As discussed in this afternoon’s trade notice, we’re rolling out the short legs of this position by selling a double-diagonal, as follows:
Day limit order
Buy to close 2 SPY Dec 128 calls
Sell to open 2 SPY Jan 127 calls
Buy to close 2 SPY Dec 113 puts
Sell to open 2 SPY Jan 114 puts
for a net credit of $2.45 or better.
Note that 2 contracts represent our entire short positions at the 113 and 128 strikes. There’s still a chance of a second trade before the session is over—but only if we get a strong move in the last half-hour.
Analysis: By rolling out to the January cycle, we’re taking a position that’s risk outweighs its value as an upside hedge and turning it into additional potential income. As I noted earlier in the day, this is the first time we’ve rolled short positions out to the back month as an official newsletter trade, and I hope the majority of members will appreciate the added educational value (not to mention the chance to turn this month’s loss into a profit come January expiration).
This trade significantly reduces our portfolio delta, but because we’re also reducing total capital at risk, delta in proportion to capital at risk increases by 75%. We’re also adding to gamma as a proportion of total capital at risk, by more than 40%—the opposite of what I’ve preached time and again about our expiration-week objectives. But here’s the pay-off: We’re more than doubling theta, which means we have a chance to recover more of our current unrealized loss in the (very) short time left until December expiration, as well as start off the January cycle with a position that could more than make up for the remainder.
So how is it that an iron-condor belongs in a calendar-spread portfolio? I’ll address that question shortly, but first let’s look at the P/L profile that results from this trade:
Our risk profile is still dominated by the Jan/Feb 128 put calendar that remains from the November 30th double-calendar entry, but we’ve covered two short positions that had little premium left and sold a good deal of what is about to become front-month premium. I included the plot of tomorrow’s risk profile (red line) to illustrate how much of a difference we can expect to see just between now and tomorrow morning. (It’s also there because the ideal expiration P/L, colored orange, is not attainable in practice.) Altogether, the resulting delta, theta, gamma and vega add up to a reasonable chance we can recover perhaps as much as half of our current unrealized loss.
And where does this leave us after expiration? Once we’ve closed the 123 put calendar, the risk profile for this newly adjusted double-diagonal—now an “unbalanced” iron condor—will look something like this:
Of course, we would never enter a position like this, not least because the only way to get such an unrealistic P/L graph would be to pay way too much for the condor. I included the above figure merely to illustrate that our potential return at expiration is positive, even counting the December loss. But what matters going forward is the risk profile of what amounts to a new, January, position starting today:
Again, this position is an unbalanced, or “broken-wing” iron condor with about a 60% probability of profit (based on current implied volatility) and relatively little risk to the upside. We’ll have to watch the downside carefully, though, because we’re taking on a 7-point spread by selling the 114 puts (20 delta) against our long Jan 107 puts. I’ll include the projected risk-management price thresholds in the next Weekly Update. Until then, please feel free to send any questions you may have to firstname.lastname@example.org.
So now, just why do we have an iron condor in our January calendar portfolio? Because it’s merely another way we have of exiting or adjusting (whichever way you prefer to look at it) time spreads to our advantage. We don’t get a good opportunity to do this at every expiration, but when we have long positions that are far enough apart and the underlying share price is in the right range, this is just a natural continuation of the original calendar trade, and we’re now adding it to the Calendar Options tool box.