max loss. As expiration approaches, the difference between max profit and max loss is just a few percentage points of price movement and max loss is much more than max profit.

In this example we can see that a move down of one expected move really doesn’t challenge our position, while two times the expected move is playing with fire. So, one approach might be to hold as long as the move stays within the expected move to the downside and switch to closing or rolling once the move exceeds that or some other multiple of expected moves. In any case, a trader has to know their risk tolerance and have a management plan for both winning and losing trades.

What about calls?

A logical question might be- if this works so great for puts, why not double up and do it for calls as well? Well, there’s one problem- skew. On indexes implied volatility is higher as strikes go to lower values and declines for higher strike prices. As a result, out of the money puts have higher implied volatility than out of the money calls. More importantly, far out of the money puts have higher implied volatility than puts closer to the money.

Look at our setup for this example. Implied volatility of the single long put is around 25, while the two short puts have implied volatility of 39. This helps two ways. The short puts have more of their premium tied to volatility, bumping up their price compared to the long put. Also, the higher implied volatility pushes the strike price further down to get a matching premium to the debit spread, making the trade a higher probability of success. We are selling more of the higher implied volatility and buying lower implied volatility, a key reason to use front ratio spreads.

A similar setup for a 1-1-2-2 call trade would reverse the dynamics. The long call closest to the money would have the highest implied volatility and the two short calls would have the lowest. To collect similar amounts to the put trade, the call strikes would be much closer between the debit spread and credit spread, and the difference in the deltas of the strikes would also be closer together, meaning a narrower window of max profit, and a higher probability of max loss. While still a trade with positive probability, it generally isn’t as attractive as the put side.

1-1-2 vs 1-1-2-2

I haven’t talked much about the two long puts bought at less than one Delta to open the trade. They are very unlikely to ever be in the money, and most traders would opt to close or adjust the trade well before they came into play. So, why have them? The simple answer is that they define or limit the risk of the trade, potentially reducing the capital required for the trade, and protecting from absolute disaster in the event of a market crash of over 37.5% in under 55 days. It could happen, like it did in February and March of 2020 during the Covid pandemic. We are giving up 20% of our premium to protect for a once or twice in a lifetime super crash.

So, what if we eliminate the long puts and do a naked 1-1-2 ratio spread? Is it different in outcome or probabilities? The answer is that it is very similar in most ways, and we will also see that a lot depends on the type of account you are trading in as to what choices there are. First, let’s start with the setup of the 1-1-2 trade.

The 1-1-2 setup is similar to the 1-1-2-2
The 1-1-2 trade has two naked puts sold short, but way out of the money.

While this table shows the risk as unlimited, it is actually $618,855, the value of two 3100 puts if SPX went to zero by expiration ($620,000) less the $1,145 collected to start the trade.

Some accounts and some brokers require all trades to be defined in their risk. For example, retirement accounts generally aren’t allowed to use option margin and so any naked put would have to be cash secured. For this trade, eliminating the two long puts would mean the max loss would go up to $618,855, assuming that SPX went to zero, while we are holding two short 3100 puts. SPX will only go to zero if we see modern society end, and in that case, we’ll probably have bigger problems than our option positions. But rules are rules, and so if you want to trade without the long puts in a retirement account, you would need $620,000 capital to make a likely $800-$1200 or less than 0.2% return in 55 days or less. We’ll discuss other alternatives after we review the details of the 1-1-2 trade.

The profit profile for 1-1-2 is similar to 1-1-2-2
The profit profile for the 1-1-2 is very similar to the 1-1-2-2 other than the virtually unlimited loss.

Remember that our starting underlying price is $4000 and the trade is profitable at expiration as long as price is above 3100. The chart above doesn’t show losses all the way down to zero price, but just imagine zero price and -$618,855. Our probability of profit is 96% if held to expiration based on the Delta of 4 for the naked puts.

value vs time for 1-1-2
Most scenarios show a profit with 1-1-2

Looking at 1-1-2 values over time at the same price moves that we looked at for the 1-1-2-2 trade, we can see that the premium changes are fairly similar. Staying within one expected move keeps the trade moving in the direction of decay.

zoom in on 1-1-2 value over time
Zooming in on most likely outcome’s value over time

If we zoom in on the likely outcome, we see that premium behaves very similarly to what we saw with the 1-1-2-2 trade setup. We just have more premium collected to start with, taking a bit longer to fully evaporate and have the premium turn to a credit for closing. The concept is the same.

Summarizing the differences between the 1-1-2-2 trade and 1-1-2 trade, the 1-1-2 trade collects about 20% more premium in exchange for more loss if the market drops more than 37.5% in the 55 days of the trade. How likely is it for the market to drop more than 37.5%? Is buying the long puts for protection worth it? That’s up to each trader to decide.

