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.
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.
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.
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.
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.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.
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.
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.
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.
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 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:
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.
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.
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.
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.
I hit a milestone trading the broken wing butterfly strategy, passing 500% return in one year.
In June I hit a milestone trading the broken wing butterfly strategy, passing 500% return in one year. I learned the basic concept from Nick Batista and Mike Butler of TastyTrade.com. I was so pleased that I wrote the following note to Nick and Mike:
BWBF Success 500% in a year
Nick Batista/Mike Butler-
I’m writing to thank you for introducing me to trading broken wing butterflies.
A few years ago, you guys turned me on to the concept of Broken Wing Butterflies. I played around with the concept and settled into a trade that I was able to repeat over and over. Last June I set up an account with $9,000 trading only butterflies. Earlier this year I added Broken Heart Butterflies to the mix, because my strategy was a little susceptible to big drops. Not really sure why I have kept a single strategy in this account, but I’ve just kept going with it. After a year, I’m now at $54,000, which is 500% above where I started. I’m “only” up 119% this calendar year as I’m carrying around 50% cash most of the time to have for fighting downturns.
I played with this trade for over six months until I settled on this strategy in early 2020. I realized that butterflies hold value until expiration is close, so I adjusted this to a 21-day trade. I also wanted to make the trade worth my time, so I collect a lot up front. And I realized that hitting the high profit butterfly butterfly was close to impossible, so I just hold to get my premium collapse, which is much faster than a simple spread with the same risk.
typical setup of a broken wing butterfly trade (negative premium = credit to open)
My butterfly strategy is to sell two of the 25 delta puts and buy one a strike or two above, and buy the one twice as far below. I sell these 17 to 21 days before expiration and collect 12-18% of the width of the narrow spread or max risk. I close when this gets to 2%, by converting to a free butterfly. This works around 90% of the time. I was doing this in several accounts last year and had over 100 wins in a row at one point, making 10% in two weeks, over and over again. Eventually, I had some tests where I sell the debit side and roll the credit side, often for a debit. As long as I have cash to fight, I can hold out. I then wait them out for recovery.
Adding the Broken Wing Condor
I noticed that my tests were more likely when the market was going crazy up, hitting new highs every day and then a correction occurs. So, I was attracted to the broken heart butterfly in those situations for a little more probability, but less benefit. I think it is actually a broken wing condor, but whatever. For that trade I buy a 40 delta put and sell the one a strike or two below, then sell a spread three times as wide centered around 20 delta. I try to collect 6-8% of 2/3 the width of the wide spread (max risk). I open this up 14 days to expiration. Because of how this setup decays faster on the credit side, I target to collect 1-2% on the close. So I collect about 7% to open and collect another 1% to close. I can make a little more if I’m on the verge of being tested with 2-3 days left to expiration. Worst case, I sell the debit spread and roll the credit. I think I’ve only had one or two of these need to be rolled. I’m all about return on capital, so I look to make at least 10% a month on any short option strategy I do, while keeping probabilities very high.
All in all, I’m happy with how this is going and continue to watch Tasty for new tidbits every day. I especially like your show, because you are all about trade mechanics- what works and why. You also seem to venture out from standard Tasty style trades and look for creative ways to think about opportunities. Your discussions on leveraging skew and other unique situations are very insightful. Anyway, I just wanted to let you know that what you do is really helpful and that your approach to trading has given me tools to keep experimenting and try new things that have ended up being very successful for me financially.
Thanks so much-
(I received a nice note back from Nick)
If you want to see how I set up broken wing butterflies and how they work, go to the page I wrote on it here.
The basic 7 DTE trade is that I sell a 40-50 wide spread one week out at 10-12 delta for the short strike. I usually collect over $1.50 in premium, and I try to buy it back 2-3 days later as part of a roll for something under $1.00, usually by collecting around a dollar in a roll. For the most part, I roll the position every Monday, Wednesday, and Friday.
Since early January 2021, I have been trading a continuously rolling 7 DTE put spread on SPX. I finally took time to separate the data for this trade from my other trades to show how well it has worked. I’m averaging greater than 6% per week return on capital. The basic 7 DTE trade is that I sell a 40-50 wide spread one week out at 10-12 Delta for the short strike. I usually collect over $1.50 in premium, and I try to buy it back 2-3 days later as part of a roll for something under $1.00, usually by collecting around a dollar. For the most part, I roll the position every Monday, Wednesday, and Friday. No matter what happens, I roll and try to collect additional credit.
Said another way, I’m in a trade for a couple of days and collect about 2% on average for the effort. For example, a 50 wide spread collecting a net $1 on a roll has collected 2%. The profit comes mostly from time decay (Theta) and somewhat from upward price drift.
What is a roll?
For those not familiar with rolling, it is a trade where one position is closed while a similar trade with better profit probabilities is opened all in the same trade. In this case, I might buy back a position with 5 days left to expire for $0.75 and sell a similar position with 7 days to expire for $1.75, a net credit of $1.00.
Managing when the market goes down
Most of the time (76%), the trade wins outright and I close for less than what I sold the spread for. When the market goes against my position, I roll down and out as much as possible while collecting more premium.
In the few events where I end up in the money, I use debit rolls to reposition out in time at lower strikes. In this situation, I may pay more to close my 5 DTE position than I receive for opening a new 7 DTE position. The idea is that SPX will eventually turn around and the roll won’t cost that much if I stay within a reasonable distance. I’ve used this technique on many put positions last year during the Covid crash and now on this trade. Since the trade should generate lots of credit most of the time, I’ll take the risk of a total blow-up, and use profits to protect the position however far is needed. Probably not everyone’s cup of tea, but it’s my plan- roll, roll, roll, no matter what. I don’t know where I would want to set a stop for this trade- it’s defined risk, and rolling gives me the possibility and probability of full recovery, eventually.
Historically, 98% of my rolls with this strategy are for net credit, and only 2% are a debit. That’s a lot more cash coming in than going out.
Why does this work?
