The Best Time to Trade Iron Condors, Part 4: Trading With The Trend (When You Have To)
...continued from Part Three
Dealing With Long-Term Trends Ctd.
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Letís construct the following trade with SPY at$140:
- +1 February 130 put
- -1 February 132 put
- -1 February 148 call
- +1 February 150 call
By analyzing the pricing data, we can determine that weíd receive a credit of $1.25 per contract for thisposition. (This trade would actually bring in around $0.77 per contract using data from01/11/2008.)
Unless volatility has spiked recently (and we have a strongthesis that volatility will plunge soon and this credit will promptlyshrink), a credit that large for this position would set off alarm bells.
These alarm bells tell us that the body of our trade isnít wide enough. So we can use options pricing data to help us adjust toany significant changes in the broader market environment as needed.
Trading With the Trend (When You Have To)
In spite of the caveats and analysis above, there still may be briefperiods in which a strongly trending market threatens the successof your positions. Here are some ways to deal with that scenario:
- Add positions to take advantage of market movement. Instead of trying to adjust or fix broken trades, itís better to add new positions that reflect the changed situation, thereby smoothing out the aggregate risk curve of your portfolio.
- Lighten up on your allocations until a clearer picture emerges. That way youíll have more capital to deploy when youíre more confident about the environment. Asset allocation is extremely important. It is also one of the areas that new traders frequently misunderstand or underemphasize.
- Use iron condors to hedge existing directional positions. If youíre certain that you’re in a bear market, and youíve got significant short positions, iron condors and other market neutral options strategies can protect those short positions in the event of a temporary reversal.
In conclusion, we want to emphasize that the appropriateness of anystrategy depends on much more than the current trend in the equitymarkets. There are very few - ifany - strategies that can be helpful or harmful simply becausestocks change direction.
Risk management, asset allocation anddiscipline are far more important to a successful options trader thanknowing where the markets are going tomorrow or next year.
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