[Music] Hey everyone, welcome back to the show! Thanks for tuning in. My name is Mike; this is my whiteboard, and today we're going to be talking about three iron condor adjustments.
We've been discussing these adjustments for different strategies, and I think it's super important to understand what we do when we're placing a trade, what we're looking for in certain high IV trades, certain low IV trades, or maybe certain trades where we're looking at more of a neutral environment. But what's even more important is understanding what we can do—not necessarily what we should do—but what we can do to improve our cost basis on different market moves and how those market moves affect these strategies. So today, we're going to be talking about three iron condor adjustments and different things to think about when we're adjusting these iron condors.
We're going to get right into it. We're going to talk about the opening trade with an iron condor, which is basically the combination of an out-of-the-money put spread that we're selling, along with an out-of-the-money call spread that we're selling. If you think about these strategies as combinations of other things, it becomes a lot easier to mentally understand how these spreads are going to be adjusting and how they're going to be battling each other in this case.
So if I'm selling an out-of-the-money call spread, which is a bearish assumption, against an out-of-the-money put spread, which is a bullish assumption—just like a strangle—this is going to create a profit zone right in here. Our max profit is going to be realized if this stock price trades anywhere between 75 and 85 at expiration. But since we're collecting a credit, if it exceeds these strikes here—if it exceeds 85 or if it goes below 75—we still can make a profit as long as it doesn't go more than a dollar below 75 and more than a dollar above 85.
In this particular example, we're looking at selling an iron condor for one dollar credit. You can see that this is a three-dollar wide iron condor, or a three-point wide iron condor, and that's just because my call spread is essentially the same width as my put spread. So we're looking at the 85, selling that call there, and we're looking at buying the 88 call to create that call spread.
We're looking at selling the 75 put and purchasing the 72 put to create that three-point wide spread on each side, which gives us that risk assessment of the three-point wide iron condor. So with that in mind, we know that we collected a dollar here. If we're selling premium, and this is a premium selling strategy, we know that the most we can make is the credit received because the best-case scenario is that the stock price is between these short strikes at expiration, which would allow all of these options to expire worthless—exactly what we want when we're selling premium.
We would be able to keep that one dollar credit as our profit, which brings us to our max profit of 100. If we're selling a three-point wide spread for one dollar, that must mean that our max loss is 200. All you need to do is take that width, or if you have a non-equidistant spread—let's imagine that I sold a five-dollar wide call spread but a three-dollar wide put spread—then my max loss in that scenario would be four hundred dollars because I can lose more on this five-dollar wide call spread than I could if I lost on the put side of that three-dollar wide.
So it's really important to realize that if you're not trading with equally distanced options here, then you're gonna have to take the larger of the two and assess your risk off that one. But luckily, this one is equidistant. I've got the 85 and 88 giving me a three-point wide spread and the 75 and 72, which gives me a three-point wide.
So regardless of where the stock price goes—if it blows through the upside or the downside—it's going to be the same risk profile. So I'm still going to have that max loss of 200, and because I've collected a dollar, my breakevens are actually a little bit better than these strikes. Since I collected a dollar, I can apply that to the downside as protection, so my breakeven to the downside would be 74.
The same theory applies to the upside—since I collected a dollar, I can just apply that to the upside for the short call, which brings my breakeven to the upside to 86. So we've laid out the iron condor, what to think about it, and how it's created. But now, what can we do when the trade goes against us?
So let's go to the next slide, and we'll look at what we might be able to do if the stock price goes up. If the stock price moves up, there are a few things that we can do. The best thing that we've shown we can do is to move the untested side up, or roll the untested side up.
You'll see our studies all the time for this on strangles; the same thing applies to iron condors. We're just dealing with defined risk, so we'll be able to collect less of a credit than if we were dealing with naked options. But at the end of the day, it's going to benefit us for a few reasons.
So let's say that 20 days went by, or 25 days went by, and. . .
We're left with 20 days on this options expiration cycle, so the stock price actually comes up to our long strike of our call to 88. The stock price has moved significantly up, about 10 percent. So, what can we do?