The general concept is that this trade is selling a spread that starts with about a 90% chance of expiring worthless. Essentially, it would take two expected moves in the full time-frame of the trade to put the short strike in the money. It also decays quickly and approaches zero well before expiration in the majority of the time. So, my expectation is that most of the time I can get around 1/2 of the premium collected to decay in about 1/3 of the time to expiration, then get out and do it again. By always being in the trade, I take advantage of the fact that time is always passing, which is the only sure thing with options. Being two expected moves away to start allows the position to filter out a lot of noise and still make money without a lot of stress over where the market is going. When we get the expected move down, the position is still in good shape because that’s only half-way to the short strike. By rolling down and out, we can re-establish further away from the money and still collect a credit. Even several down days in a row can be absorbed, as this happens somewhat regularly. My experience is that defensive rolls work out back to a full win without getting in the money 80-90% of the time. To be really problematic, it takes a move of over 5% down in less than a week that doesn’t recover at all to move the position into the money. I’ve been in survival mode several times with this trade and recovered fully each time. I expect that there will someday be a scenario where I can’t roll enough to recover, but I have saved back cash reserves to allow starting over if that time ever comes.
On the other hand, this trade generates 4-6% return on capital per week most of the time, so it should double its value in about a five-month time frame if there is not a major drawdown and even with no compounding re-investment. I’m not sure how to calculate the probability of a winning week, but I’m pretty sure it is well above 90%. The probability of an in the money scenario is likely in the 2% range, and I expect this scenario a few times a year, with a position that drags out without recovering for over a month happening in the once every few years timeframe.
I’ve adjusted my mechanics a few times during the time I’ve been trading it. I started this the second week in January, at 100 wide and switched to 50 wide contracts when I realized that the extra width wasn’t gaining much, and was extra risk and extra buying power. I’m now trading 40 wide. I’ve gradually gotten more methodical in my approach, although I’m still not that rigid. Originally, I was selling 4-5 DTE and rolling 3-5 times a week. Since I switched to 7 DTE, I’ve found the trade much less time consuming with more premium and time cushion, but slightly less decay. However, the concept is the same- sell way out of the money put spreads and roll out every two days or more often to collect additional premium.
Why SPX?
I trade SPX only for this, and I think it is perfect because it has less price swings that almost any other underlying, and it is big enough that the commissions/fees are negligible. I tested RUT and NDX and found them to be too volatile for my taste. I’ve tried SPY, but I find it hard to get filled near the mid-price on my rolls, and commissions are a much higher percentage of the trade. I got the original idea from a post in a Facebook group last December, and tweaked it until it fit with my style. There are a lot of ways to vary this, but this strikes me as a nice way to trade fairly near to expiration options with a high probability of success without a lot of drama. I know several people who now also do their version of this trade, some using stops, some getting in and out based on the market, some using technical indicators to inform their decisions.
Results summary
The sheet at the end of this post shows each individual trade. At the first of the year, I showed trades that I rolled out that were losing by their cost basis to me. So, if I sold a spread for $1.50, bought it back for $2.10 and sold the new position for $2.50, I would show closing at 1.50 and opening the next trade at $1.90, my adjusted new cost basis. In June, I decided that this wasn’t very transparent, so I switched to showing the actual closing cost and opening sales price when I have to roll out on a tested position. Either way, these were my actual trades. I think that is easier to see how the trade works when the market is challenging. I’ve scaled up the number of contracts I trade, but for simplicity, I’m showing just one contract. The dates are the expiration date of the position- I don’t track which date I actually roll.
When I charted this out, I was surprised to see how consistent this trade has been in accumulating profits. Keep in mind that my results are just for the trade, and don’t take into account having cash on the sidelines to use for defense if the trade goes into the money. My goal in this trade is to consistently generate cash as time passes by, and for the most part that is what has happened.
My results for this trade are in line with these expectations so far. In over 8 months, I have made money every single week on this trade except three, which is amazing to me, considering that the market had a few weeks where it really trended down. In the first four months of this trade I doubled my money. While this is the most consistently profitable trade I regularly do, I only use a small portion of my capital with this trade due to the tail risk from a major crash.
I hope this explanation and the data attached helps you understand this trade a little better. As you all know, this is one of several trades I do. I thought this would be of particular interest, especially considering how well it has worked. I’m very aware that there is considerable risk in this trade, despite its high probability of success, and that even in the majority of times significant volatility to the position can be expected.
I’ve shared this trade in a number of other forums and received a lot of questions. Here are some common ones:
How does this compare to 0 DTE?
One reason I started this trade was that I wanted an alternative to the 0 DTE or expiration day trades that I see a lot of people doing. I tried my hand at these using stops, and I would have long strings of wins followed by a big loss that I couldn’t get out of in time. It was very stressful to me, and most importantly, I wasn’t making money for all my effort. When I came across this concept, I saw that I could use many of the same management techniques, namely rolling, that I use in longer duration trades, and avoid expiration day stress.
Where does 4-6% return on capital per week calculation come from?
A couple of ways to think about this. I’m making at least three trades a week with this strategy. Each trade has an average profit of around $0.80 per share, or $80 per contract. The capital at risk is the width of the spread, $40 per share, or $4000 per contract. Either way, that’s 2% profit for the capital at risk. With three trades a week, I total up to 6%. I could just as easily say 25% per month, or 100% per quarter, but that is less intuitive.
Why not use stops?
I know a lot of people are big fans of stops. They prevent losses from getting out of hand, which in many situations is an absolute necessity. Stops also eliminate the possibility of a position recovering. My view is that market movement is mostly random up and down, and my experience with stops is that I often get stopped out right before the market reverses, locking in a loss that would have been much less if I had stayed in the trade. As a result, I prefer to find ways to extend out the trade on positions where I have a reasonable expectation that the position will recover in a reasonable amount of time. With the S&P 500, this has been a very reasonable expectation, especially if I can re-position my strikes down while collecting more credits in the process.
Advantage of defined risk over naked puts
I know that many people are big proponents of selling naked puts because there is more premium per contract than with a spread. However, naked puts take more capital in most situations, and have undefined risk. Because a spread requires less capital, the return on capital can be much higher. Having defined risk through a spread, provides a floor for the trade that prevents the possibility of completely blowing up an account with an outsized black swan type loss event. For those reasons, I avoid selling naked puts, and instead sell credit spreads. One caveat is that if a naked put is sold cash secured, the risk is reduced to market risk and can never blow up an account- however, returns will be a small fraction of trading a spread. It’s all trade-offs and a matter of strategy preference.
Are these three trades at once or one?
