Condor Options

Around 2:30 it was starting to look like the bulls went home early, but buyers have stepped in since then, leaving little doubt that some hedging is called for this afternoon. We need to be careful here, however—the S&P is pinned in overbought territory and creeping into an area of strong technical resistance defined way back in 2008.

Instead of taking on the vega risk of another full position, we’re neutralizing our portfolio delta with a fractional hedge position, as follows:

Day limit order
Buy to open 3 SPY February 130 puts
Sell to open 3 SPY January 130 puts
for a net debit of $1.05 or better.

Note, again, that we’re sizing this trade at 75% of our other positions, or 3/4 of the standard base position for single-calendars.

Analysis: The market has an uncanny ability to make decisions difficult for option sellers, and today was a perfect example. SPY tested our risk-management threshold twice this afternoon, only to pull back into safe territory, before making a final run up after 2:30pm Eastern. In the end, another day’s increase in gamma made it clear that an adjustment was needed—but, as noted above, the underlying index is at precisely the point where we need to be careful about a whipsaw reversal.

Thus the decision to take a measured hedging approach. This afternoon’s trade exactly meets our strategy goal of neutralizing delta when an upside adjustment is triggered, and it does so without adding as much vega as the next closest candidate (the 128/132 double-calendar) and without raising our lower breakeven as much as rolling up half of our position at 124.

The ratio of front-month to back-month implied volatility is lower than we typically like for an entry trade—yet another reason to dial back the size of this position. Nevertheless, the IV ratio for the 130 puts is a bit better than the IV index shown in the Portfolio Analysis table, which is why we’re again using the puts instead of the calls even though it adds to our in-the-money short positions.

As the new portfolio risk profile pictured below shows, our main concern going forward is gamma. If the rally continues up to our new adjustment trigger, we’re planning to reduce gamma risk by closing some or all of our position at the 127 strike. A downside reversal would have us looking to pare back at the 127 and 129 strikes.

Last, a reminder that we’re entering the time window for February trades, so this would be a good time to review available margin.