Condor Options

SPY recovered a bit after the last trade notice went out, but it’s resumed its fall now and confirmed our risk-management signal. With SPY August implied volatility now over 30%, we’re selling (vol) into that spike by opening the following butterfly hedge:

Day limit order
Buy to open 2 SPY Aug 125 calls
Sell to open 4 SPY Aug 119 calls
Buy to open 2 SPY Aug 113 calls
for a net debit of $1.55^† or better.

Note that 2/4/2 contracts specified above represent a position size equal, in dollar terms, to the amount allotted to each regular calendar position. (For autotrading purposes, the specified number of contracts constitute one base-position unit.)

Analysis: In the midst of what’s shaping up as the worst week for the S&P since November 2008, we’re managing to keep up with the downtrend…barely. The two rolling trades we made earlier today canceled out increasing downside delta risk as SPY slid through the first half of the session. This hedge trade counters the steep down leg in the final hour, reducing portfolio delta from just over 5% of total capital at risk to about 2.2%. At the same time, it increases theta from about 1.3% to approximately 1.7%, increasing our profit potential at these new lows.

There are always trade-offs, and we’re giving up some positive vega and marginally increasing gamma risk (again, in proportion to capital at risk). But a more neutral stance with respect to implied volatility will be a plus if and when the market rebounds, and negative gamma always increases with an adjustment that moves the center point of the P/L curve closer to the current underlying price.

We’re still long enough September premium that, after this hedge trade, the probability of being profitable (not including commission costs) at expiration is now over 50%. That’s a theoretical projection to a certain extent, but we’re also net short a boat-load of August premium that, one way or another, will go to zero at expiration.

Our new projected risk-management price points are SPY $120.90 and $125.50. We’re already overextended in terms of total capital allocation, so our next move, if necessary, will likely be to reduce risk by closing positions.

^†Average fill price.