I trade this with just one position, opened and closed three times a week or more with a roll. For example, each Monday I close the following Friday position 4 days out and open a position for the following Monday 7 days out. Then, on Wednesday I close the Monday position 5 days out and open a new position for the following Wednesday 7 days out. Then, on Friday I close the Wednesday position 5 days out and open a position the following Friday 7 days out. I just repeat over and over. If the market jumps up somewhere in between rolls, I may choose to roll to higher strikes in the same expiration for an extra credit.
Why not hold to expiration if the odds are so high?
The strikes I pick decay quickly, and I expect the position I roll into to decay more than if I had held the position I closed. This is why I can make $3 in a week with a position that sells for $1.50 to $2.00 to open on average. By rolling to a new position, I make better use of my capital. Also, rolling early gives more flexibility to manage compared to positions that are closer to expiration.
What time of day is best for the roll?
I’m still trying to determine when the most profitable time to roll is. I don’t believe time of day is as critical as the action of the market. Ideally, the IV of the strikes at 7 DTE are much higher than those at 5 DTE to maximize the difference in premium. But when is that most true? What triggers that situation? It appears to be a mix of variables that I haven’t yet been able to model or pin down. My tactic is to monitor the net credit available throughout the day and trade when I can get what seems high based on my previous experience. So, it is more art than science, which is never my preference. Alternatively, I just put in the trade when I have time, knowing that time decay generally works out so that no matter what credit I get to roll, it will average out in profits in the end. I’m not convinced this is optimal, and I may be leaving some return on the table. This is an area I continue to study.
What strike do you roll to? Always to 10-12 delta?
Ideally, I’d always roll to 10-12 delta strikes if the market were constantly grinding higher. However, the market varies and sometimes goes down and rolling to 10-12 delta would require paying a debit to achieve. My strategy is to collect a credit to roll whenever possible. So, if I can roll to an ideal short strike in the 10-12 delta range for a credit, then I do it. If I can’t, then I roll to the lowest strikes I can while still collecting a credit. This causes the delta value to drift when the market is in a downturn with an expectation that eventually the position will work its way back to the ideal delta values. Because we work from values so far away from the current price, we can afford to drift closer from time to time, knowing that the probabilities still favor the position decaying.
What about bear markets?
I don’t know when we will have a bear market. Obviously, if I did, I’d get out of this trade to avoid losses and get back in at the bottom. Lots of people predict crashes, and if you predict a crash enough times, you’ll eventually be correct. I’m not naïve, I know a bear market will come some time. But since I can’t predict it, I’ll deal with it when it or a significant correction comes. I’ll use the mechanics I’ve described for this trade, and fight to make a profit with defensive and survival rolls. Remember, in down markets the strategy is to aggressively roll down strikes, improving the probability that even a modest recovery will lead to a profit.
Is there a scenario where this trade could be a total loss?
Sure, this is a highly leverage trade, and as such a fairly small correction could put this position deep in the money and marked for a near total loss. Any number of events could trigger a sudden drop in the market- for example: a surprise Fed announcement, another unexpected financial crisis, a natural disaster, a military or terrorist action against the US or US interest, or another pandemic. Most situations would progress slowly enough to allow this trade to be adjusted and rolled out and down, but some could be so sudden that there would be no action that could be taken. After 9/11 the market was closed for several days, and opened way down when it did open. Is it possible that the market could be closed for the life of a contract? Absolutely. I’m sure there are numerous scenarios for total loss that I can’t anticipate with this strategy. The only thing I can do is be prepared that a total loss won’t ruin me financially because I keep cash on hand as an ultimate hedge.
How much do you scale up your position to compound profits?
This trade can provide a lot of cash. I see three ways to use the cash that is generated. One is to take it as income. Another is to save it as a buffer for when the market requires a survival roll for a debit, or even a total loss. And finally, cash profits can be plowed back in to increase the amount of contracts traded. So, how much to use for each purpose? It depends mostly on how much income you need from the position. I know that taking income distributions means that money can’t be used to build the size of the account. But, I take out what I need to. With what’s left over, I have a simple rule. I want as much cash available in the account as is required for the strategy. For example, in a $40,000 account, if I have $20,000 capital required for five 40-wide spreads, then I want to have $20,000 cash buying power available and not used. If the account grows to $48,000 balance, I can add another contract- that’s another $4,000 at risk and another $4,000 cash buying power sitting in the account. Effectively, this cuts my portfolio return in half, but with compounding from scaling up, the portfolio would theoretically
These returns seem unbelievably crazy. Are you making this up?
These results are actual trades I’ve done. I don’t know what will happen in the future, but this trade has worked well so far. There’s no guarantees, and past performance does not predict future results. This trade has substantial risk, and potential for big rewards.
Can I see a log of this trade over time?
Sure, here’s eight months of raw data:
2022 Update-
As we moved into 2022, the market changed dramatically. 2021 was a very calm year with no downturns in the S&P 500 of over 5%. However, with inflation growing and the Federal Reserve taking action to tackle inflation, the market became much more two-sided and essentially bearish.
So, for this trade, I have adjusted to sell both sides of the trade, puts and calls. Instead of a credit put spread, I now sell an Iron Condor. I aggressively adjust my strikes up and down with each roll now, using credits from moving the untested side rolling toward the current price to pay for debits if needed to roll the tested side away from the current price. This has reduced volatility of my positions and made the trade manageable in this near bearish environment.
The other change that I have made is taking advantage of Tuesday and Thursday expirations. With expirations every day, I can move my positions out to 7 DTE every day, allowing regular adjustment of my strikes while rolling out each day.
Combined, I feel like I have more control managing my 7 DTE positions in a volatile market. Results are looking positive with these changes and I will update when I have enough data to show. Once the Federal Reserve is done tightening the economy and switches back to stimulating, I will likely switch back to puts only or some hybrid that goes in and out of calls.
I’ve used my go to option strategies of credit put spreads, complementary back ratio call spreads, and using call spreads to cover calls to take advantage of the reversal from the mid-March lows
What a difference four weeks can make. From the end of February until March 23, my account dropped over 45% in value, worse than the stock market. However, since March 23 the account has gained back all of the loss and then some, a much better performance than the overall market. At the end of the day Friday, my account was up around 9% for the year, and up 4% from the high value at the end of February. All this from an account of mostly short option spreads, specifically credit put spreads. What happened, and what can be learned?
I’ve used my go to option strategies of credit put spreads, complementary back ratio call spreads, and using call spreads to cover calls to take advantage of the reversal from the mid-March lows. It’s been a fight every day, and a different approach than normal, but the positions are working.
