Condor Options

We’re hedging our downside risk into the weekend with the following position:

Day limit order
Buy to open 4 SPY Aug 132 puts
Sell to open 4 SPY Jul 132 puts
for a net debit of $1.52† or better.

Note that 4 contracts is our base position for single-calendars. Trading whole-number multiples of the base-position size ensures that adjustments will not result in unbalanced positions. In addition, in order to come as close as possible to matching our Model Portfolio risk profile, it’s important to allocate an equal dollar amount to each initial opening trade in a cycle.

Analysis: After last week’s 2.5 standard-deviation rally (calculated using SPY implied volatility) a little consolidation is to be expected—but a 0.9% exhaustion gap on Thursday followed by a 1.1% gap down this morning isn’t exactly the kind of consolidation we were looking for. Nevertheless, the market will do what the market will do, and it’s our job to manage risk in tough months so we still have capital to take advantage of more profitable periods.

To that end, we’re opening this out-of-the-money put calendar as a hedge against any nasty news (Greece, Portugal, Italy,…United States) that might come out over the weekend. I don’t trade on candle patterns, but that spinning top yesterday followed by a down day today doesn’t look encouraging.

We’ve been using butterflies as downside hedges in order to sell volatility into spikes, but there are two reasons this time is different: 1) The “spike” this morning was hardly a blip in the big picture, and this afternoon the VIX has come nearly all the way back down to where it closed yesterday. 2) SPY implied volatility is well within our range for buying calendar spreads, and, after all, this is primarily a calendar-spread strategy.  More important, though, is risk-management, and after today I’m more concerned about rising implied volatility than falling—although as I just tweeted (@volatilitytrade) in response to a question about where I think IV is headed, the current event-driven environment makes it a coin-toss.

Regardless, the key to this trade is, first, getting our portfolio delta close to ideal. The new figure of 1% of total capital at risk is a little bit on the low side for our current portfolio vega, but we can always roll a portion of this position up if we get whipsawed. The aforementioned vega is about in line with where we expect to be this close to expiration, and our probability of profit is still nearly 50%.

Yet again, we’re in for an exciting (lol) expiration week. Just so it doesn’t get too exciting, we’ll probably concentrate on either reducing gamma exposure or, perhaps, very cheap butterfly hedges, to ride out the next few trading days.

†Average fill price.