Condor Options

We’re hedging downside risk with the following butterfly position:

Day limit order
Buy to close 1 SPY Oct 113 put
Sell to open 2 SPY Oct 103 puts
Buy to open 1 SPY Oct 93 put
for a net debit of $2.34 or better.

Note that the 1 contract specified for the wings of the butterfly represents half the number of contracts in each leg of our core double-diagonal position.

Analysis: As stocks continue to get hammered, we’re offsetting increases in portfolio delta while selling volatility into the spikes. This trade reduces delta as a percentage of capital at risk from approximately 3.2% to about 1.5%. Portfolio vega remains slightly positive, and theta increases from about 0.8% to nearly 1%.

But the most obvious effects of adding this hedge position are clearly visible in the risk-profile graph below:

We’re moving our lower breakeven down more than $7 and raising the odds of being profitable at October expiration to almost 70%. What’s also clear, however, is that with 2%–3% daily moves in the S&P becoming routine again, and the VIX approaching its six-week high near 45, our new projected downside risk-management threshold, at SPY $105.25, doesn’t look all that far away.

We’d like to see support at SPX 1100 hold for at least a few days, or, if the market breaks down, a reaction rally to kick in before SPY drops much below $106. Of course, Mr. Market all too often refuses to give us what we want, so we’re prepared to adjust or add positions as necessary to keep risk under control.