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Butterfly Within an Iron Condor: Responding Instead of Reacting

Josip Causic

Trading requires mental toughness and trading is about deciding what action to take when faced with an adverse situation. These actions can be either positive or negative. We can choose to respond or we can just react. Usually responding is the correct course of action.

The week leading into the July 4th weekend was quite volatile and a lot of traders got burned one way or another, some covering their shorts for a loss or and some closing their longs on the way down. It is during these adverse situations that the true trader’s character shows up; is the trader ready to call it quits because of the doubts in his or her trading skills or is the trader aware of the bigger picture of his or her trading career and able to see that the week of  July 4th was nothing else but just another trading week? The answer is in the eye of the beholder. We create our own reality and we are ultimately responsible if we are just reacting instead of responding in any given trading situation.

This article will share a trade that has gone wrong and the double fix that was done to repair it.  This content is written for educational purpose and it is not to be used blindly on any given trade that has gone wrong.  We will follow the trade with a chronological presentation.

An iron condor was sold on the XEO Thursday, June 28,  when the weekly options were listed and it was trading at 610.  The sold legs will be the center of our focus, the 620 call and 595 put. That very same day the XEO tanked and it appeared that giving 15 points (610 entry price minus sold 595 put) of “breathing room” to the downside made sense. The upside “breathing room” was only ten handles. The low of that day was 602 and it seemed that by the expiry the sold 595 put could be challenged. The XEO recovered virtually everything by day’s end, creating a doji looking daily bar.  The next day, Friday the 29th the situation was different due to good news from Europe. The U.S. market gapped up and took off, threatening the short 620 call. It was at that point that the correct choice had to be made between reacting (closing the IC for the loss) or responding (choosing to do an adjustment).

Original Iron Condor Position


Figure 1: Original Iron Condor Position

There are multiple adjustments that can be done on an Iron Condor and the option trader always has choices. However, keep in mind that every single adjustment is a completely new trade, and the trader who chooses to respond by adjusting the trade that has gone bad is ultimately responsible for the possibility of having an even greater loss than the original max loss of the initial IC.

The possible adjustments could be rolling the Bear Call up or rolling it not just up but also out, meaning to another option cycle, or selling another Bull Put below the current price, or placing an Iron Condor outside of the already existing one, plus so many other possibilities. The adjustment that I chose on this particular trade was placing a Butterfly within the IC. Once again, this response was NOT done blindly. [There were other Iron Condors that were open on the same option cycle, June week A, but on different underlying and these were not adjusted with a Butterfly. However, they aren’t the focus of this article.] A Call Butterfly could be viewed as a combination of a Bear Call and a Bull Call.

First Adjustment - Opened a Call Butterfly


Figure 2: First Adjustment – Opened a Call Butterfly

This first response created a completely different trade and did not guarantee a profitable outcome, unless the XEO closed right at 620 or a few pennies either side of it on Friday July 7th.  As the market is a living and breathing thing, a second adjustment had to be made, two days later. Personally, I would not repair a brand new car that has been in two bad collisions!  But that is an overgeneralization. If the second collision involved only a broken headlight, then an exception to that rule could be made. Likewise on this trade, the Butterfly was partially taken off by closing the Bull Call portion of it for a profit of 3.10 (original Butterfly was a debit of 1.00). It is important to understand the technical-based reasoning for the closure of the Bull Call for 4.10. The reading of the Bollinger Bands on a daily chart was showing that the price action was piercing the upper band significantly; hence, the forecast was made that the XEO was rallying right into resistance and was likely to reverse in a matter of days. Going into the July 4th weekend, the prediction was made that most likely after so many bullish days there was going to be a pull back and taking the Bull Call off was a logical response. On the same day, July 3rd the original 595 put was closed for a nickel.

Figure 3: Second Adjustment – Closing the Bull Call side of the Butterfly for a profit and closing the 595 put from the original Iron Condor

The remainder of the IC was left with the contract size skewed: two Bear Calls and one the remaining 590 put from the original Bull Put spread. The forecast for the XEO to go down proved to be accurate.

The low of Friday July 6th was 617.25, and the XEO closed at 620.20. The two 620 calls were repurchased for 0.30 each.

Figure 4: Closing the 620 calls

Looking back, one could make an observation that the second response (closing of the Bull Call part of the Butterfly) was unnecessary. But at the time that hindsight was not available. It is true that without the second response the Butterfly part of the trade would have made more money, yet overall the trade still worked out well. The Iron Condor netted $80 (1.45 minus 0.65) and as mentioned earlier, the Butterfly was profitable by $310. Responding (choosing to do something) rather than being forced to (re)act is a better choice.

In conclusion, when an adverse situation takes place and our trade does not work out, as was the case with this XEO Iron Condor, respond instead of react; choose to do something rather than being forced to act. Reacting can be disempowering. Responding is empowering. Keep that in mind when trading. Approach your trading from a place of confidence rather than a place of fearfulness. Scared money never wins.

This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.