Condor Options

We’re hedging our delta to the downside this afternoon with the following trade:

Day limit order
Buy to open 1 SPY Mar 137 put
Sell to open 2 SPY Mar 132 puts
Buy to open 1 SPY Mar 127 put
for a net debit of $1.82 or better.

Note that the one contract specified above for the “wings” (outer strikes) represents half the number of contracts we currently have open in the SPY Mar/Apr 134/139 double-calendar.

Analysis: Complacent markets are prone to sharp mini-panics, which is why our strategy rules don’t let us pile on gamma around one underlying price range even when the market seems to be stuck drifting sideways. Now [due to an unexpected personal matter], I’m writing this analysis after the fact—but nonetheless, the Calendar Options hedging strategy was developed to be resilient against, among other things, whipsaws.

If today’s [yesterday's] sell-off turns out to be nothing more than a little speed bump in this go-go, risk-off rally, we will adjust our hedge p0sition to recoup much of any loss it incurs (and possibly even add to our potential profit). In the meantime, this trade reshapes our current P/L curve to fit our risk-management goals.

First and foremost, delta: This hedge trade cuts our delta risk from about 5.7% of capital at risk to approximately 1.3%. Given the likelihood that this drop is a minor correction in a strong, unbroken up trend, we’re using a negative-vega trade that brings our portfolio vega, as a percentage of capital at risk, down from about 7.8% to about 5.3%. We’re increasing our rate of time-decay (always desirable) but also increasing gamma slightly…the two tend to go hand-in-hand, as both theta and gamma, in positive-theta trades, are greatest at the peak of the risk curve.

Note that I’ve plotted two projected P/L curves in the figure above. The red line (the middle one, for members who don’t see red) is the profit (loss) expected after the coming weekend’s time decay is factored in, which is where we usually exit at least part of our position. But because we don’t have much capital at risk this month [reality check—if you've committed more than about 5% of your total investment capital to currently open Calendar Options trades, that's too much], we might ride out expiration week to get past the inevitable increase in March IV that will result from the anticipated first-quarter SPY dividend…

…Which brings us to the top (orange) line—expiration Friday. Looks like we could hit the jackpot, right? Wrong. That’s not how an option-selling business works. I included this line to show the probability of ending up with a profit at expiration, if the S&P finds a new, narrow range and we hold at least part of our current open positions up to expiration. But what we’re really going for is somewhere in between the red and the orange—a small profit in a challenging month, to have the opportunity to reap bigger profits when conditions are more favorable.

Of course, further risk-management actions could (and likely will) change the picture. We’re currently watching SPY $132.75 and $136.50 for our next trade signal.