Buying power requirements

I usually don’t spend much time talking about buying power because most trades I do are defined risk credit trades where the amount collected is a significant portion of the capital at risk. This trade is not so much, whether defined risk (1-1-2-2) or a naked ratio spread (1-1-2). In non-margin accounts, we collect 0.7% or 0.2% respectively, which isn’t much.

Below is an analysis of different possible ways to trade. I looked at trading each of these strategies three different ways. First, I looked at a cash secured account, like a retirement account. Next, I looked at an account with margin for naked options. Finally, I looked at a much different approach, trading futures options with span margin. The margin and span margin amounts came from entering this trade into the tastyworks trading platform.

Buying power differences for Margin and Futures
Comparing buying power impact of different account types for the two strategies

I highlighted some key takeaway points. First, is how leveraged span margin with futures options can be for this trade. Our most capital efficient trade would be doing the 1-1-2-2 on futures span margin where we would collect 100 times the premium as a percentage of buying power (20%) than the non-margin account of the 1-1-2 trade (0.2%). Of course, with leverage comes much more risk. I chose to consider a loss of 10 times the initial credit as a practical worst-case scenario. The span margin would end up costing huge amounts more in a disaster and could potentially wipe out an account if the trade used a high percentage of the account’s capital.

A couple of weird margin anomalies to point out. In my margin account, the defined risk 1-1-2-2 trade required almost twice the buying power as the undefined 1-1-2, which is weird because clearly there is more risk in the naked 1-1-2. I think it may be that the calculation for defined risk is normally much less than undefined and the software may just assume that margin is not useful in defined risk. On the other hand, defining the risk on the futures version cut the buying power by 1/3. Different brokers may calculate their margin requirements differently, so don’t take this as universal truth. Similarly, remember that while defining risk usually increases the return on capital, it makes outsize losses more likely, especially when scaling up. Notice that the highly leveraged futures 1-1-2-2 would lose twice as much as a percentage of capital that the futures 1-1-2 setup in a 10x loss. I discussed this phenomenon in detail in my post on comparing risk.

Remember that margin and span margin change as the trade progresses depending on the market behavior. Span margin is subject to big swings when prices go against a position. A broker may force a position to close much earlier than a trader would want to get out due to expanding capital requirements. So, while initially the position is cheap to enter, a trader needs to limit each position to a fraction of the overall account size.

But the good side of this is that this trade can be entered for a very small cost. The trade is very high probability. We can also make more than the premium collected. I didn’t include it in the chart, but maximum profit for the most leveraged choice above would be $5,805 profit on $4,000 buying power, a return on capital of 145%. And there is over a 20% probability of that happening.

One final note on the buying power analysis table. To keep the quantities an apples-to-apples comparison, I used double the number of /ES futures options because futures options only control half as much value as SPX index options. So, technically, those futures options trades listed are 2-2-4-4 and 2-2-4 because they use twice the number of contracts to get the same notional exposure. I reviewed differences between index options and futures options in detail in my post about different ways to trade options on the S&P 500 index.

What about small accounts?

Readers looking at this may be thinking, “Gee, this is great for multi-millionaires, but what if the account is too small to consider any of these buying powers?” Great question- there are other alternatives. First off, a trader could use half the buying power listed by just trading options on one contract of the Mini S&P 500 futures (/ES). The 1-1-2-2 example would only take $2,000 buying power for $402 premium received. But, if that is still too much, we can make it a lot less.

Many traders are more familiar with options on the SPY exchange traded fund, which trades at approximately 1/10 the value of the S&P 500 index. For futures options, there is also options on the Micro S&P 500 futures contract (/MES), equal to 1/10 of the /ES contract size, or 1/20 of the size of an SPX option. By using SPY or /MES, we cut the size of the trade down by 1/10 compared to the above table. If the account is taxable, another choice would be the $XSP index, a 1/10 value index of the S&P 500 with favorable tax treatment, but lower liquidity. Again, all these alternative versions of S&P 500 options are discussed in my post on different S&P 500 choices.

So, for an account with futures trading capability, this trade could use /MES futures options and get into the 1-1-2-2 trade for just $200 buying power. An account with options margin could use SPY or $XSP and get into the 1-1-2 trade for $6,800 buying power. A trader doesn’t need a million dollar amount to trade this.

Concluding thoughts

I know a number of people who have traded versions of this trade during the bear market of 2022 without any issues. In fact, it could be argued that this trade, like most trades that collect credits from selling puts, works best if entering when the market is already down and implied volatility is high. Bad scenarios are already priced into option premium and there is a lot of cushion between strikes. This trade is most dangerous when volatility is low and prices are high- the probabilities are not as good, because a move of more than two times the expected move down is not nearly as far.

