Condor Options

We’re opening the following position for April expiration:

Day limit order
Buy to open 4 SPY May 119 puts
Sell to open 4 SPY Apr 119 puts
for a net debit of $1.33 or better.

Note that 4 contracts per leg is our base position size for single-calendars. Trading whole-number multiples of the base size ensures that adjustments will not result in unbalanced positions.

Analysis: One the “incremental improvements” we’ve been exploring for the Calendar Options strategy, as mentioned in this week’s Update, is tighter criteria for assessing the risk of entry trades. I’m still documenting the changes and will share the details in a post next week, but after backtesting the past six months (which included both our best quarter and our worst quarter since inception), I’m ready to adopt the modifications right away.

So, what does that have to do with this trade? One of the new criteria for entry trades is that each new position must reduce our portfolio delta bias without significantly increasing gamma (as a percentage of total capital at risk). In practical terms, that means we don’t want to add a position that’s too close to the current portfolio-level delta-neutral point. For SPY, at current volatility levels, we need our positions to be centered at least three strikes apart…but we also don’t want to eliminate all of the current delta bias as the chances of mean-reversion increase. That wasn’t possible until SPY staged a convincing breakout over $117.50, which is what triggered this opening trade.

Another modification that appears to reduce risk is taking a more bullish stance when adjusting for a move higher. Whether we’re opening a new position or rolling an existing one, if the underlying is trending up, we’re now targeting a delta-bias reduction in the two-thirds range. (If we’re adjusting for a downtrend, the one-third to one-half rule still applies.) By placing this trade at the 119 strike, we’re satisfying all of the updated criteria.

As shown in the analysis table and P/L graph above, this trade has a significant bullish bias to offset the negative delta of our existing position. Alone, it has about a 34% probability of profit at expiration, but when combined with the position at 116, we’re increasing our odds significantly compared to what they were when we opened CS#1. Our new portfolio-level risk profile is shown below:

Note that I’ve decided to start using the risk (dollar) weighted portfolio profile instead of the base-position profile, as this more accurately reflects our preferred allocation method and the model portfolio we use to track returns. In proportion to capital at risk, this trade reduces our portfolio delta bias by about 75% and our volatility risk by more than 10%. Gamma is now higher at the current underlying price, but that’s only because SPY is closer to the center of the new risk curve; comparing the center points, we’re reducing gamma by 16%.

Our portfolio now comprises a 116/119 double-calendar, which is the basis for our new price-level risk-management thresholds. We’re not changing the rules for setting adjustment points, so our alert levels are just inside the mid-point between each breakeven and its nearest strike—that’s about $119.40 overhead and $115.30 on the downside.