Condor Options

In what the headlines are trumpeting as the best week for the market in three years (some have claimed it’s “one of the best weeks ever [emphasis mine]”, our current risk profile has suffered more from the plunge in implied volatility than from the move in underlying SPY shares. While that might not sound like a good thing, it means that we’ve been managing delta risk prudently and, considering how far IV has fallen, vega risk as well.

IV for SPY options, in particular, dropped nearly 7 points last week—a 20% move. Our unrealized return did an about-face, from more than 5% of total capital at risk (approximately 1.4% Model Portfolio return) last Tuesday to a 4.8% loss (-2.4% Model Portfolio return) at Friday’s close, despite having three days of time decay working in our favor. And yet that percentage is still much less than our target gain (what we can reasonably expect to earn in a good month), as well as our projected gain for this month at expiration, at the current SPY share price and implied volatility.

Nevertheless, the dramatic shift in unrealized return last week demonstrates just how powerful a little vega can be—and the risk that it carries. Perhaps the main feature that sets Calendar Options apart from other calendar-spread income strategies is the many ways we’ve developed to guard against that risk:

• Starting with an initial allocation to long-vega income strategies (calendars and double-diagonals) that’s no more than half the amount we have allocated for short-vega income trades (iron condors);
• Putting on fewer and/or smaller calendar positions when implied volatility is elevated;
• Using lower-vega positions (double-diagonals) when IV is very high;
• Avoiding trade entries where front-month IV is significantly lower than the back month; and, with the most recent updates to the strategy,
• Managing portfolio vega by hedging with short-vol trades (butterflies) and adjustments (‘flies, iron condors).

Now, as I’m sure many of you noticed, the one not-so-little hitch in the list above is, how do we know when implied volatility is “elevated” or “very high”? My answer to that question continues to expand—in the interest of providing the clear, comprehensive education you’re paying for—and the post (or posts…it might become a two-part series before it’s done) I’m working on isn’t (aren’t) quite finished. It (they) will be available within the next day or two, but for now I’ll wrap up this Update with a look at our current portfolio risk profile.

Steady As She Goes

At the close on Friday, our portfolio was virtually delta-neutral. With the addition of last week’s double-calendar position, plus the passing of a couple days, portfolio vega is up to 3.7% of total capital at risk—still relatively small compared to where it would be right now if we hadn’t been conservative at the beginning. Our projected risk-management price thresholds remain at about SPY $120.25 and $128.25, and we continue to watch the $126.50 level to trigger a minor adjustment to our (at that price, in the money) double-diagonal.

Since the overall shape of our P/L graph hasn’t changed much from the one in last Wednesday’s trade analysis, I’m including a view that projects out to the Thursday before December expiration, instead of all the way through expiration, for today’s Update. What this shows is that, while our primary risk remains to the up side, the P/L curve at the top end doesn’t flatten out until the final day before expiration, at least according to the mathematical model. Models can be misleading when trying to simulate complex non-linear systems like an options portfolio, but the point is that there’s still a good chance of bringing in a decent profit this month, even with SPY around $128.