Lots of mistakes on the way down
I made a number of strategic errors along the way that accelerated my losses. For months preceding the COVID crash, I maintained a negative Delta position in my portfolio as the market moved up to new highs seemingly every day. I watched my short calls go deeper and deeper into the money, while I sold puts just below or at the strikes of my short calls for lower and lower Delta values. I took some losses and reset my positions with more neutral to positive Deltas to go with the run up as the new year started. As the news of the coronavirus started hitting the news from China in late January, I scrambled and went negative Delta on a down day, which backfired when the market proved resilient after a one week drop. I discussed this error in a previous post. The market went on to hit new highs in mid-February and I held my own, moving to a positive Delta as it appeared that the coronavirus would not be that big of a deal. I even let a large group of underwater short call spreads be assigned for a big loss after many earlier rolls had kept hopes alive for getting my money back if the market went down.
The following Monday, the market started making big drops down. Initially, this worked out okay. I still had a number of short call spreads deep in the money that benefitted from the initial drop. But at strikes just below these call spreads were short put spreads that started growing big negative values. I had sold these to collect premium to offset the rolls I did to the call spreads, thinking that they would never approach being in the money.
In the early weeks of March I was worried that a whipsaw up would drive my call spreads back negative, so I bought the call spreads back when they reached 25% of the width of the spread, a nice improvement from values of over 90% of the width of the spread, but a loss compared to selling them originally for 15-20% of the width of the spread. Meanwhile, I let the put spreads keep going deeper into the money. I even sold some additional put spreads at what seemed like high volatility and low Deltas, only to see them get swamped a few days later when the market dropped 5-10% multiple days in a row. By this time, whatever the market lost, I lost double. One day the market went down 10% and I lost 20% of my account- in one day! Those were hard days to keep a positive attitude.
The data that kept me going
I never really considered cashing out to stop the losses. If anything, I knew that getting out would simply lock in the losses I had in my account. The losses were paper losses- once the position is closed, the loss or gain is real. That doesn’t mean that there is any guarantee that a paper loss will reverse- in fact, the raw option probabilities at the time suggested otherwise. But other data gave hope for better days.
Volatility is mean reverting. When volatility is at historic highs, it is likely to come down sooner than later. At its peak, the VIX was just over 80, implying an 80% move in the S&P 500 in the following year, based on option prices. Normal VIX values are around 18. It will take time to get back to normal values, but values in the 50s, 60s, and 70s are unsustainable. The way the VIX comes down is for the market to go up. The only question was when it would turn around.
The VIX almost always overstates what future moves will be. And volatility skew drives put premiums to high prices in all market environments, but especially in times of high volatility. The only time that owning puts makes money is while the market is dropping quickly, and that is the only time that being short in puts loses. My position lost money due to both changes in underlying prices that moved my put strikes into the money, but also due to increased volatility that made the premium go up. Knowing that these premiums were unsustainable, I felt comfortable that I would get my put premium back if I could hold on long enough.
The options I sell are typically 5 to 8 weeks out from expiration. That gives me time to wait for a reversal, time to adjust positions without panic. Normally, I close positions 2-3 weeks prior to expiration, but conditions will sometimes drive me to either act earlier, or go closer to expiration. The key is that having time gives me choices. Normally, I look at time decay as my primary consideration for how I manage my positions. During this crash and partial recovery, price movement was my main concern. In Greek terms, Delta (price movement) was the primary concern, while Theta (time decay) and even Vega (volatility changes) took minor roles.
All of these factors have been drilled into my head from watching and studying the research of the great folks at TastyTrade.com. They have presented numerous studies that show how market downturns are opportunities for those who can take advantage. Of course, you have to have capital to really take advantage, and I was pretty tapped out by the time we hit bottom.
I have my own approach, and I also build a variety of models and studies to help guide my strategies. I’ve never been comfortable with undefined risk strategies, the use of naked options. This recent period has re-inforced that point of view. My research has focused on how to use spreads to define risk, but also provide a profitable rate of return. Spreads behave differently than naked options, and require different strategies. Ideally, I get the majority of my profit from far out of the money credit put spreads. On the other hand, I mostly sell calls as part of a back ratio spread, because I’ve found credit call spreads to be problematic due to long periods of market up movement.
My recent winning approach
As we approached the bottom on March 23rd, I closed the remaining credit call spreads in my portfolio. My sense was that we were getting to a point where upside risk was greater than downside risk, and I didn’t want to lose on the way back up.
1. Rolling the credit put spreads
With the market down 20-30%, I had many credit put spreads that were deep in the money with strike prices as much as 20% above the underlying price at the time. I figured that if I could move the spreads even half way closer to the current trading price, I’d have much better odds of getting some or all of my money back. On the worst down days, I rolled my put spreads down, either widening the spread, or paying to be closer. This meant rolling short puts with Deltas of 90 or more and moving them to around 70 Delta. Many of these moves paid off big within a week of the move when we had a 10% move up of the market in a day. I used up days to roll out put spreads that were at the money or slightly out to later expirations, collecting premium and giving myself more time. I wrote a separate post on this strategy a few weeks ago.
2. Adding delta neutral back ratio call spreads
I generally take both sides of the option spectrum in my trades. I sell puts and calls on the same underlying at the same expiration. I use the same amount at risk capital on each side. As I got rid of my call spreads and rolled my credit put spreads down, I wanted to double-dip with calls, but without the risk of getting beat up with a whipsaw move up. If I sold credit call spreads, I feared that big up moves would drive these new call spreads into big losses. I didn’t want to lose on both the way down and on the way back up. So, I used back ratio spreads instead. The way I set these up is I find call strikes that have the same width as my put spread, and have Delta values where higher strike is half the Delta of the lower strike. I sell the higher Delta call and buy TWO of the lower Delta calls. The call position is Delta neutral and takes on no additional capital risk, because I use the same width as the put spread I already have. For example, I may sell a 30 Delta call and buy two 15 Delta calls. If my puts are out of the money, I may even sell calls in the money, for example sell a 60 Delta call and buy two 30 Delta calls. I collect a premium, which I keep if the strikes end up out of the money. If the underlying goes up, I make money from owning twice as many calls as I sold. For more details, read a further explanation on my web page on back ratio spreads.
