Condor Options

It might feel like today’s 40-point plunge in the S&P was planned to make a mockery of my statement yesterday that “we can afford to reduce our downside hedge position.” But the market will do what the market will do, and what we do in response is adjust our risk profile as needed to keep potential losses under control the best we can.

With that goal in mind, we’re placing the following, unbalanced butterfly order:

Day limit order
Buy to close (open) 2 SPY Nov 125 put
Sell to open 4 SPY Nov 117 puts
Buy to open 2 SPY Nov 111 put
for a net debit of $1.90 or better.

Note that the 2 contracts specified for each of the long legs above represent twice the number of contracts we’re now short at the 125 strike after yesterday’s adjustment. Because the short position must be closed before opening a long position in the 125 puts, some brokers will require this order to be placed in two parts.
Analysis: This trade is similar to our prior put butterfly hedges, but we’re selling the 117 strike instead of 119 because of the steepness of today’s plunge. Our portfolio delta has gotten close to 4% of total capital at risk‚ and that’s not a comfortable level with vega less than 1%. This trade cuts our delta bias to a little under 0.7% of capital at risk, which is nearly perfect for a slightly vega-positive portfolio.

With fewer than 10 days left until expiration, gamma is becoming the leading issue. Before this trade, with SPY in the middle of our P/L curve, gamma was starting to flatten out—but now we’re forced to take on a little more in exchange for the theta-positive delta hedge that the Calendar Options strategy rules call for. Nevertheless, even with this new hedge in place, gamma is still manageable as long as SPY remains between about $122 and $128 (very roughly speaking).

While we don’t anticipate an upside risk-management alert unless SPY gets back over $127, we’ll again consider unwinding some or all of our downside hedge position on a closing price over about SPY $125.50.