We’re adjusting the SPY October 93/103/113 put butterfly hedge to create a theta-positive position with delta closer to neutral. We’re accomplishing this with the following iron-condor trade:
Day limit order
Buy to close 1 SPY Oct 103 put
Sell to open 1 SPY Oct 113 put
Buy to open 1 SPY Oct 127 call
Sell to open 1 SPY Oct 125 call
for a net credit of $0.97 or better.
Note that the 1 contract per leg specified above represents the number of contracts we’re currently long at the 93 strike (half of our short position in the 103 puts). The result will be an October 93/103/125/127 “broken-wing” iron condor.
Analysis: Once SPY rallied back above about $113 last week, this hedge position began costing us time premium, in addition to delta losses, as the market continued to climb. But over-trading and whipsaws can be more costly than a small reduction in profit from an unneeded hedge position, so we don’t just trade in and out of hedges on a short-term basis. We watch for conditions under which unwinding or adjusting a position creates the risk profile we want to end up with—in the case of this month’s portfolio, a neutral to slightly bearish delta bias.
With that aim, we were looking for SPY to hit about $116.75…which, as previously noted, it did on Friday, before collapsing back under $116. Needless to say, this morning’s nearly 3% jump in the S&P leaves little doubt as to the validity of our trade signal. With SPY now around $119, this adjustment leaves us with a bearish bias rather than the ideal, bullish-leaning neutral portfolio we’d like.
We are, nonetheless, well within our risk/reward comfort zone, with only ten trading days left in the October cycle. By selling the 125/127 call vertical, we’re boosting the potential amount we could recover from the the original hedge trade by about one-third, while increasing upside risk relatively little compared to what we’re already carrying with our initial Oct/Nov double-diagonal position. And considering how overbought the S&P has become by short- to intermediate-term measures, a little bearish bias could turn out to be a benefit.
In any case, we’ll let the quantitative rules of our strategy dictate whether and when we need to take any further steps to manage risk, and after today’s adjustment our new projected risk-management price thresholds, at approximately SPY 111.75 and 122.90, are more than $10 (about 8.5%) apart. Portfolio delta bias per dollar at risk is now no greater than it was Friday, when the S&P was almost 3% lower, and we’ve reduced vega risk by more than half.