Well, one thing that we can do is create an iron fly. If we move the puts spread, which was originally down here, we close out of that position and we adjust the strikes to sell a put on the 85 strike and purchase the 82. What we can do is create an iron fly, and we're going to collect more credit.
So, what does this do in terms of our max profit, max loss, and break even? Well, if I collect a 40-cent credit for rolling up these put strikes, that's going to make me in a much better position than if I were to have done nothing. If the stock price actually ends up at 85 now, which is exactly where we would want it to realize max profit, if it expired exactly at 85.
00, all of these options would expire worthless because an option is in the money if it's in the money by one penny. So, if it's actually at 85. 00, these strikes—all of them—would expire worthless.
The puts would expire worthless, and the calls would expire worthless, which would give us our max profit of 140. Now, you have to remember that I sold the original spread for one dollar. So, if I'm able to adjust these put strikes and move it up here to the 85 strike to create an iron fly, which is basically just a defined risk straddle, I'm just selling a put and selling a call, and I have defined risk wings on either side that are three points away from that strike.
If I'm able to do that for 40 cents credit, I just add that 40-cent credit on to my original sale of the spread. So, for that reason, if I'm able to reap my max profit, it would be 140. Now, since I've collected a dollar forty now as opposed to just a dollar, that's going to adjust my max loss.
My max loss moves from two hundred dollars down to 160 because I'm collecting an additional 40 cents. And with that said, you guessed it, my break even is going to change as well. So, my new break even is going to be adjusted here; my break even is going to be giving an extra 40 cents to the upside, so it's going to be 86.
40 to the upside. And since I collected 1. 40 to the downside, my new breakeven is going to be 83.
60 on the downside. So, this would actually be 83. 60, not 73.
60. I apologize for that typo, but it's going to be adjusted because of the fact that if my stock price does move past my long put strike, I would be at my max loss of 1. 60.
Since we're moving these strikes up, it's going to be adjusted, and we're going to have to make that adjustment ourselves. One comment I have here is that if we do this, of course, it's going to be harder to profit because I'm moving my range from a 10-point wide range, as we had originally, down to a pretty slim range of right around two dollars and eighty cents. Because I know that if I'm selling this spread at 85 and I've got a dollar forty to the upside before I break even and a dollar forty to the downside before I break even, I know that my range of profitability is two dollars and eighty cents.
So, of course, it's going to be harder to profit. My max profit is only going to be realized if the stock price is right on these short strikes at expiration. But at the end of the day, I did lower my max loss by doing this.
I collected 40 percent more premium by collecting another 40 cents on my original dollar, which allows me to realize a lower max loss if the stock price continues to move up or if it stays right here. So, all in all, it's going to be harder to profit, but it is going to lower my max loss and reduce my cost basis overall, which is really what we're concerned with when we're dealing with trades that are going against us. Now, let's go to the next slide, and we'll talk about what would happen if the stock moved down.
One thing I want you to consider is implied volatility. So, you saw that when the stock moved up, I went ahead and created an iron fly right away. The reasoning for that is because normally when we see a stock rise, you'll probably see implied volatility go down.
On the flip side, if we see a stock going down, we normally will see implied volatility rise. So, what is implied volatility? Let's quickly review.
Implied volatility is just a reflection of the option price action. So, if implied volatility is going up, that means that option prices are going up, not only with at-the-money options, but they're also inflating across the spectrum of the option chain. So, if implied volatility is increasing, especially in the outer options that are far out of the money, I'm probably going to be able to get a little bit better premium in those far out of the money options.
So for this reason, if I can assume that when the stock price goes down, I'm going to be able to collect some premium by not creating that iron fly, then what can I do? Well, maybe instead of creating the iron—instead of creating that iron fly where I would be moving this call spread all the way down to 75, I would be able to. .
. Just move it down a few points and still collect a fair credit. So, if I'm able to move my call spread down to, let's say, 80 and 83, where I'm still creating a nice wide range for me to be profitable while collecting a little bit less credit, but since I've got 35 days left in this option cycle, I'm able to do so.
