Condor Options

We’re neutralizing the delta of this hedge position with the following iron condor order:

Day limit order
Buy to open 1 SPY Mar 144 call
Sell to open 1 SPY Mar 139 call
Sell to close 1 SPY Mar 137 put
Buy to close 1 SPY Mar 132 put
for a net credit of $1.43 or better.

Note that the 1 contract per leg specified above represents the number of March 137 puts we’re long from Tuesday’s hedge trade.

Analysis: There’s no easy way to say it…this week’s whipsaw was very damaging to our March position, and with just a week left until expiration, we’re virtually guaranteed to take a loss this month. The main question is how much of a loss and what can we do to reduce it—but first, let’s look at the effects of this adjustment.

As noted above, the main purpose of this trade is to zero out the negative delta of the butterfly hedge position. One nice thing about using butterflies as hedges is that they’re easily adjusted into condors, using a conventional butterfly or condor trade. The benefit of this approach is that we have a chance to recoup a greater portion of any loss incurred in a whipsaw reversal than we would by just closing the hedge position—but at the cost of taking on additional risk.

To put it in practical terms, this adjustment converts our put ‘fly into a March 127/132/139/144 iron condor. We’re reducing negative portfolio delta from more than 3% to less than 1%, and moving our projected upside adjustment price point up to about SPY $138. We’re also offsetting volatility risk, taking vega from more than 6.4% down to about 3.4%. Here’s what our portfolio risk curve looks like after this trade:

…And here’s where we see the damage. The loss we’re forced to lock in from the downside hedge is about equal to the potential profit from our core double-calendar position. So at best, it looks like we could break even—but if only it were that simple…

Unfortunately, we’re faced with two complications: 1) expiration-week gamma, and 2) dividend risk. From the risk graph above, it appears that time-decay is working strongly in our favor—but what the model doesn’t show is how March implied volatility will be bolstered by the approach of Q1 ex-dividend on expiration Friday. The model is showing an accurate theoretical projection for the day before expiration (the orange line), but the estimate for earlier next week probably isn’t what we’ll actually see.

So, if we keep our positions open into expiration Friday, we could recover the vast majority of this week’s whipsaw loss; in the meantime, the dividend keeps our expiration-week risk higher compare to non-dividend months. (Note that I’m experimenting with ways to get around this in the future—and that this is an issue I’ve seen no other options-trading newsletter discuss, which is yet another reason we think the Condor Options newsletters outshine the competition.)

Depending on where it looks like SPY will close this Friday, we might pare back our risk ahead of next week—or even close out entirely and set our sights on better prospects next month. For more risk-tolerant members, I’m considering following through next week to illustrate how an advanced trader can manage expiration-week gamma when the potential reward is attractive enough. I’ll post an update early Friday afternoon.