Condor Options

The post below is a free sample of the kind of commentary and analysis we provide in the newsletter. Over the last year, we’ve added a number of features to the weekly update, some of which include data not tracked by any other publication I know of – including the ranked volatility ratio table and S&P 500 volatility skew estimates. Enjoy.

After the close on Wednesday, this is the status of our open positions:

• SPY October #1 XXXXXXXX: This trade is currently priced at about $0.27 for a gain of 13% on capital risked. It carries no significant delta bias.
• SPY October #2 XXXXXXXX: This trade is currently priced at about $0.41 for a gain of 3% on capital risked. It carries a delta bias of 3.8 per 1-lot position.
• SPY October #3 XXXXXXXX: This trade is currently priced at about $0.24 for a gain of 9% on capital risked. It carries a delta bias of -1.6 per 1-lot position.
• EWZ November XXXXXXXX: This trade is currently priced at about $0.69 for a loss of 6% on capital risked. It carries a delta bias of 1.8 per 1-lot position.
• SPY November XXXXXXXX: This trade is currently priced at about $0.61 for a loss of 8% on capital risked. It carries a delta bias of 3.1 per 1-lot position.

Pay attention to the difference between the white and red lines in the risk profile at the end of this report. That’s the amount we stand to gain on our open positions as long as the market doesn’t go completely crazy over the next few weeks. Of course, we’ll hedge our net delta exposure each week to stay on top of things, but I really like our positioning here.

One reason I’m not as concerned about the day-to-day volatility of this market is that our current positions already have a huge price range baked in. 2-3% daily moves in equities are already de rigeur. Additionally, we have seen from the news flow this week that where Europe is concerned, no single announcement or decision is likely to be final for some time, especially if we assume that Greece will get its next tranche of funding. For a really helpful timeline of the expected events over the next few months, go to this post from Pragmatic Capitalism.

Volatility Ranks

The attached table (click to enlarge) shows the ranked volatility premium for 18 assets including metals, oil, emerging markets, the euro, and several U.S. equities. Specifically, we’re looking at the ratio of one-month implied and historical volatility. The AAPL ratio is just crying out to be sold here. With one-month historical volatility at 21% and October ATM options quoted now at 42%, the difference between IV and HV is at a recent record. The chart below subtracts HV from IV, and as you can see it is registering the second-highest reading since May 2010. The only higher reading was due to especially quiet trading around the 2010/2011 holiday season. Part of the reason for this gap is the Apple earnings due on October 18, and probably also ahead of the Oct. 4 launch of the iPhone 5. But even if we handicap expected HV somewhat higher than 21% to account for those events, odds are still good that AAPL options are richly priced here. We’ll look at a trade tomorrow to take advantage of this setup.

(source: Livevol Pro. For a free no-obligation trial, enter the code ‘condor’ when you check out.)

Volatility Skew

Average skew across the next four expiration cycles hit a short-term peak last week, and the decline in skew is one reason our open positions have accrued profits. The mean skew reading in this chart is 34.8%, so a reading of 37.4% is still above average, but the average is really brought down by a 0.304 reading for October SPY options; the average of the subsequent three months is 0.398, which is historically quite high. The conclusion I draw from this is that condors for November are still attractive; I would rather be net long gamma for any new positions in October and would not be a seller of OTM Oct. options.

The skew formula for each month is (-25 delta put – 25 delta call)/average of 50 delta puts/calls.

Risk Profile

The SPY beta-weighted risk profile for our open positions is shown above – click to enlarge.