Condor Options

I put the word “portfolio” in parentheses because, as you all know, we have no open position at this time. For a number of reasons, we’ve been in an options-market environment that favors short-vega strategies, and our iron-condor newsletter did exceedingly well this quarter. Since we all have about twice as much capital allocated to condors and butterflies as we’ve designated for calendar spreads (right?), as suggested in the Calendar Options Strategy Guide, that’s great. But we also want to keep some skin in the long-vega game, assuming we diligently manage risk, because we never know when the climate will change.

To that end (managing risk), this morning’s jump into the “Blue Zone” (just the color I happened to choose) by the VIX suggests that this might not be the best time to enter a calendar position…or, it just might be the signal that implied volatility is headed higher and we want to get long vega. Trouble is, we don’t really know for sure, and that pesky volatility term structure of late has tended to work against using calendars as a way of buying volatility in the short-term.

So does that mean we shouldn’t pursue any calendar trades this month? Not at all. In fact, SPY average implied volatility is still well within our target entry-trade range. But there are two other factors that point towards a shorter timeframe for our trades.

One is simply that lately rising volatility has been biased towards the front month. That means whenever the market shifts into risk-on mode, the risk is mostly priced into short-term options, which hurts our calendar positions. If we want to overcome that bias with time decay, we’ll have to concentrate on the time period where our net theta is greatest—and that means waiting until about three weeks before expiration before entering any calendar position.

(An interesting aside: This same phenomenon has made it advantageous to enter iron condors earlier, and that’s something Jared has picked up on in his iron-condors newsletter with great success.)

The other, related, factor is that April premium is currently underpriced compared to May. Much of this is just normal contango; nevertheless, with May IV under 18% a one-and-a-half point difference is enough to call for a conservative approach.

The obvious question, then, is “Are we going to sit on our hands for another week?” Not necessarily. I’m looking at possibilities for entering a double-diagonal position early next week. The drawback to that approach, as long-time subscribers know all too well, is that brokers still (incredibly) require you to put up margin for the vertical component of both spreads. So even though we might see a return on capital at risk in the 10%-15% range, our return on total margin could be as little as half that. On the other hand, if we stay in cash, our return is zero—so I hope we all agree that if a double-diagonal is what the situation calls for, it’s well worth doing.