Weekly options: A business approach

March 16, 2015 12:00 PM

Nine-day rut iron condor

The nine-day RUT iron condor is one strategy that facilitates trading options as a business (see “Visualizing the condor,” below). RUT is the Russell 2000 index. An iron condor is a four-option strategy that can be conceptualized as a put credit spread on the bottom and a call credit spread on the top. Ideally, the RUT just sits in the middle and the trader keeps all the premium he collected when expiration comes and goes. Life usually is not that simple, however, and this is where the craft (and a bit of art) come in.

The trade is put on each Wednesday morning. Sheridan suggests 10:30 a.m. as the best time.

“This lets the market settle a bit before entering, gives you some idea of how crazy the day might be and most importantly, avoids big potential gap openings,” he says.

It is conducted as follows:

  • You sell the put strike that carries a (negative) 14 to 16 delta and buy the put that is five points lower. The long strike caps the loss in case of market plunge. It is insurance.
  • On the call side, you sell the call that carries an 8 to 11 delta, and similarly, buy the call five points higher. This should deliver a credit of 80¢ to $1, against a total risk of $5. 

Sheridan explains: “The reason I sell higher delta in puts versus calls is to get position deltas close to zero and let theta do its job. In SPX and RUT, selling the same delta on the put and call side will get you out much further on the down- side and much closer on the upside. This is because of the high volatility in OTM puts and lower volatility in OTM calls.”

The profit target is 10%, figured against total risk. The maximum loss is 15%. The maximum days in the trade are seven. Do not take the trade into expiration as market whipsaws can turn profits into losses in short order, and neither time nor adjustment can recoup the losses.

The adjustments would then be preordained as follows: 

First upside adjustment: When the delta of the short call option increases 12 to 14 points, and is now 20 to 25, roll up the put side to short with 14 to 15 delta, similar to the initial put side. Achieve a minimum net 40¢ for the roll. If the market moves big on the first day of the trade, the delta of the short call shoots up by eight delta points. Make the adjustment then; don’t wait.

Second upside adjustment: When delta of short call is 30, roll put side up again to 14-15 delta for the short strike.

First downside adjustment: When the delta of the short put option increases 12 to 14 points, roll down the call side to short with a 10 delta. Achieve a minimum net credit of 40¢ for roll. If lightning strikes, and the market moves down big on day one and short put delta increases by eight or nine points, adjust at that time.

Second downside adjustment: When the delta of the short put hits 35, 
roll the call side down again. Achieve net 40¢ on roll.

Cutting the strategy’s risk with an adjustment is shown in “Position management” (below). If the market reverses, when the short delta increases by 10, adjust or just take off at max loss. When the max loss is hit, get out.

After an adjustment is made, the profit target is decreased from 10% to roughly 7%. That is typically the net cost of the adjustment.

In this example, the adjustment is by “rolling up” or “rolling down” the credit spreads. There are many other ways to adjust. Examples are adding a long option, adding a vertical credit spread, a vertical debit spread, adding another kind of delta neutral strategy on top of the iron condor, such as a calendar spread, butterfly or double diagonal. The possibilities are myriad. None is right or wrong, but is important to keep things simple. However, the most important aspect of adjusting is the timing; that is, when you adjust, not how. Too complicated? Explore the four-day iron condor, a popular strategy because you are only at risk two days per week. 

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About the Author

John Sarkett is the author of several books on options, including “Option Wizards: Real Life Success Stories from the Financial Markets.” His e-mail is jas@option-wizard.com. Dan Sheridan can be reached at dan@sheridanmentoring.com.