I do have some long stock positions where I have sold covered calls in the past. Most of those calls have gone deep in the money a long time ago, and I rolled them periodically to collect a small premium. The recent COVID crash gave me an opportunity to finally get out of these positions and reset for a turnaround. Even out of the money, these positions still had a lot of time value due to volatility being at high levels. As I looked at each position, I generally did one of two non-traditional things- I sold a credit call spread, or even a back ratio spread in a later expiration. What this means is that while I still sold a call on my position, I used some of the proceeds to buy higher strike calls. By doing this, I have choices if prices go up substantially, but I’ll still keep premium if prices go down or stay flat. The back ratio spreads have the potential to create additional profit, with two long calls outgaining one short call, on top of the return from the underlying shares that are being covered. There are some minor downsides to this, but in a period where price movement is the key consideration, back ratio spreads are a great use of calls, even when covering long shares of stock.
How it worked out
From late March through the middle of April, the market has gone back and forth, up and down, with more up days than down. The market is up substantially from its low on March 23, but still well below the highs reached in late February. My positions have taken advantage of these moves.
My put spreads get more and more healthy as the market moves up. Almost all of them are now out of the money, although I still have a few under water. I’m rolling them out as they approach 21 days to expiration, and only for a credit. I actually rolled up a put spread that had gotten too far out of the money- the short strike had a Delta in the single digits, so I reset the spread to a 19/13 Delta because expiration was still 35 days away. I now use down days to open put spreads with slightly higher volatility. It feels more like normal times.
The call back ratio spreads have generally worked out great. They benefit from big price swings, but are vulnerable to decreases in volatility. They work best with long expirations- 4 to 10 weeks, so I’m pushing my expirations out to accommodate them. I also adjust them frequently, rolling up when the market goes up and rolling down when the market goes down. I collect premium both ways, moving to Delta neutral each time. In a declining volatility environment and an up and down market nearly every day, collecting additional premium keeps me ahead of Theta and Vega decay.
I do have a few regular credit call spreads where the width of my put spreads were too small for a corresponding back ratio call spread. These are my new problem positions because the big up moves have put some of them in the money. I’m determined to fight these, and one by one, I’m converting them into back ratio spreads or closing them before they get out of control. I’m also only opening new put spreads that have a width that a optimal back ratio call spread can match.
Of the upswing back, I’d say that 50% of the gains have come from put spreads getting out of the money, 25% from my long stock/ETF shares, and 25% from call strategies.
Looking ahead
Now that my portfolio is getting closer to my normal strategies, I’m starting to pay attention to Theta values and work toward a more neutral Delta position. I’m still negative Theta because of how many long calls are in my back ratio call spreads, but I’m working these down by going to strikes further out of the money where Theta is more in decline. The underwater put spreads also have negative Theta, which should reverse when they get out of the money. I’m still long Delta, but my call positions are slightly negative. As my puts get more out of the money, Delta will go down. I’m also working to free up capital, so I can have funds to jump in if volatility spikes back up.
Conclusion
While I’m not happy with how I got into this mess, I’m feeling quite fortunate to have beaten the market back to for the year. The challenge is to keep up the positive momentum.
Generally, there is a way to roll any option position to a new more favorable position and even collect a credit, if more risk is taken on. This may mean converting a $10 wide spread to a $12 wide spread and collecting $0.05, but improving the the possibility of profit.
Every good option trading resource says that a trader needs to have a good management plan to avoid big losses. Usually this is followed with vague explanations of setting mental stops and adhering to them. I fully agree with this, except that I believe a trader shouldn’t have vague plans. When an option trader opens a trade, the trader should know what conditions, good or bad, will necessitate an exit. And a system like that will work great until it doesn’t, like maybe during a coronavirus outbreak.
Most of my option strategies involve selling defined risk credit spreads that I enter with many weeks until expiration. My plan is to exit every position 2-3 weeks before expiration, buying back the spread for less than I paid for it. For each strategy, I have a target profit to exit, and a loss limit that I use to get out.
But, sometimes a good plan just fails. What should I do if the market drops 5% overnight and my options strikes were 2% below yesterday’s close? I can wait for a bounce back, which once I’m underwater makes sense if I have time to wait. With my approach, I usually have time. But when a 5% drop becomes 15% or 25%, it’s pretty clear that the odds are I’m not going to see my spread get anywhere close to getting out of the money. This is one of several desperate scenarios I’ve found myself in, not just the past month, but other times as well.
So, what is there to do? Most professionals will say to take the loss and start fresh. If the position is a total loss and hopeless, just leave it until expiration and hope a miracle occurs. All the capital is gone. That’s probably sound advice, and if anyone asks what they should do, that’s what I’d say. But, that’s not always what I do.
Against all advice, and probably all probabilities, I will take a total loss and roll it into something else that has a better chance for success, but increases capital at risk. To repeat, I add even more capital at risk to try and salvage a bad situation, perhaps making a bad situation worse. If that just freaks you out to think about it, just stop reading and move along. Options involve risk, and these approaches might be called risk squared.
If you are nutty enough to still be with me, let me explain. More than most investments, options truly balance risk and reward. Or maybe it is more like a balance between probability of profit and potential reward. Most initial strategies I open have a high probability of profit, but a somewhat limited reward. Those strategies therefore have a dark side, the potential for big losses a small percentage of the time. More often than I should, when those losses happen, I choose to fight to get my money back, because the odds are somewhat switched the other way- I hope to get a big return on the additional capital I add to the position by recovering much of my loss.
Here’s a quick example of a credit/bull put spread. Let’s say I sell a $10 wide spread and collect $1 premium. In real money, I’m risking $1,000 to make $100. Since I collect $100, I’m really only risking the other $900. The odds are probably around 90% that if I hold the spread to expiration, the options will expire worthless. Or I probably have a 95% chance of being able to buy back the spread for $0.50 or less around halfway to expiration. I like those odds. (The odds are actually better, but that’s a different topic.) A few months ago, I did a trade like this over and over, and won 26 times in a row, each time keeping way more than half of what I collected. That’s great, but this post isn’t about the good times, it’s about that 5%, 10%, 20% or whatever percent that things don’t go as planned.
When a trade like the one above has the underlying equity drop in price many times more than the expected move, the position sits at max loss. So, the above $10 spread would sit with a value of $10, a cash value of negative $1,000 in my account. When this happens, it usually happens to a lot of positions at once, even if the portfolio of options is well diversified in every way possible.
