Learn from a Good Option Trade Gone Bad

04/04/2012 9:30 am EST


Josip Causic

Instructor, Online Trading Academy

This iron condor was working out perfectly until the very last day, writes Josip Causic, describing the lessons in trade planning and management he learned as a result of having it turn against him.

This article shall look at the perfect trade; at least it was perfect until the very last day. We will analyze what could have been done differently versus what actually was done.

Trading credit spreads on weekly options has greater advantage over trading monthly options in terms of forecast, which needs to be accurate for a shorter time. The disadvantage of trading weekly credit spreads is that if the price action goes against you, there can be a significant loss.

This is not surprising because risk and reward always go hand in hand. Back in February, I had a small position on that worked extremely well until the very last day when the market gapped up.

The position was actually an iron condor that was position-sized based on the max loss. The trade produced a credit of only 85 cents, while the risk was so much greater ($4.15, to be exact).

See related: How to Determine Position Size in Options

The wings were equal distance, meaning both strike-price spreads were the same five points wide. Once the trade was entered, the underlying was forecast to most likely remain trading within the sold strike prices. Those strikes were the 605 call on the upside and the 580 put on the downside.

The protective legs are worth only a brief mention because they both would have gone out worthless had the trade worked out as anticipated. The sold 605 call was covered by the higher strike price, or 610 call; whereas the sold 580 put had put insurance at 575, which was the lower strike price.

The bottom line for trading iron condors is that the underlying should stay within the range, in this case, between the 605 call and the 580 put. There are different ways of managing an iron condor trade. Conventional wisdom includes buying back the entire four-legged creature for half the max profit.

For instance, if the sold iron condor brings in a dollar from both the bear call side and bull put side, then the buy to close (BTC) would be placed for the entire iron condor at 50 cents. In my case, the credit was 85 cents due to low implied volatility and a sideways-moving market.

The premiums were not rich enough, hence the skinny premium of only 85 cents. Had I applied the conventional “wisdom” of closing with a BTC order of half the profit, it would have been closed by buying it back at 40 cents because the underlying does not trade in penny increments, but nickel increments.

Chronologically, let me go over the closing prices. The position was entered on Friday, Jan. 27, 2012 while the underlying was at $592.84.

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For the entire week, and until the very last day, everything looked good. The two closing orders were entered after the trade was opened, as BTC orders for 0.05 on both the obligations.

Notice in the table above that the 580 put was purchased back for a nickel, while the other sold leg, the 605 call, was not filled. Besides placing the BTC order as GTC (good ‘til cancelled), I also placed an alert at those same levels. I had two alerts on, one if the price was trading at or below 580, and another one if the price was trading at or above 605. None of those were triggered until the very last day.

On Friday, February 3, 2012, the alert for trading at or above 605 went off. Figure 2 shows the price action on Thursday and Friday with three-minute candles. The 605 level, marked with a red horizontal line, was punctured on Friday morning.

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At the time of the alert on Friday morning, the premium of the 605 call was trading at a much higher value than what the total credit of my iron condor obtained. In fact, the next figure shows the time and sales (T & S) for that particular contract. The lowest traded premium for the 605 call was a dollar, while the total credit for the entire iron condor was only 85 cents.


By looking at the bottom T & S’ fourth column (the Date), we could see that the very first trade (1.00) was traded with five contracts at 7:07 PST and then the premium went higher. Had I placed a BTC for the 605 call at the market price when the underlying reached the 605 level or higher, then I would have paid more than just the intrinsic value of my contract.

However, I have seen this situation so many times where the price reaches a certain level—such as 605—flirts with it for awhile (triggering the stop loss orders), and then suddenly turns around and heads lower.

By having the alert on, we traders need to choose to manually manage the trade. The last figure shows the order history of my 605 call trade management.

Read the remainder of this article here.

By Josip Causic, instructor, Online Trading Academy

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