While not for everyone, the 1-1-2-2 and 1-1-2 trades provide a very high probability of success with a nice payout when used with leverage. The trade requires monitoring to maximize profit and to prevent catastrophic loss, so it really is not a set it and forget it trade. The key is to have a plan to manage the position if the market goes against the trade and stick to the plan.

Change Log for Website

This post lists recent additions and changes to the website. For frequent users, this change log might be helpful to see what has changed from past visits.

The following is a listing of recent additions and changes to the site. For frequent users, this change log might be helpful to see what has been added new or changed.

December 16,2024: Added a new page for the Very Long Very Short Put Diagonal Trade. This trade, also a version of a “Poor Man’s Covered Put” has much more to than what one would expect at first glance. However, this trade has elements of almost every aspect of options there is, so a lot to study for every option trader.

October 30,2024: Added a new post with a cautionary tale of trading the 112 trade on August 5, 2024, the fastest volatility spike ever.

October 2024: Lots of new comments from readers and responses on various pages of the site. Keep those questions and ideas coming!

August 24, 2014: Added an update to the page about 100% success in the 112 trade to highlight the issues with the August 5 volatility debacle that did wiped out many 112 traders.

July 23, 2024: Added a new post sharing results from the 112 trade in the first half of 2024. 100% success.

July 2,2024: I added a new page contrasting debit vs credit option trading strategies. It’s one of a few considerations traders should consider when picking strategies that work best for their style of trading.

May-June 2024: Lots of new comments and replies came in from readers. Always good to hear from folks with their questions and comments.

December 30, 2023: I added a couple more books to the Resources page. I also updated Tasty links for their new TastyLive.com URL.

December 20, 2023: Made a number of changes and additions to the home page of the site. With all the new content, it seemed like it was time to highlight some of the content that isn’t as obvious.

November 22, 2023: Added a duplicate post on the 1-1-2 Put Ratio Trade. I did this to capture the search engine traffic from the numbers of traders looking for information. So, whether it’s 112 or 1-1-2, there’s a write-up. Just read one or the other- they are the same.

November 14, 2023: Added a page on the 112 Put Ratio Trade. While I mentioned it a bit in the post on the 1112 Put Ratio Trade, I decided the naked option version deserved a write-up of its own.

September 19, 2023: Added a page on Covered Calls. Yes, I know I just wrote a post on the same subject. (Secret note: the write-ups are exactly the same. This is actually a test to see if pages do better than posts in getting search engine connections. Universally, my most read articles are always pages, but maybe that’s just a coincidence. Most readers would never recognize the difference between a page and a post, but posts are supposed to be part of an ongoing blog, while pages are more “permanent.” I’ve used them interchangeably, and I want to make a data-driven decision on what the impact of that choice is.)

September 18, 2023: Added a post on 5 Bullish Call Trades. This is the culmination of a series of trades that I felt like I had overlooked regarding data driven ways to utilize calls in a bull market without absorbing too much time decay. With the market in what appears to be a bull market, it was time to focus in on this topic. 4 of 5 of these trades have recent extensive write-ups that were completed in the past 3 months.

August 4, 2023: Added a post on Buying Out of the Money Call Spreads. This is a strategy that would appear to most option traders who mostly sell options to be a sure loser, but back-testing shows it to be quite profitable over time.

July 26, 2023: Added a post on the Poor Man’s Covered Call, a low cost variation of a Covered Call, based on selling a call against an in the money long call that acts as a replacement for stock. So, a bit of a cross combination of the two most recent previous write-ups.

July 25, 2023: Added a post on Covered Calls. Not sure why I never wrote one before, but given it is one of the most popular option trades around, I thought it was time to weigh in on it with a level of detail that isn’t available many places.

July 5, 2023: Added a post on Replacing Stock with a Call Option. When markets are going up and IV is low, buying calls can be a good way to get in at a low cost. This post goes into more detail.

June 19, 2023: Added a post on Underlying Security vs Risk Permission. There are a lot of factors to picking the type of security to buy or sell options for a specific type of trade. This post digs into what to consider and why some approaches may be better than others.

May 24, 2023: Added a post on Trading Options while working a Full Time Job. I went back to work this year and changed my trading routine. I know many readers can relate, even if they just want to make better use of their time.

May 20, 2023: Added a chart to the 1 DTE Straddle post to show profit and loss at various times of the day.

