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Tuesday, December 28, 2010

Adjusting an Iron Condor

This is a follow up on the Iron Condor opened here. POT has been going up in value for a while looking really strong.

Let's remember how our position looked on December 17.

I had a nice risk/reward ratio, risking $249 to win $251 and a decent profitability range that allowed POT to go from less than 140 up to 147.49 and I would still be in a winning position.

POT hit a high of 145 Yesterday and at this point you should start considering an adjustment. POT is threatening the upper break even point. If you adjust the position you lose capital making the adjustment, but you increase your chances of being profitable by widening the profitability range. If you don't adjust you keep your same risk/reward ratio, but you know chances are that POT breaks your profitability range and yo u end up with a loser. The other factor is time. If you want to adjust it's got to be now! 24 days before January expiration. Credit spreads, such as the Iron Condor, work and yield good profit based on time, and 24 days to expiration is pretty much the limit to open a new position that benefits from the options' time decay. So I went for it yesterday.

The idea is to get rid of the 145 CALL and the 150 CALL. In order to make things clear, let's see what we had first:

Long 1 Jan 130 PUT @1.13
Short 1 Jan 135 PUT @2.36
Short 1 Jan 145 CALL @2.57
Long 1 Jan 150 CALL @1.29

What we want to do is get rid of the calls side of the position. The 145 and 150 CALL that we are short now.
BUY 1 Jan 145 CALL
SELL 1 Jan 150 CALL

At the same time we want to establish a similar position with the calls but at higher prices. Say the 150 - 155 Calls.
SELL 1 Jan 150 CALL
BUY 1 Jan 155 CALL

So, adding both plays, if we want to do it all in one single transaction it would be a Butterfly like this:
BUY 1 Jan 145 CALL
SELL 2 Jan 150 CALL
BUY 1 Jan 155 CALL

And that's what I did for a debit of $77 plus $11.80 in commissions
BUY 1 Jan 145 CALL @3.52 (-$362)
SELL 2 Jan 150 CALL @1.95 (+$390)
BUY 1 Jan 155 CALL @1.05 (-$105)
Debit $77

So our final position looks like this:
Long 1 Jan 130 PUT @1.13 (-$113)
Short 1 Jan 135 PUT @2.36 (+$236)
Short 1 Jan 150 CALL @1.95 (+$195)
Long 1 Jan 155 CALL @1.05 (-$105)

PROFIT RANGE : POT stays between 132.88 and 152.14 by January 22.
MAXIMUM RISK: $287 if POT goes outside our profit range

Now, if POT is inside our profit range by January 22 we make $213 dollars, but we would have to deduct $77 that were used adjusting (widening) the profit range. So, as you can see our real profit would be 213 - 77 = $136. Still not bad for an initial risk of $249 it is more than 50% return on margin. Of course we would also need to deduct commissions.


See how this trade played out on January 11, 2011

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