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Saturday, June 9, 2012

Two ways to protect Iron Condors from a Flash Crash

Today's article is a guest post by Gavin from Options Trading IQ. Gavin's strategy is focused on income portfolios, where he trades Credit Spreads, Iron Condors, Calendar Spreads, Butterflies and Covered Calls. Always trying to keep his profit curve as smooth as possible with the extensive risk management he applies. Check out his website!

Two Ways to Protect Iron Condors from a Flash Crash
(By Gavin, Options Trading IQ)

The Flash Crash. It's something that is burned into many traders’ minds and is a concern for all credit
spread and iron condor traders. Imagine for a minute that before the flash crash, you had 50% of your
capital tied up in iron condors. Unless you were protected through some type of hedge, stop loss,
contingent order or a combination of the 3, you would have suffered huge losses. So, what can we do
about it? How can we protect our iron condors from sudden and severe market moves? Let's take a look
at two ideas.

Here is a pretty standard iron condor setup:

Buy 10 RUT July 19th 660 Put @ 4.40
Sell 10 RUT July 19th 670 Put @ 5.40

Net Credit: $1000

Sell 10 RUT July 19th 830 Call @ 2.60
Buy 10 RUT July 19th 840 Call @ 1.60

Net Credit: $1000

(Click on image to enlarge)

Now let’s look at some trades that can hedge against sharp moves.


There is nothing worse than placing an iron condor and then 20 minutes later the market has a massive
move. We've all been there and it's incredibly annoying. You're on the back foot from the word go.

Hopefully you are being careful not to enter trades right before a big announcement like the Fed
minutes or a GDP report. But, if there is some big data or news due out in the first week of your iron
condor, there is a strategy you might like to try as a hedge and that is a double butterfly using weekly
options. Weekly double butterflys give you some protection for that crucial first week of the trade.

Typically I place this trade on a stock that has a high beta like AAPL, CMG, PCLN etc., but you can also try
it on the indexes, or even the same instrument you are using for your condor.

The idea is that you place the center point of your two butterflys between 3% and 5% out-of-the-money.
That way if the stock or index has a big move in the first week of your condor you will have some profits
on this trade to offset any unrealized loss on your condor.

Typically I don't adjust these trades, but I might close out one side once I hit a decent profit and then
leave the other side open in case of a snap back. Also, if the stock hasn't moved much, I will close the
trade for whatever I can get the day before expiry, or sometimes I will just let it expire. So you have to
be prepared to take the maximum loss on this trade. Let's take a look at some examples.

The first is a RUT weekly double butterfly set up as follows:

Buy 1 RUT June 16th 770 Call @ 5.90
Sell 2 RUT June 16th 785 Call @ 1.50
Buy 1 RUT June 16th 800 Call @ 0.45

Net Debit: $335

Buy 1 RUT June 16th 715 Put @ 1.25
Sell 2 RUT June 16th 730 Put @ 2.50
Buy 1 RUT June 16th 745 Put @ 5.10

Net Debit: $135

As you can see the max loss on this trade is the sum of the two debits; $470 and the max gain is $1030
which occurs if RUT finishes at either 785 or 730.

(Click on image to enlarge)

 Ok, so let’s now take a look at the same type of trade, this time using AAPL as an example:

Buy 1 AAPL June 16th 580 Call @ 5.10
Sell 2 AAPL June 16th 595 Call @ 1.52
Buy 1 AAPL June 16th 610 Call @ 0.44

Net Debit: $250

Buy 1 AAPL June 16th 530 Call @ 0.69
Sell 2 AAPL June 16th 545 Call @ 1.71
Buy 1 AAPL June 16th 560 Call @ 4.40

Net Debit: $167

As you can see the max loss on this trade is the sum of the two debits $417 and the max gain is $1083
which occurs if AAPL finishes at either 595 or 545.

(Click on image to enlarge)


Iron condors are short volatility trades, so it's not a bad idea to add a few long volatility trades into your
portfolio as well. There are two schools of thought here, use the same instrument as your iron condor,
or find a stock / ETF that is close to a 52 week low for implied volatility.

The advantage of trading the same instrument is that the two trades will generally move in opposite
directions so it provides a better hedge.

The advantage of trading a different instrument is that you can take advantage of perceived differences
in implied volatility. You may end up profiting on both your iron condor and your hedge position.
The opposite is also true however. If your iron condor suffers a loss due to a big move, but for some
reason implied volatility on your hedge instrument stays the same or falls, you will suffer a loss on both

The next question is what expiry month to choose? As you are buying options, it’s best to go at least
a few months out so it gives the trade time to pay off. This also has the benefit of hedging multiple
months’ worth of condors (although you may need to adjust the strikes from time to time).

I prefer to use the long strangle as opposed to the straddle as it is cheaper to implement. If you want to
make it even cheaper you can turn the strangle into a short iron condor by selling some further out-of-
the-money puts and call. Let's take a look at an example.

Buy 1 RUT Sept 20th 550 Put @ 4.70
Buy 1 RUT Sept 20th 890 Call @ 2.55

Net Debit: $725

(Click on image to enlarge)

So there is two ways to hedge your iron condors from severe market moves. You can play around with
the two strategies above and find a system that suits you, there really are unlimited “options”.

I hope you enjoyed this information and found it useful.

I’m giving away some free resources, and coaching material to all Lazy Trader readers and they are
available only through this link to Options Trading IQ.

Related Articles:
Different ways to adjust an Iron Condor
Adjusting an Iron Condor
How to adjust or roll a Credit Spread
How to adjust a Double Calendar Spread
Repair a Call Option by Rolling to a Debit Call Spread

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  1. Hi Henrik,

    Thanks for posting this article. I'll be checking the comments every day this week, so if anyone has any quesions, i'll be happy to help.

    These are just 2 examples of how to protect against a flash crash, there are quite a few others as well.

    1. If underlying moves fast on you near the 670 P or 830 call, you can have it put to you or called from you. besides hedging, do you always buy the put or sell the call before it hits the strike? If so, how close do you let it get to strike before putting on the trade??

  2. Well, because RUT trades European style,the options can not be exercised until expiration. So there's no risk of being put or call the underlying. I know the author doesn't let market price hit the short strikes. You can also jump over to his site and ask him directly


  3. This comment has been removed by the author.