May 17, 2023: Added a post on Covered Strangles, a conservative options trade that reduces volatility with higher probability of profit than owning an equivalent amount of stock outright. It’s my first deep dive into Level 0 option trades, something I’ve had a number of requests to address.

February 27, 2023: Added a new Phone Stock Charts page with stock price charts formatted for a smart phone, and potentially screen-cast onto a monitor or TV. Not for everybody, but if this is something you are looking for, like I was, you’ve found it.

February 27, 2023: Updated the Current Prices page with more interactive charts, replacing those from a previous provider that had security flaws.

February 26, 2023: Added a post on the topic of 0 DTE trades.

January 16, 2023: Provided responses to a couple of great reader comments and questions regarding the 1-1-2-2 trade.

January 13, 2023: Added a new post on my 2022 learnings.

January 3, 2023: Added a new post on buying 1 DTE straddles on indexes.

December 28, 2022: Added a new page describing the 4 Different Types of Option Underlying Securities– stocks, ETFs, indexes, and futures.

December 23, 2022: Added a post regarding the best Delta for ROLLING put spreads. This is a new topic that I had curiosity about from years of observing that some rolls do better than others, and I couldn’t figure out why.

December 20, 2022: Added a post researching the best Delta values for selling put spreads. This is a follow up to page on credit put spreads written earlier.

December 6, 2022: Added a page on Options Portfolio Management.

November 28, 2022: Accepted an extended comment to the page Rolling Iron Condors and added a response. Comments are always welcome and appreciated. Note that comments from first time commenters must be reviewed and accepted to keep those crazy spammers from ruining the site.

November 9, 2022: Response added to a comment about how to roll a back ratio call spread up or down to get back to Delta neutral.

November 3, 2022: Added a new page on Options Margin Usage. In this page, I compare different types of margin available for option traders and the benefits and risk of each.

October 15, 2022: Worked with the ad provider to reduce the number of ads on the site and make them less obnoxious. Should be no more pop up adds when changing pages, and less ads per page.

September 30, 2020: Added a new page explaining how brokers permit different levels of risk in option trading.

September 7, 2022: Updated the Favorite Strategies Page and the Ratio Spread Page, adding more details to both.

August 25, 2022: Added a new post with an example that illustrates the Goals for Rolling Iron Condors.

August 23, 2022: Replied to a new comment about my alternative 7 DTE trade posted a week ago.

August 18, 2022: Added an alternative strategy in a comment for the post on 7 DTE trades.

August 18, 2022: Added a post describing the 1-1-2-2 Ratio trade.

August 2,2022: Responded to a comment on rolling Iron Condors with perspective on defending call side in up moves.

June 5, 2022: Added this page- the change log

June 5, 2022: Added new post explaining the Expected Move and how to visualize it.

June 4, 2022: Added a new post explaining my approach to rolling Iron Condors in bear markets.

March 12, 2022: Added a post explaining different types of options on the S&P 500 index products.

January 14, 2022: Added a post about comparing risk of different option strategies.

If there are subjects you’d like me to address in future, leave a comment below.

The power of rolling Iron Condors

In the bear market of early 2022, I re-discovered a strategy that I had mostly discarded during the bull market of the preceding years, the Iron Condor. The Iron Condor is primarily a neutral trade that when managed with aggressive rolls can provide good returns in choppy, down-trending markets. My goal is to maintain a position that can tolerate fairly big market moves up or down, while benefiting from time decay.

I had discarded the Iron Condor trade because I found I was always losing on the call side of the Iron Condor. Initially, I liked the idea of making money on both sides, but I found in a constant up market, I often lost more money from calls than I made from puts. So, I switched to mainly put spreads and other short put strategies, which did great. But then 2022 came along, and it was clear that the market was no longer going up, and that we were heading for a bear market. I started adding credit call spreads to my credit put spreads to balance risk and have a neutral strategy. Over time I saw that some of my set ups and management strategies were working better than others, so I investigated and came up with a process that now works well in the current bear market environment.

The basic setup of an Iron Condor

Selling Iron Condors is an extremely common option trading strategy. The strategy is a combination of two calls and two puts, four separate options working together. Usually, an out of the money put and out of the money call are sold, and then a further out of the money put and call are purchased to define the risk and reduce cost. The trade wins at expiration if the price ends up between the short strikes, and hits max loss if the price moves beyond one of the long strikes. However, I rarely if ever hold to expiration and roll my position way before expiration is a concern.

California Condor
Here is an actual California Condor with a profit curve of an Iron Condor option trade drawn over it.

An Iron Condor is named after the shape of the profit curve at expiration, which kind of looks like a condor with a bit of imagination, kind of like how star constellations are named. The iron part of the name designates that it is made up of a combination of puts and calls, as opposed to a put condor, or call condor which has four legs of the same type of contract. An example of a put condor is the broken wing put condor strategy I have described in a separate post.

