Condor Options

We’re opening the following position to hedge our upside delta and vega risk:

Day limit order
Buy to open 2 SPY Oct 130 calls
Sell to open 4 SPY Oct 124 calls
Buy to open 2 SPY Oct 118 calls
for a net debit of $2.81 or better.

Note that the 2 contracts specified above for the wings represent the number of contracts allocated to each leg of our core, double-diagonal position.

Analysis: The resulting risk profile might look more than a little crazy, but we’re following our strategy rules and bringing delta back to neutral with an out-of-the-money call butterfly. Why this trade in particular (besides the fact that it matches our delta target)?

1. It reduces our exposure to volatility risk. The VIX is finding some support at the low end of its August–September range, but that’s not enough to change the fact that it’s in a strong intermediate- term downtrend.
2. The hedge position will benefit from time-decay as long as SPY remains above about $119, and
3. It offers ample opportunity to remain profitable by adjusting the position as the market moves.

Since our new expiration risk profile appears more decisively bullish than we intend to be over the long-run, in the context of how we plan to manage risk going forward, I’ve plotted our projected P/L curves in two-day increments. The graph below shows that we have some leeway to adapt over the next few days depending on which direction traders decide to take the market from here.

For example, if today’s trade signal turns out to be a whipsaw*, we can restore downside profit potential with our usual technique of rolling this butterfly into an iron condor. Making such an adjustment with SPY dropping back under, say, $119.50, would produce a risk profile that looks something like this:

Getting back to our profile after today’s trade, portfolio delta and vega, again, are virtually neutral. This comes at the expense of more negative gamma, but we’re also increasing profit potential enormously (should SPY slowly drift up to $123.50 just before expiration…eh, right). More important, we intend to spread out risk as soon as we can discern whether today’s breakout holds or is just another bull trap.

^*Indeed, shortly after today’s trade alert went out, the signal that triggered it reversed in the last 15 minutes of the session.