Here’s what I do for this situation.
Plan A- get out
First, I try to get out before it gets this far- plan A. In a slow moving market, this is often possible, and I lose something like 1-2 times the premium I collect, but keep over half my capital. When I can, I do this, but there is downside to this practical strategy. Often, underlying prices fluctuate a lot and a position will show a loss, but then turn around for a profit. There is a whole statistic around this, the probability of touch. Read about it in my Greeks section of the website, under Delta. Suffice it to say, if I’m too quick to take a loss, I’ll take more losses than I should. So, the more time I have, the more leeway I give the position to recover. And when there isn’t time, I aggressively get out to preserve capital. In slow moving markets, that works, and it’s the smart trade.
Plan B – wait and see
When the market moves quickly against me and just blows through my strikes, I can continue with plan A and take a bigger loss, but assuming I’ve lost 80-90% + of my capital at risk, there isn’t much capital to preserve. At this point, closing locks in a huge loss to save a small amount of capital, or I can wait and potentially get a big chunk of capital back. Since I trade in a timeframe of several weeks, I like to take time to evaluate the situation. This is a luxury compared to day-trading options that are at expiration. The first question I ask is, how likely is the trade to turn around in the time left on the option contract? If the issue that caused the price drop appears temporary with the possibility of recovering by expiration, then it makes sense to do nothing but wait. If the issue behind the drop is continuing to make the underlying price drop, I will also wait to see how bad it gets before acting, even though that likely guarantees that the position will move to max loss. I wait, and I evaluate options.
Plan C- roll down and widen the position
When a position looks hopeless, I can either give up or do something about it. Generally, there is a way to roll any option position to a new more favorable position and even collect a credit, if more risk is taken on. This may mean converting a $10 wide spread to a $12 wide spread and collecting $0.05, but improving the probability of profit, or more accurately the possibility of profit.
Recently, I had a chance to do this when more than one put spread was blown out by the huge market drop from the coronavirus. Here’s one example. I had sold SPY puts spreads with strikes of 310 and 305 when SPY was trading at over 330 in mid February this year. I like to think of the trade in terms of Delta values. The 310 strike had a Delta of around 18 and the 305 was around 10. That is the sweet spot for me to open a put spread, and I collected $0.75 per share. Expiration was set for late March with a plan to get out in early March. However, the market dropped rapidly, due to the coronavirus, and SPY was well below 300 in a matter of days, and below 275 a week later. By that time, Delta values were between 80 and 90, and the spread was trading between $4.50 and $4.75. I was hopeful that maybe this was temporary, so I waited. When the price of SPY dropped to below $250 on a huge sell-off day, I rolled the spread down to 275 and 267.5 with an April expiration, and collected $0.03, and now increased my capital at risk. I thought more time would allow me to get out, even though my Deltas were still over 75. Unfortunately, the market kept going down. A little over a week later, SPY dropped below 220, and I decided to act again, rolling down to 240 and 230 for another $0.05 credit. Still, Deltas were over 75. Then the market went up, a lot. When SPY went over $250, the Deltas were under 30, and the spread could be bought for $2. I bought it back. In the end, I lost $1.18 premium per share. My original position would have expired a $4.25 loss. I could have rolled out and down again to get a chance at an actual profit by May, but I really wanted to free up capital with the market up. A few other similar positions were rolled down and out further using the freed capital, and maybe they’ll end up a profit. The point is, this position was set up for max loss, and by aggressively converting through a risk-adding roll, the loss was significantly reduced.
A few things I consider when I do this. I try to roll down underwater put spreads on big down days. This may seem counter-intuitive. If I’m at max loss and the market drops more, my position doesn’t actually change much. A $5 wide spread might go from a book value of $4.85 to $4.90 on a $15 underlying drop. I could then roll down the spread $15 for a small debit, or widen the spread to $5.50 or $6 and collect a small credit. I usually play around with different possible rolls, both on the same expiration date and later dates. If I can get more time for not a lot of extra cost or capital risk, that is preferable, since I’m waiting for a recovery.
Indexes vs. Individual Stocks
I also tend to do this more with equity index ETFs than I do with individual stocks. There is a lot of historic examples of markets bouncing back from big drops, even if the bounces are temporary. Individual stocks have more complexity in that they may or may not follow the rest of the market and have their own unique issues that drive their price in unique ways. My goal in a desperate situation is to use big declines in market value to reposition my option spreads to be able to get out of the money when a bounce occurs. I’ve just found that indexes are more likely to accommodate that strategy.
Spreads partially in the money
I want to differentiate between a spread that is fully in the money and one that is partially in the money. When I have a credit spread where both the short and long options are in the money, then I’m fully in the money, and max loss is a real possibility. When only the short option is in the money, but the long is still out of the money, I’m likely only sitting with a premium value of around half the width of the spread- $2.50 for a $5 wide spread, so the position is partially in the money. When a position is partially in the money, I have a couple of active choices, close before I lose the other half, or roll out for additional time and a credit. If the underlying price is actually closer to the short strike than the long, I can almost always roll out to a later expiration date with the same strike prices for a credit, and I may be able to roll down or narrow the width for less credit. The point is there are more positive choices that don’t add capital risk when a spread position is only partially in the money.
Naked put considerations
I also want to point out that these types or rolls are for credit put spreads, not naked puts. If you sold a naked put and you are in the money, the only choice available to avoid a loss is to roll out in time. The good news is that it is almost always possible to roll to the same strike price at a later date and collect a credit, something that isn’t true with a spread. The bad news is that there aren’t really any other choices. A naked put has undefined risk, and if the underlying price keeps dropping, the losses keep adding on.
Reverse an early assignment
When positions get deep in the money, the risk of early assignment grows. Assignment is when an option buyer exercises the option before expiration. Since we are talking about market downturns in this post, this is when a put buyer makes a seller buy the underlying security. Because I try to close or roll positions well before expiration, I don’t get assignments very often. But it can happen, and when it happened the first few times, it can be very troubling. I woke up one day and found that I had bought $500,000 of SPY, and also had an accompanying -$500,000 cash balance due. Before panicking, remember that a spread has an equal amount of long contracts to the amount of contracts that were assigned. If I had 20 short contracts assigned into 2,000 shares, I also had 20 long contracts still sitting in my account. When I get an early assignment, it usually means I get a negative cash balance in my account, and I can’t make any other trades until the assignment is adjusted in some way. There are a number of choices on how to get out of this and either not lose any more, or even reverse the situation and roll into a position to get some of the losses back.