To build on the condor metaphor, the difference in option strikes are often referred to as the body and wings of the combination trade. The body is the difference between the short put strike and the short call strike. The wings are difference between the call strikes or between the put strikes. The wings on the puts may be equal in width to the wings on the call, or they may be different. Wings that are different widths might be call unbalanced, or broken wings, as the profit profile will no longer be equal levels each end of the price ranges of the trade.

My preferred Iron Condor setup

What I have determined works best for my management strategy is to use the S&P 500 index options (SPX), targeting a starting point 28-35 days from expiration, with option Delta values of 30 for the short strikes and around 20 for the long strikes. I like equal width for the put side and call side, so the Delta values for calls will be a bit wider than the put side, and the net Delta of the Iron Condor will be slightly negative. With implied volatility between 20 and 30%, I generally target 100 wide wings, with the body between the short put and short call of around 15o points on SPX.

Premium and Greeks for Iron Condor
Here is the setup of an actual trade from early 2022 on SPX using the criteria from this post. In this example 30% of the wing width was collected, and a little lower deltas were used.
Profit Curve
For the above example trade, the goal is to keep in the profit zone for the first several days of the trade- the positive area under the 21 DTE curve.

I use SPX because it is the least likely underlying to have outsized moves. It is also very liquid to trade, has tax advantages in taxable accounts, and has expirations multiple times per week in the timeframes I trade. Depending on account size or type, other option products for the S&P 500 may be appropriate and can be used instead with essentially the same strategy. Other indexes or even individual stocks can be used, but managing can tougher with bigger moves, less expirations, and less liquidity.

I use 28-35 days to expiration (DTE) because my position can tolerate most reasonable moves while still having decent decay. I’ve used timeframes as low as 7 DTE, but find that many one day moves can push a position out of the profit zone, and I find myself fighting a losing battle too often. Longer durations of up to up to or over 100 DTE can work, but decay is slower, and there are very few expiration choices to roll to for the way I like to manage. All that said, my plan can vary to different timeframes, with the goal that I will only hold the position for somewhere between 1/10 and 1/5 of the time left to expiration- for example, a 30 DTE would be held 3-6 days before rolling, while a 100 DTE position would be held 10-20 days.

I choose 30 delta for short strikes and 20 delta for long strikes because they are the most forgiving in a move, while still offering reasonable decay as a spread. Higher deltas allow for more premium to be collected, and price movement will often be well tolerated as the long strike of the tested side will increase and the short strike of the untested side will decrease in value, compensating for much of the increase in value of the tested short strike. The goal of my management strategy is to keep this relationship intact, so that price movement has little impact on my option position value. I think of the area where deltas of the four options balance each other out as the profit zone. Staying in the profit zone allows Theta, or time decay, to do its work and deliver profits. I have used strikes with a bit higher delta values, but if too high, the two sides will get tested more often and then require more management. In the past, I often used lower delta spreads for safety and better percentage decay. However, I have discovered that low delta positions don’t actually tolerate price movement well because the untested side of an Iron Condor quickly runs out of premium to offset any of the movement of tested side. This observation has been a game changer for my use of Iron Condors.

I use equal width wings on the Iron Condor for a couple of reasons. Equal width seems to tolerate price movement, both up and down. Equal width also leads to a net negative Delta position, decreasing the total position profit when prices go up and increasing profit when prices go down, which is good in a bear market where downturns are frequent. Negative delta actually is somewhat neutral if the value is only slightly negative- Iron condors also have negative Vega, or decrease profit when implied volatility goes up. So, typically when prices go down, implied volatility goes up, and impacts of the negative Delta and negative Vega cancel each other out.

My Iron Condors are opening somewhere around 50% of the width of the wings. For example, if I have 100 wide wings, I would expect to collect $50 premium. I initially resisted this, thinking that the probabilities would be too low. However, since the time in the trade is so short, and I plan to actively manage moves against my position, I find that the risk reward ratio becomes favorable. However, the example trade that I’ve used is a little wider body and collected only 30% of the width.

Strikes compared to EM
This chart shows previous market movement at the time of entering a trade, along with the expected move based on implied volatility and boxes to illustrate the strikes of the Iron Condor. The dates are the opening date, the expiration date, and the planned target date to close. This trade used long strikes that were at the expected move at expiration.

