Last update: July 2021

Keren had a great question on hedging iron condors in the Clubhouse so I’m dedicating today’s commentary to that. I’ll post it here in its entirety, then respond with a one-two combo of education and enlightenment.

I have a question regarding the timing of adding a hedge. Module 6 (from Cash Flow Condors Premium System) states the rules for hedging entails.

1. Adding a bull put if support is broken
2. Adding a bear call if resistance is broken

The RUT did break out of resistance recently. However, I was hesitant to add a bull put due to the risk of being whipped out of the hedge at a strike price that is not as far OTM. Would it not be a better strategy to add the hedge once the underlying has pulled back slightly? The RUT pulled back slightly yesterday. On the 20D 1 Hr chart when you add Full Stochastics it has recently fallen below 20 the oversold threshold. Since the RUT has skewed slightly bullish recently I thought this might be a better time to add a bull put. If we hedge this way we are anticipating mean reversion. However, if we add the hedge when major support or resistance levels have broken that seems like the worst time since the strike price will be not as far OTM. Isn’t there a higher likelihood of the underlying reverting back to the mean when it has broken out of a consolidation zone than keep running higher or lower?

I believe it was during a cash flow club Tyler hosted about hedging where he stated that hedging can be subjective. Were the rules stated in the module also backtested? Or has personal experience shown the positive expectation in using these hedging rules? Thanks, Tyler! The modules were great!

There’s a lot in here, so let’s unpack this puppy one question at a time.

First, Keren was hesitant to add a bull put spread with RUT breaking resistance due to being whipped out.

That’s always a risk, no doubt about it. Whether or not hedging Condors is a better technique than just letting them ride depends on your chart reading and timing. If every time you enter a hedge the market reverses aggressively and you get stopped out, then I’d suggest not screwing around with hedging. On the other hand, if most of the time when you hedge you make money, then it’s a worthwhile endeavor. I journal every one of my RUT Condors with the hedges labeled so I can determine if I made money overall by being proactive. And, well, I have. So I hedge. Sometimes I lose a bit on those extra credit spreads but most of the time I don’t.

So it’s a value-add for me.

Next question – would it not be a better idea to add the hedge when the RUT has pulled back slightly?

Sure. But that presumes a) it will pull back and b) you’ll still need the hedge at that point. Consider the RUT right now at $1413. Has it pulled back after the breakout attempt (over $1430 two weeks ago)? YES! So this go around you would have been better off waiting. But, do we really need to add an extra bull put spread here? My short strike for September is up at $1520. We’re over $107 points away at this stage. Remember, we only hedge when things are going against us. And right now I’m profitable on the bear call side of my Sep Condor so there’s no need to fiddle with extra bull puts at this point.

Next question – Isn’t there a higher likelihood of the underlying reverting back to the mean when it has broken out of a consolidation zone than keep running higher or lower?

This depends on how much faith you put on breakout patterns. Most people (and I’m one of them) believe when a stock breaks major support/resistance it’s more likely to continue running. That’s why the bull breakout pattern is one of the first you learn in the Master Trader.

And that’s exactly why the suggested trigger for adding an extra bull put to your Condor is waiting for a break of resistance. If resistance isn’t broken then your bear call won’t get in trouble. And if your bear call won’t be in trouble then there’s no need to hedge.

Final question – Were the hedging rules stated in the module also backtested?

I did not include hedging as part of the backtest for a few reasons.

ONE: The simpler the rules, the easier the backtest. It would have taken a lot more time to backtest an Iron Condor system with hedging.

TWO: Even with the suggested rules in the Condors for Cash Flow system, there’s still a bit of discretion involved in the exercise which increases the difficulty of backtesting it.

THREE: Of the 60 months that were backtested we won 54 so without hedging the system already had a 90% win rate and was overwhelmingly profitable so there wasn’t really any need to muddy the waters with hedging to prove selling iron condors over time is a money maker. (apologies for the massive run-on sentence:))

Hope that helps!

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