The simplest thing to do would be to just sell the shares, which would likely get the cash balance back positive, and eliminate all the new shares. However, if the assigned shares are sold by themselves, the link between their value and the long options hedging them is broken. What link am I talking about, you may ask?- I don’t have a spread anymore, I have shares and long options. The link is that the shares were bought at the short option strike price. Let’s say I have a $5 wide spread, short a $250 strike put, and long a $245 strike put. If one contract is assigned, I buy 100 shares for a total of $25,000. But the assignment was because the underlying security was trading for less, say $225 a share. If I sell the shares at the market, I’ll only get $22,500 for them, a loss of $25 a share. Didn’t I buy a $245 put for some reason to help with this?
Another transaction I could do would be to sell both the shares and long put at the same time. Most likely both are well in the money. If that is the case, I could sell the combination and lose no more than the difference in strike prices. In my example above, I would make at least $24,500 to sell the combination of shares, because the long option price would be relative to the underlying price. For example, if the underlying price is $220, the long option would be worth $25, and the sale of the combination would be $245 per share, or $24,500 cash. If the underlying price was closer to the strike price, the sale might make a little more if there is time value in the long option.
My experience is that puts that are exercised early usually are exercised at very near the low of whatever is going on, say after a day when the market was just devastated. If the shares are sold alone and the long put is held onto, the market is more likely to go up and eat away the value of the long puts, which locks in the oversize loss. I’ve done it myself, but I don’t do it anymore. Instead, I look for ways to reset my position without losing a hedge.
An easy way to reset the position that was in place before an assignment is just undo the assignment- sell the shares and sell the same put that was assigned. So, if a $250 strike short put was assigned, just sell the assigned shares and re-sell the $250 strike short put. Likely, the sales price will be just under $250 per share total, maybe $249.90- just under due to the bid-ask spreads of each leg and any remaining time value in the option being sold. For example if the underlying was trading at $220, the shares would well for $220 and the $250 strike option would sell for just under $30, at total of just under $250. So, the total cash received would be just less than the $25,000 that was required to buy the shares. And we’d basically be back to where we started before the assignment, less a tiny amount of pricing spread and maybe some time value in the option. The problem is that since shares were assigned the previous night, they might be assigned again the next night, and the we’ll be right back in this mess again.
Here’s one more choice- let’s reverse our position at a different price and different expiration, a four legged trade. Some brokers allow this to be done as one trade, but most will require this to be done in at least two separate trades, which is fine. The plan is to sell the newly assigned shares with the remaining long put, and then open up a new spread that is more favorable, like we could have if the short option hadn’t been assigned. Using the example, we’ve been using with our $250/$245 spread with the $250 short strike assigned to us, we’d sell the shares and the $245 strike long put for about $245 a share, or a total of $24,500 cash. Then we sell a new put spread closer to the money, and maybe a bit wider to collect a $5 or more credit per share or $500 total per contract. After all that, we have a position more likely to get out of the money with more time, albeit with a bit more capital at risk.
Conclusion
So, when the market trashes a put spread, there are ways to recover, even if there is an early assignment. I try to pick the least bad of several terrible choices. Some ways are more complicated than others, but desperate positions may lead to desperate measures.
Final disclaimer- this information is just information, and not my advice. Trading options involve significant risk, often multiple times the value of the initial trade, and every trader has to understand and consider the risk of a trade for themselves. Every situation is different, and there is no correct answer for every situation. Adding addition capital to a lost position can likely lead to loss of that capital as well.
Earlier this week, I decided to go all in on adjusting the Delta of my option portfolio. Monday, to be specific, I moved from a somewhat positive portfolio Delta to a very negative portfolio Delta. In hindsight, this was a bad move for a variety of reasons, and I thought it was worth writing a post to share.
Background
For those of you new to option Greeks, Delta is the option parameter that measures how much a underlying security price change will change the price of the option. If a stock goes up $1, how much will the option price change? For every position in your portfolio, you can measure this impact, and with a little math, you can figure this out for your whole portfolio. The key is to price weight the Delta values so that different priced stocks and ETFs are weighted proportionally to their impact on the portfolio. There is a whole section on Greeks on this site that goes into the particulars if you need more information. There is also an overview of Delta included. However, it isn’t necessary for you to fully grasp all the theory to understand the point of this post.
Before my changes, my portfolio moved about half the amount on a percentage basis as the market moved in the same direction- if the market went up 1%, my portfolio went up 0.5%. After the change, my portfolio moves two times the market in the opposite direction- if the market goes down 1%, my portfolio goes up 2%.
Why did I do this, you might ask? Well, the market has gone nowhere but up for the past three months, and is due for a reversal. It is up so much that I saw in the weekend Barrons publication that one indicator says we reached “Euphoria” levels this past week, which says we are likely to be lower a year from now. Also, the coronavirus was in the news and could have a big impact on the global economy. Last week the market was down for the first time in three months, and we had all four days close at a loss. (The market was closed Monday for MLK day.)
Over the weekend, I decided I was positioned the wrong way- my portfolio was positive Delta and all indications were that the market was going down. And Monday, the market opened way down, over a percent and a half lower than the close on Friday. My portfolio showed a loss of just under 1% for the day. If this is what we are going to see for the next several weeks, I needed to get positioned to profit.
If you aren’t familiar with my approach to option trading, I’m a big proponent of defined risk credit positions. In other words I sell options spreads for a premium and then expect them to decay in value so I can buy the spreads back for much less than I sold them for. I sell both put spreads and call spreads, often on the same underlying security on the same expiration, an Iron Condor. Typically, I try to be Delta neutral (price neutral), so I benefit whether the market goes up or down, but mainly when it doesn’t move very far in either direction. But for three months the market has gone up- a bunch! The call spreads of my Iron Condor were getting breached and were losing money. It is no fun to lose money when the market is going up.
To adjust for the very bullish market, I’ve started selling many more put spreads and call back spreads for the last month or so. I stopped opening new Iron Condor positions. I have several put spreads without calls. These positions benefit when the market goes up more than when the market goes down. The Delta value of these new positions are all positive. That was working well with the market climbing almost every day, and profits were rolling in. Then last week the market turned….