I have devised a graphic that may help to visualize this setup in regards to the expected move and time frame of the trade. The graph has several components- a historic rendering of what the index has done for the past several weeks, a curve showing the expected move for the next several weeks based on current implied volatility, and two boxes to represent the put and call strikes shown from the time of opening until expiration, and the target date to take action. My point with this chart is to show that while the strikes chosen are within the expected move at expiration, they are outside the expected move through the time I expect to be in the trade before I manage it. Said another way, if the position were held to expiration, it is very likely it would be breached on one side, but because the plan is to manage early, a breach is not likely- it would take an outsized move beyond the one standard deviation expected move.

Managing the trade with rolls

I manage my Iron Condor with what I think is a fairly unique rolling strategy. I roll my positions out in time and change all strikes in the direction that price has moved. If price goes up, I roll all the strikes up. If price goes down, I roll all the strikes down. I just roll whichever way the market goes. Here’s the interesting part- if I keep in the “profit zone,” I can roll up or down for a net credit with each roll, and my existing position will have a net profit. Usually, one side will be sitting with a profit and one side with a loss. The losing side is being tested- its strikes have higher deltas than when the trade started. The profitable side will have lower deltas than when the trade started. My profitable side should have a bigger profit than the loss of losing side. When I roll, I will likely have to pay a debit to get my losing tested side back to a good set of strikes at the new expiration. However, I should be able to collect a bigger credit on the profitable untested side than my tested side cost. Ideally, every roll is closing a profitable trade and collecting a net credit to open its replacement. All of this sounds great, too good to be true, but there are a number of details to unpack.

The first challenge is to stay in the profit zone. My general rule is that if I keep my untested short strike must never drop to a Delta value below 15. The reason is that when the Delta of the untested side gets below this point, it quickly stops being able to meaningfully contribute to offsetting price movement in the tested direction. For example, if the price drops, the short call will get further out of the money and drop in value, while the puts will go up in value. For a while the Deltas will mostly balance each other out, but as the Delta of the short call drops below 15, the put spread will start increasing much faster and the calls decreasing less. If this happens, it is time to act and roll all the puts and all the calls down to where there is again premium on both the put and call side. If price has gone up too much, it’s time to roll up all the puts and calls.

Actually, I try not to wait until the untested side gets to 15. I think of my position of having three possible states, green, yellow, or red. Green is when both short strike’s Deltas are above 20- everything is great and there is nothing to do. Yellow is caution, one of the short strikes are between 20 and 15, and probably will need to roll soon. Red is stop and take action, one of the short strikes is 15 or below, so it is time to roll immediately. So, my choice is clear for Green or Red, but I need to use some judgement in the Yellow state. If the day starts in the Yellow, I am more likely to let it ride for a while and watch to see if it recovers or gets worse. If the market has trended throughout the day and moved into the Yellow, I am likely to roll before the end of trading so I don’t end up deep in the Red overnight. If there is a strong trend pulling the position quickly toward Red, that may also be a good indication to act. Yellow is a judgement call.

I find that it is harder to have a profitable, credit roll when tested on a quick up movement. As mentioned earlier, equal width wings means that there will be a negative delta overall, and while volatility reduction can help, big up moves can be hard to stay on top of. That’s why this strategy works best in a bear environment, when the market is trending down.

Don’t over manage. Markets bounce around a lot, and it can be tempting to want to act on each little trend that happens. If I have the right strikes- the right body width and wing width for the market conditions, my position should be able to tolerate price movement. If I’m trading at 30 DTE, I want to wait 3-6 days between rolls, so I need to be choiceful about not rolling too often. If the market moves a huge amount in a couple of days, I may need to roll early, but then I’ll want to try to go longer before the next roll. The other thing to consider is that often the markets overshoot in one direction or the other, so I try not to move too far to chase moves that go on for days, and stay patient that the market will counter the trend.

If a position isn’t winning regularly and isn’t holding its premium in control, that’s a sign that the strikes aren’t right for the market and the duration. For a while I was trading 7 DTE Iron Condors on SPX with around 100 wide bodies and 50 wide wings. I would adjust nearly every day, but I couldn’t keep the position in the profit zone, and I often took losses. There wasn’t enough space in the body and the wings weren’t helping enough. By widening out the body and wings and adding more time, I found the position much easier to manage, and more likely to be profitable, and much less likely to take a big loss.

One way I can tell if I have a forgiving position is to compare my premium to the premium of the same position a few strikes higher or lower. For example, with Schwab StreetSmart Edge, I can pick Iron Condor as a strategy, pick an expiration date, pick a body width and a wing width. The application will then give me a list of strike combinations and premiums for those parameters. If all the choices around my preferred strikes have similar premium, then I know that price movement will have minimal impact on my chosen position. If there is a rapid change in premium for other strikes above or below my choice, it means my Iron Condor parameters are not very forgiving, and I should adjust time or widths or both. Other brokers will have similar ways to compare prices by shifting up or down all the strikes.