I might consider doing that as opposed to creating that iron fly right away. So here, if I've got a dollar that I originally collected and I sold this additional spread for 30 cents, or moved my spread down for 30 cents, my new max profit is a dollar thirty. Unlike my previous example, where my max profit is only realized if the stock price stays right on those short strikes at expiration, I still have some room here.
So now, my max profit can actually be realized if the stock price is anywhere between 75 and 80 at expiration because that would allow these options to expire worthless, which is exactly what we want. Since I'm only collecting 30 cents, my max loss doesn't go down as much as if I were to be collecting 40 cents like in the previous example. But since I still have this nice wide range of profitability, maybe this would be a better option than creating that iron fly in this example.
So, what happens if we get blown out? I think this is the question that a lot of people ask on the support channels: what happens if my trade gets blown out? Well, number one, it's okay if that happens because of the fact that we're dealing with defined risk.
So, we should know what our max loss is going into the trade, but is there a way that we can adjust it? So, let's go to the next side, and we'll talk about that. If the stock price blows through our strikes, is it worth it to maybe roll down to those same strikes?
Well, what I want you to realize is that, as we talked about, that implied volatility factor—sure, if the stock price blows through our strikes, especially to the downside, we might see—and we should see—an implied volatility increase; normally, we would see that. But if the stock price is way far away, let's say our stock price is all the way down to maybe 60 or 65, if I look to roll these strikes down to 80 and 83 and can only do it for a 10 cent credit, would I want to do that? Well, for me personally, I probably wouldn't unless I'm collecting about 30 cents.
That's probably my personal threshold for iron condors, between 25 and 30 cents because we have to consider some things. So, if we've got the great commission structure where I'm selling options, or any commission—basically, any trade that I'm making—is a dollar fifty when we're looking at options, if I move this spread down, not only do I have to close that original call spread for three dollars (it's just a dollar fifty for each leg), but now I have to open a new one. So, if I can only do that for 10 cents of credit, I've already pretty much wiped out all that credit in commission costs.
And if, for some reason, I need to close this later on in the trade, then that's another three dollars. So, I collected 10 cents, but if I have to close this spread, open this one, and then close this one later, that's nine cents of commissions. So, I would have wiped out all of the credit that I would have received originally.
For me, it's always important to realize our commission costs when we're placing the trade. So, for me personally, I probably wouldn't move these strikes down to this level or even this level down here unless I'm getting around 25 or 30 cents because at that point it would be worth it. Even if I'm rolling down that position and then I have to close those legs again, I would still be profiting about 10 or 15 cents with commissions included.
So, for this case, if I'm looking at rolling it down to these strikes and I'm only getting a 10 cent credit, I probably wouldn't make an adjustment; there's not enough credit for me to be realizing this and making it worthwhile. So, let's go and wrap all these up with some takeaways for you. The very first takeaway is that we seldom have to accept max loss.
If we look at all of these examples, if I could roll down that last example for 10 cents and really my main goal was to reduce my max loss and not think about the future or the commissions, then sure, I could totally do that. But in the other two examples, we reduced our max loss and collected an additional credit without accepting that max loss. So, when we're looking at defined risk or even undefined risk, there are many ways we can make adjustments to collect additional credit that reduces our max loss that we originally thought we had on the trade.
Secondly, think about the implied volatility factor and credit potential. Normally, when a stock price moves down, we would expect to see implied volatility go up, so that might give us an opportunity to keep our profit range a little bit wider while creating and collecting a fair credit like you saw in the second example. Lastly, we don't adjust further than the iron fly.
When we're looking at adjusting iron condors, we're not going to overlap those short strikes; we're going to keep them at the same strike, at the very most in terms of adjustments because of the fact that if we overlap. . .
Those strikes we're now dealing with are somewhat of an inverted iron condor, where we're going to have to buy back those short strikes if the stock price is within that range at expiration. This is just going to cost us more in commissions, and we're not going to be able to realize that full credit potential. So, we don't normally adjust further than the iron fly with iron condors.
Thanks for tuning in! My name is Mike. If you've got any questions or feedback at all, shoot me an email at one of these emails here, or you can follow me at @doTraderMike.
Stay tuned, though! We've got Jim Schultz coming up next. Hey everyone, thanks for watching our video!
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