We get this question fairly often: “Why don’t you use hard stops in your trades?” And there are a couple of answers:
- Because we’re not dealing with breakout momentum stocks or hair-trigger day trades here. These are positions that are meant to be held for 3+ weeks. Sure, you could set some arbitrary stop - at your breakeven point, say - but then you’d better be prepared for a lot more churn, lower profits, and a nice commission bill to boot. Our typical iron condors have something like a 70-90% chance of seeing the underlying touch one of the short strikes during the life of a normal trade, and of course the odds of touching a short strike are always higher than the odds of expiring in the money, so if you bail every time the underlying kisses a short strike, you might as well just sit in cash all day, because that’s where you’ll be a lot of the time anyway.
- Iron condors already have built-in stops. They are called “long strikes”. No matter how far an underlying lies past the long strike of a position at expiration, the position will never lose more than the amount risked. When you’re grabbing some calls or getting into some stock, you usually have a good idea of the amount you’re prepared to lose in that trade. You know that if things go wrong, you don’t want to lose more than X dollars. Same deal here. If everything goes horribly wrong in a condor, you know you’ll never lose more than Y dollars (where Y equals the width of spread minus credit received), so you can adjust your position size accordingly.
That doesn’t mean we don’t advocate getting out of a trade that’s going bad, or making an early exit in order to protect profits, where warranted. But the point is that you really could adopt a strategy of opening condors and never looking at them again until expiration Friday, because as long as you were entering enough trades of sufficiently diverse ranges and sizing them properly, the built in stops would restrict your downside and let Ms. Theta work her magic.