I have updated the earlier graphic to illustrate how a change in price over time will dictate the choice of a new position to roll to. The new price now dictates a new expected move, and new ideal strikes and expirations. Hopefully, this chart will help those that are fond of graphical illustrations.

roll down and out
After 7 days of mostly down moves, I decided to roll down my positions and roll out to a later expiration. In this image, the old position and expected move are there along with an updated expected move and new strikes.

Eight legs in the Roll

Since an Iron Condor has four legs, rolling involves closing four legs and opening four new ones. I don’t think any broker or exchange allows a eight-legged trade, so at a minimum this will take two trades to complete the roll. My preference is to roll the puts as a trade, and roll the calls as a trade. I usually start with the side that is being tested and might need a debit to roll to a new expiration and strikes. Then I do the other side, usually moving the same amount and keeping the same width, expecting to collect more to roll the untested side than I pay to roll the tested side.

At times, I may have a situation where I don’t have enough buying power to roll one side while the other side remains in place. If that happens, I’m probably using more of my buying power than I should, or the position is just too big for my account. It isn’t that big of a deal to manage the situation, however, I just close the untested side out and roll the tested side, then open a new position on the untested side. Worst case scenario, I can close the whole Iron Condor at once- freeing up its buying power, and then open a new one with the same buying power. As long as the wing widths are the same and the new Iron Condor collects more to open than the old Iron Condor cost to close, there should be a net gain in buying power. But again, any time buying power restricts a trade, it is probably time to pare down some positions in the account.

How Iron Condors tolerate price movement

Probably the best way to explain how an Iron Condor tolerates price movement is with an example. Earlier in this post I showed an opening trade from April 1, 2022. Let’s look at it again and look at how it fared after 7 days.

Premium and Greeks for Iron Condor
Here is the setup of an actual trade from early 2022 on SPX using the criteria from this post.

Notice that the premium collected is approximately $15 each on the put side and the call side.

Closing position
After a week, price has dropped to 4500, but the premium has dropped for a profit.

The premium on the put side has gone up to around 16.50, while the call side has dropped to just under $6.

After 7 days
After 7 days the premium increased on the put side but decreased on the call side, as illustrated by the larger and smaller strike position arrows, and the result is a net profit.

So, after 7 days, the trade made about $800 on $10,000 risk, an 8% return. But, that’s just the start- the plan is to roll, and so the closing trade above was combined with the following opening trade:

new roll position
On April 7, this trade was opened while closing the old position for a net credit and strikes that are back at the edge of the expiration expected move.

The combination of closing the old trade and opening the new trade is a net credit of just under $14 premium. This is the result we are looking for- a profit on the trade being closed, and a credit to move out in time and get to better strikes for the latest situation.

And just to finish the example trade, let’s look out another week and see what happened to the market and the trade that was rolled to.

roll result
After rolling down, the market kept going down, but stayed within the new strikes with plenty of space to spare.

By April 13, the market had dropped even further, approaching where the puts from the original position had been. However, the roll down gave the new position plenty of space and the trade was sitting at a profit, and ready to roll again.

Closing the rolled position
After 6 days, the rolled position had decayed even after a market move. Again, puts lost money, but the calls made the position profitable.

This trade made $1430 in 6 days, a 14% return on capital. Since the market went down, the put side of this trade lost money, although not that much since the price didn’t end up that close to the put strikes since our new strikes were lower than the old ones. Time decay helped counter the price movement against the puts. The money was made on the call side through both price movement and time decay. In the end time decay, represented by Theta, eats away premium as long as price doesn’t get too close to the strikes.

These are examples of trades I did during the Spring of 2022 in the face of a bear market. Not every trade faired this well. Some market moves were too fast and too far for me to be able to roll before the position went too far to one side. But more often than not, this rolling methodology has kept me from having positions blown out, and keeps day to day portfolio value from varying out of control.

You may notice that the example trades shown here don’t exactly follow all the mechanics I’ve described. Since those trades I’ve become a little more likely to intervene early, although it’s a balance with avoiding over-adjusting.

Finally, I don’t always get my rolled positions re-centered, like I did in the example I presented here. Often, I’m happy to just move in the direction of the market and make sure my new strikes are a bit out of the money on the tested side. In this crazy bouncy market, we get lots of reversals, so I let my positions stay a little off when the market has moved a long way and technical indicators suggest the last several days move may be about finished. However, these choices come down to individual trader preference and market outlook. No one knows what is happening tomorrow or next week, so we each have to decide what trade is best based on the information available. For a real life example of this type of decision making in action, see my post on the Goals of Rolling an Iron Condor.

