OptionsCourse (< 20)

Closing Option Trades: Russell Index Iron condor & PCLN short strangle

August 15, 2011 – Comments (0) | RELATED TICKERS: PCLN , IWN

I recently opened two option strategies – a RUT iron condor and a PCLN short straddle.  The Russell 2000 Index (RUT) Iron condor was opened on Thursday with the aim of closing the trade following the weekend. The PCLN short straddle was opened to take advantage of time decay over the weekend.

In this article I will present the pros and cons of each option trading strategy especially with regards to the closure of these trades.

Russell 2000 Index Iron Condor Trade

The Iron Condor strategy proved extremely difficult to close.  Iron condors are made up of two vertical spreads, a bull credit put spread and a bear credit call spread.  Of course each vertical spread is made up in turn of a long and short option.  Hence iron condors are inherently extremely difficult positions to trade since they are composed of many individual option positions.

Additionally the fact that the iron condors are composed of many options makes trading costs a significant factor.  Just as an example, TD Ameritrade ThinkorSwim charges $1.50 per contract.  An iron condor made up of 10 contracts in each leg will thus cost $60 to open the position and $60 to close, thus racking up $120 in commissions.

Liquidity and bid-ask spreads were major factors affecting the trade.  The Russell 2000 Index options exhibit poor liquidity.  Currently for ATM (at the money) options, the bid-ask spread is approximately 80 cents.  When this spread is factored over multiple positions this makes filling bids extremely difficult. In order to close my options positions I found that I had to move my ask price close to the natural price rather than the mark. This is despite relatively large trading volumes and high open interest.

Key points regarding trading iron condors

The iron condor strategy has the following advantages:

- To benefit from falling volatility.

- To capitalize on time decay. 

- To limit potential loss.

 - Ability to adjust option positions.

However in hindsight the choice of trading the Russell 2000 Index was a poor one.  It is important to choose an underlying asset that is easily tradable with narrow bid-ask spreads and high liquidity.  A better choice for index trading would have been the S&P 500 Index ETF (SPY) which has a bid ask spread of only 2 cents.

Closing the PCLN short straddle weekend trade

In contrast Priceline (PCLN) options proved easy to close.  PCLN also exhibited relatively wide bid-ask spreads, which at the moment stand at around $1 for ATM (at the money) options.  The key to closing the trade for a reasonable price however was due to the fluctuating volatility of PCLN options. 

I closed the PCLN short straddle at the open of trade, having entered an order prior to market open.  I calculated the price that I expected I could reasonably achieve, factoring in where PCLN was trading in pre-market trading and time decay over the weekend.  The price at the open exhibited very wild swings due to fluctuating implied volatility, with the price initially elevated.  However after the first few minutes of trade volatility dipped and the price of the options decreased, allowing me to close the trade at my expected price.

I closed this trade in two legs, initially closing the short call leg of the straddle since I was expecting a rising price and wanted to protect this side of the position.  I expected a rising price by following the future quotes of the indices and following the international markets prior to the NYSE open.

Being composed of far fewer option contracts made the PCLN short straddle a lot easier to trade than the Russell 2000 iron condor. 

In summary, short straddles are easier positions to close than iron condor trades.  PCLN options however are risky to trade due to the volatility swings and wide bid-ask spreads.  Wherever possible one should aim to use options that are as liquid and tradable as possible.

Disclosure:  I recently closed both the short straddle on PCLN and the Iron condor on the Russell 2000 Index.  I don't plan on opening any new positions on these assets in the next 72 hours.