Condor Options

It’s been another wild week, as the market tries to find a bottom amid one string of bad news after another. Through disciplined adherence to our strategy rules, though, we’ve managed to keep risk under control without sacrificing a great deal in terms of profit potential. On the other hand, our unrealized return is quite another matter.

As of this writing, our August portfolio is showing a loss on total capital at risk in the 20% range. Model Portfolio return, to be perfectly honest, is something of a conundrum considering how large an additional infusion of capital this month’s hedge trades have required. My plan is to use the maximum amount risked at any one time during the cycle as the basis for calculating Model Portfolio return, which would reduce any percentage loss compared to using the value of the account at the beginning of the cycle, but likewise would bring down the percentage of any gain we might achieve. I think that’s a reasonable way to approach the situation, but I’m open to feedback from any member who objects.

The reason for the huge gap between our current risk curve (white line below) and our expiration P/L profile (red line) is the extreme degree to which implied volatility has skewed toward August options compared to September contracts. Average IV for August SPY options has climbed to a level more than 20% higher than September, and we’re short a lot of August premium.

The good news is that no matter how high August implied volatility goes, all of that short premium will disappear at expiration. The bad news (besides the slim chance of being forced to liquidate all of our positions at the current level of loss) is that we might again have to keep our three remaining positions open until the final hour of  trading before expiration. We’ll want to reduce gamma next week, of course, and that will require adjusting one or more of our current positions and/or closing at-the-money positions and thereby reducing our potential profit.

For now, though, our portfolio greeks, considering how far the S&P has dropped since mid-July, are amazingly close to ideal. As of noon today, delta per dollar at risk was about 1.2%, with vega a hair under 2%. Gamma, too, is still quite tame, at about 0.9% of total capital at risk, while theta has risen to nearly 4%. And after all we’ve been through, our theoretical probability of having a profit at expiration is still over 50%.

Despite all the rosy-looking numbers, it’s important not to become complacent. Given the technical damage done and the number of possible shoes that might still drop, it could be weeks, maybe months, of highly volatile trading before the market digests this latest crisis and begins to rally again. So let’s keep focused, and always put risk-management first.