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December 19, 2012

Know when to roll

When trading Iron Condors, you are selling 2 spreads for a total net credit. Ultimately, you're betting that the underlying stock or Index (or whatever you're trading) will not breach a certain level on the upside, and a certain level on the downside.
But what if it starts to move against you?
  • Do you just close and take a loss?
  • Do you adjust?
  • How do you adjust?
There is no one specific answer. That's what makes every trader unique. Every trader has their own trading style, risk profile, among other factors. One trader might prefer rolling out, while others might like to buy Out of The Money (OTM) options to relieve pressure. It all depends on individual view on the market structure.
I believe rolling out is best when markets are trending and buying (OTM) options when markets are chopping. You might disagree, and that's OK too. 
Let's take a look at a simple example: 
You sold a 10 delta spreads 40 days away. If the underlying is moving lower and your put spread goes from 10 delta to 25. What do you do? Look at your call side. Let's say you sold a call spread for .90¢, and it's now worth .14¢. That's not giving you much of a hedge against your put spread because it can only go down to 0. The best thing to do, if you don’t want to roll your put side, is to buy back your call spread for .14¢, taking in .76¢ profit on the call side and opening another spread for a higher credit. Worst case, if you're forced to roll your put side, you have some of the profit you took on your call side to work with.
The most important factor in this equation is the timing of these adjustments. The closer you are to expiration, the more it will cost. However, if you make the adjustment on time, you can turn a losing Iron Condor into a money maker.