Good luck trading and rolling Iron Condors!

Rolling Losing Positions?

I recently responded to a social media post which asked why there is so much hate out in the social media world regarding rolling losing option positions. If you frequent any discussions about managing option trades, and someone discusses rolling a losing position, there will be some critic who comments to say that rolling options is horrible and locks in losses, and is a low probability trade, and basically is un-American. I sometimes get these kinds of responses myself, and if you read much of what I write, you know that I disagree with that. Rolling is a key part of many of my strategies including the rolling 7 DTE trade that I frequently trade. So, the following is my thoughts on rolling losing option positions.

As someone who rolls almost all my positions, win or lose, and often writes about it, my thought is that a lot of people that write negatively about rolling don’t really understand the benefits. It isn’t an issue that everybody should roll, or that nobody should, but more that it is a method that works well for a certain mindset. Some traders approach managing trades very differently and that’s great for them.

I think the issue is when the discussion comes to managing a losing position. There’s really three choices: hold, stop, or roll. A legitimate argument can be made for each approach, but I think the right answer comes down to the type of position that is in trouble, the trader’s view of the market probabilities looking forward, and personal preferences around risk and reward.

I roll my credit put spreads on SPX in virtually every situation. I want to avoid expiration drama, so I never hold to expiration. When I used stops in the past, it seemed like I got stopped out just as the market bottomed out and I found that frustrating. I now specifically seek out trades that accommodate rolling options and develop mechanical triggers on when and how I’ll roll a position.

For me the benefit of rolling a losing position is giving myself time and space to be right. I almost always collect a credit for a roll, so I’m paid to wait for a turnaround. Each roll improves the cost basis of my trade. When my position is being tested I try to roll both down and out for a credit, so that I don’t need a full recovery to come out with a profit. Since most of my positions are credit spreads, I do have an issue that if my position gets in the money, it is no longer able to roll for a credit, and I’m forced to pay a debit to stay in. Because my positions start at least an expected move away from the initial price, I rarely end up in the money paying a debit. I’ve found that with the trades I do, I collect credit 97-98% of the time, and the debits I pay have generally been about the same as the credit I get when I’m rolling a winning trade which happens much more often.

The big benefits I see from rolling credit spreads is that I keep time decay working for me 24/7. I don’t have to decide when to jump back in after being stopped out because I’m never out.

For those that say that rolling locks in a loss and puts you in a worse position, I understand that the act of rolling options, closing a losing trade and opening one is truly closing a losing trade. However, my new position is poised to earn all the loss back plus a profit beyond. Usually, when rolling a loser, the market is approaching an oversold situation and is increasingly likely to start back up. Since almost all my rolled positions are still out of the money, I usually still have positive expectancy and better than 50/50 odds of a profit. Market downturns are the best time to buy, so in many ways I’m forcing myself to buy the dip.

Rolling losing option positions does introduce a lot of volatility into a portfolio value. I get great returns through rolling, but my positions’ marked values go up and down more than many people can tolerate, and I understand. Every strategy for management has pros and cons, and some are no-goes for some traders. Each person has to find mechanics that match their tolerance for risk, and expectations for return.

It isn’t easy emotionally to roll in tough markets, but I don’t think it is any easier to take a loss when you are stopped out. I lost a lot just today, Nov 30, 2021, and did a number of rolls as part of my mechanics. However, I’ve been through this numerous times before, recovering fully each time, and built up cash reserves in good times, so that I’m ready for whatever the market is going to do.

Some types of trades just aren’t made for rolling options. For example I won’t roll a credit call spread that loses because I find they just compound losses as the market drifts higher more often than it falls, and it isn’t a fight I can win consistently. I don’t use rolls as much in individual stocks because moves can be extreme and last a long time. I don’t try to roll trades on expiration day because the numbers don’t work out. So I do have limits and don’t blindly roll every kind of trade. I find that many people critiquing rolling as a strategy are talking about one of these losing situations that even I won’t roll in.

I’ve had many people reach out to try to understand rolling options and from their questions I can see that it is a hard concept to grasp. I love it when the lightbulb comes on for someone, and it is also troubling when someone misses the point and drops a position, closing at the worst possible time. I usually get a few messages of a bad loss on days like last Friday or today, but I also get nice thank you notes from many more when the market goes up after a downturn and the person came out of a down market with a profit overall and their account at new highs.

I know my rolling approach isn’t for everyone and that’s okay. But it works for me. If it doesn’t work for you, then do what does work for you, and maybe learn a little more about rolling before you bad mouth it out of hand.

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