Condor Options

We’re kicking off the December cycle by entering the following position:

Day limit order
Buy to open 2 SPY Jan 130 calls
Sell to open 2 SPY Dec 125 calls
Buy to open 2 SPY Jan 107 puts
Sell to open 2 SPY Dec 113 puts
for a net debit of $0.42 or better.

Note that 2 contracts is our base position for double-diagonals. Trading whole-number multiples of the base-position size ensures that adjustments will not result in unbalanced positions. In addition, in order to come as close as possible to matching our Model Portfolio risk profile, it’s important to allocate equal risk to each initial opening trade in a cycle. (Hedge positions may vary).

Note, too, that for double-diagonals and some other trades, the risk calculated by your broker may exceed the actual dollars at risk in our strategy. For example, the “unbalanced” double-diagonal above carries a risk of $6.40/share, but most brokers require retail traders to put up $11.40 in margin.

Analysis: Welcome (back) to the “new normal”. Implied volatility is elevated but range-bound,…so volatility risk remains significant, but not necessarily immediate. The greatest known risk right now for our strategy is day-to-day price volatility—and that’s why we’re staying with the proven pattern of trading around a wide double-diagonal in this kind of market environment.

I’ll post a full analysis of the November cycle shortly, but the bottom line is that our approach continues to work well under conditions that can be very damaging to market-neutral income strategies. By remaining cautious and trading around a conservative core income position, we again managed a small Model Portfolio gain even as markets remained jittery and prone to risk-on/risk-off swings and sharp short- to intermediate-term trends.

This trade is delta-neutral with a slight bias towards increasing implied volatility. There are two ways to look at the current gap between implied and historical volatility: 1) that IV will revert to mean HV, or 2) that elevated IV indicates an expectation of realized volatility increasing. The Calendar Options strategy gives us the flexibility to target increasing, neutral, or decreasing implied volatility—with time-decay giving us an advantage no matter which way the market goes.

While leaning slightly positive (bearish) with respect to implied volatility, we’re taking what amounts to a neutral delta stance. Our staggered-entry and hedging strategies give us plenty of room to adjust risk/reward at the portfolio level as the market moves up or down and risk-perception changes. The graph of our current and projected expiration profit/loss curves is shown below:

Our projected risk-management price thresholds are around SPY $111.25 and $125.25, which gives us about a ±5.8% range before any risk-management action is called for.  When the market isn’t so unstable, we normally enter additional positions—to increase income potential while re-balancing our risk profile—at a lesser variation in the underlying price. But for now I still think it’s a good idea to keep a tight rein on dollars risked by opening fewer core positions each month and reserving most of our capital for hedging.