Income option credit spreads --- Adjustment of condor credit spreads

Income option credit spreads --- Adjustment  of condor credit spreads

Consider for instance a  80/20 condor credit spread. If one were to put a spread on each and every time period (for instance monthly) for a large number of periods, the percentage of trades  in which the stock price ends is  at or above a short strike represents 20% of all trades. One of the techniques used consists in readjusting the spreads if the stock come close to a short strike, or the loss on the candor spread were to reach a given percentage of the premium received.

Let us refine a problematic trade, and trade in which the stock get dangerously close to the short strike. The question we post in this post is to estimate the percentage of such trades.

Let us consider the call side, and look at rules that trigger a readjustment when if the stock comes close to the short strike without crossing it.  The number of bad trades (at expiry) is 10% (half of 20%). of all trades. The percentage of problematic trades must be greater than or equal to  the percentage of trades that can reach the short strike. Let us then determine the percentage of of trades that reach the short strike.

To determine it we need to find an estimate of the probability that the stock will visit the short call strike, say strike 110 for a stoke trading at 100. We know that a trade that ends above 110 must have visited price 110 on its journey from 100 to a value above 110. We also know that among the visits that the stock will make to strike 110, approximately half of them (in fact it can be less than half) will end up above 110 at expiry.

Therefore the percentage of trades that will visit the short call strike is TWICE the percentage of trades that will end at a price higher than the short call strike. In the case of the 80/20, even if there is only a 10% change that a trade will end up above the short call strike at expiry, at least 20% of the trades will become problematic for the call side.

A similar reasoning can be made for the put side.

Therefore the percentage  of trades that will problematic (need readjustments) is more than the double of the trades that have been legitimate adjustments. In other words, among all the adjustment made more than half of them would have been not needed, and these trades would have been winners.

This is significant because it means that the winner that will need no intervention in an 80/20 condor is actually less than 60% of the trades (probably around 50% or less) depending one where one make the adjustments.

A number of websites and people assume that they would make adjustment 20% of the time, and do nothing during 80% of the time, when in fact it is not true.

In an 80/20 condor one should expect to be busy with adjustment at least almost  once in  every other trade.