Introduction to Option Adjustments
Option trading offers a unique feature which doesn’t exist in the stock market – option adjustment.
This means that you can actually “repair” your options position in response to changing market conditions. Now be warned – this does not mean that you can always profit from options trading, far from it. Option adjustment does introduce more overall risk, however it can increase the probability of profit.
Applying an Option Adjustment to a RUT Iron condor
You can have a look at a recent article I published on Seeking Alpha of a RUT iron condor that I opened. I opened this position in order to take advantage of falling volatility following the market crash.
The day after I opened my trade, RUT was trading higher, threatening the upper end of my profit range. The way I adjusted this options trade was with the principle of keeping the trade delta neutral, since the premise of the iron condor is a direction neutral option trading strategy. Since I plan to close the trade on Monday straight after the weekend, I use the simulated profit and loss graph for the Monday in order to calculate how to construct the option trade adjustment.
The figure above show the RUT iron condor before the trade adjustment. The profit and loss graph is for Monday rather than today and it shows that the upper end is threatened. If there will be more than a 2% movement to the upside my option strategy will be at a loss.
In order to correct this I sold a vertical put bull spread for $2.55 – this involves selling a 680 strike put option and buying a 670 strike call option. I sold a sufficient number of contracts in order to make the trade near delta neutral and increase my margin of safety to the upside.
Risks and Benefits of Option Trade Adjustments
You can see that the delta has been reduced significantly and the profit range has been adjusted. Now my option position can withstand a movement of 3.4% to either side before beginning to be at a loss and this makes me sleep better at night!
The other significant benefit of the iron condor option trading strategy is that the potential loss is limited (as opposed to short strangles or straddles).
The downside of this option trade adjustment is that it does increase my downside. Before the maximum loss was $4100 and now this has doubled to $9300. However I feel comfortable with the margin of safety with this trade.