Monday’s adjustment
So, what did I do? Since my read was that the market was at the beginning of a downturn, I wanted to reverse how my options behaved. I went through my positions and closed out every put spread that is expiring in the next four weeks. If I had opened them several weeks ago, I could close them at a profit. However, if they were recently added, I had to take a loss, especially on Monday with the market down, when puts are more expensive.
I also converted many of my call backspreads to simple credit call spreads. If you aren’t familiar, a call backspread is when you sell one call and buy two calls further out of the money. I often buy the two calls at just less than half the Delta of the call I sold, and can collect a credit. If the market goes up a lot, the two calls I bought become worth more than the call I sold. But if the market goes down, the long calls quickly drop in value. On several backspreads I had, I sold one of the long calls that I had bought. I took a loss on each of them, but I thought they were going to soon be worthless with the market going down, so it made sense to sell. The remaining spread of one short call and one long call could then decay in my favor when the market tanks.
Why do I think this was wrong?
Tuesday, the market went up 1%, and I lost a little over 2%, because of the changes I made. So, I lost on an down day on Monday because I had positive Delta, and I lost on an up day on Tuesday because I then had negative Delta.
I still think we are likely to see a down market over the next month, and I think my position will eventually benefit. But, my approach to adjusting was wrong on several fronts. Generally, my timing was terrible and the magnitude of the change was too much at once. Here are the key principles I violated.
I closed into weakness and not into strength.
I made too big of an adjustment at once.
I should have known the odds were against me on Monday.
I didn’t pay attention to how much Delta I reduced
Let’s take these one by one.
Closing into weakness
Everyone knows that the goal of trading anything is to “Buy Low and Sell High.” For an option seller, it is actually to “Sell High and Buy Back Low,” but the idea is the same. When you have a short put position (or a credit put spread), the best time to buy it back is on a day when the market is up and it is less valuable. In a choppy market with the market up one day and down the next, picking the right day to open and close positions makes a big difference.
The same is true of selling a long call position- sell calls on an up day when the call is most valuable.
Not only was the market down the day that I closed my short puts and long calls, it was down the largest amount that it had dropped in three months! A terrible day to make this change. I paid way too much for my puts, and I received way too little for my calls.
Too big of an adjustment at once
As I already said, I think the market is still headed down over the next several weeks and I think negative Delta will do well. However, I might be wrong, and I pride myself on avoiding big directional bets.
I moved to a portfolio Delta that is negative twice the value of my portfolio. If your broker provides a SPY-weighted Delta measure, you can see this by multiplying your SPY weighted Delta times the value of a share of the SPY ETF. As an example, if you have a SPY-weighted Delta of -100, it is equivalent to being short 100 shares of SPY. At today’s SPY price of $327 per share, the portfolio will behave like negative $32,700 of SPY shares. If your portfolio had a dollar value of $16,000, you would lose 2% if the market went up 1%. That’s essentially my new position.
So, what would have been a better approach? Well, if I was absolutely determined to adjust my portfolio Delta on a down day, I could have adjusted just until my Delta was zero. Then, when there was an up day in the market, I could have adjusted into negative delta territory.
In any case, moving from a Delta value that is 0.5x my portfolio value to one that is -2x is too far, too fast. I’ll be looking for a chance to work myself back closer to Delta neutral in coming days, even if I stay with negative Delta.
Odds were against me
There were at least two predictors that I should have paid attention to on Monday before making the changes I did. I should have known that it was very likely the market would go up on Tuesday, making Tuesday a much better day to adjust than Monday. As it turned out, the market was up 1% Tuesday, the largest up move in three months.
How would I have predicted this? The first reason is a bit weak, but often true market myth- Tuesdays generally bounce the opposite direction of Monday. This is the kind of story that I tend to doubt, but many market veterans quote it every time it happens. For me, it is one piece of information to consider, but especially after a big move on Monday.
The second reason is more data-based. The most losing days in a row we have had in the past 20 years is six. It has happened only a few times, but we have not had seven losing days in a row in the past 20 years. How do I know this? Tasty Trade did a study on this last year and it stuck with me. You can see it yourself in this segment on Fading Market Moves. Monday was the fifth losing day in a row. It is very rare for there to be six losing days in a row, so the end was in sight and I attacked too soon.
There are other reasons to reconsider timing, especially on down days. We generally have more up days than down, so unless the situation is critical, there is usually a better time to reduce your bullish position than on the biggest down day in months.
If the opposite situation were true, I’d feel a little different. The market can have very long winning streaks, and you really can’t wait for a down period to fix a bearish situation.
Not knowing the number
When you run a website called Data Driven Options, you should know the Delta impact of the changes you make. I trade on a platform that doesn’t offer a weighted Delta measure, so I export a list of positions at the end of every day and calculate my portfolio delta on a spreadsheet. There has to be a better way, and I think my broker will soon offer a real-time solution, but for now, I’m flying a little blind when I make a lot of changes in a single day.
That’s really no excuse. Knowing what I wanted to do, I should have looked at the total weighted Delta values of the positions I was closing and determined the impact. I honestly didn’t think I had shed that much Delta while I was doing it. I’ll be more aware next time.
What to do after messing up
I can’t go back in time and get my Monday and Tuesday losses back. To be fair, this is far from an insurmountable loss. However, I can learn from my mistakes and share what I have learned.
The other thing I can do is to adjust portfolio Delta back toward neutral. I still want to be negative for at least a few weeks, just not this negative. To do this, I’ll start selling put spreads, especially if we have some big down days soon. Otherwise, I’ll chip away slowly. Ideally, I’d like to get my SPY weighted Delta to a value equal to between -0.5 and -1.0 times my portfolio dollar value soon. Then if we see a correction, I’ll look for an opportunity to move more closer to a zero Delta position. A slight negative Delta is generally best for option positions, because volatility changes will then cancel out underlying price moves in either direction.
Conclusion
When you are trading options, a key metric is portfolio Delta. As market prices change over time, a major consideration of what types of option positions to open and close are those that move your portfolio Delta to a more desirable value in line with your market outlook. For traders like me, this usually means moving toward zero or neutral Delta.
When changing your portfolio to adjust Delta, timing and the amount of change can’t be ignored. Over-adjustment at the wrong time puts a portfolio at risk. I know, because I just did it myself.
