The Condor is one of the most powerful option strategies for generating a very favorable reward/risk ratio. It can offer generous amounts of long (positive) Theta as well as short (negative) Vega. Being short Vega tends to reward a position where the underlying instrument’s price grinds higher. That is why I often utilize an out-of-the-money (OTM) Call Condor on a stock that is at or near an important support level or appears to be breaking out above an important resistance level.
Instead of a theoretical discussion I’ll focus this post on my actual current FB position. I currently own two separate Call Condors; one with a Sep expiry and the other with a Jan expiry. These two positions are combined in what I refer to as a stacked position. I don’t want to jump ahead here so I’ll circle back to that stacked position at the end of this post. For now, I’m going to examine just the Sep Condor. The risk profile below shows my current position. I purchased this Call Condor 18 days ago for a $3.00 Debit. It is now marked at $4.11 which is a 37% profit. So far so good. The maximum potential profit for this trade however is 566% so I’ve no need to exit this position yet and leave all of that potential on the table. However, if FB moves lower in price or simply stalls out here until Sep expiry, not only will I give up my $1.11 profit but I could lose my entire $3.00 cost. In other words, I’m risking the entire $4.11 that the Condor is currently worth to hold the position. Isn’t there something I can do to reduce that risk? If there wasn’t I wouldn’t be writing this post so keep on reading!
If the price of FB advances approximately another $10 I’ll be able to sell, not buy, a $50 wide Sep Condor for a $3.00 Credit. That $3.00 Credit would completely offset the $3.00 Debit that I paid for the original Condor and leave me with $0 invested in the position. But how does selling this Condor affect my Sep position?
Below is the combined position if I am able to sell that Condor from the risk profile above. What I am essentially doing is narrowing my current Call Condor. Let me give an example using a real estate analogy. When I first bought the Condor it was far OTM. It’s comparable to me buying a big piece of property on the outskirts of town. There’s not much demand for property out there yet so I got it for a good price. My risk is that the growth won’t develop in that direction and, if that’s the case, I bought a worthless piece of property. Now, lets say that people are indeed starting to move out into that vicinity and the price of my real estate is increasing. I’m seeing a profit in my original investment and all is good but…now economists are saying the housing market is getting overheated and is due for a correction. Should I sell my property just in case there’s a housing crash or should I hold onto it with the hope of prices continuing to rise? Fortunately, there’s a third choice. I can sell off parts of the property that I own and collect enough of a profit to take my net cost down to zero. See the risk profile below.
In the above scenario I’ve sold off a piece of the most expensive property that’s closest to town and a second piece that isn’t worth nearly as much as it’s on the far outskirts of my property farthest from town. It’s the piece of property that’s most likely to be completely worthless if there’s a housing correction so I’m selling it now to at least collect something for it. All in all I’ve sold those two properties for the same price as the big piece of property that I originally bought. The worst I can now do on my real estate venture now is end up with the same amount of capital that I had before I made my original purchase.
I hope the real estate analogy helps you understand the principal of Delta Hedging (DH) a position but this is where the option scenario differs from the real estate example. I’ve finally circled back around to the concept of stacking positions. With options, each of my ‘properties’ are not just based on location but location and time. I will often repeat the same strategy multiple times using different expiration cycles. In fact, if you look at the risk profile below you’ll see that I currently own Call Condors in the Sep and Jan expiration cycle. Why different expiry’s? With a Condor I have three primary risks; Delta (directional) risk, Vega (volatility) risk, and Theta (time risk). By using the Delta Hedge strategy I can reduce Delta risk and by using different expiry’s I can hedge my portfolio against time risk. I can never predict if FB price will go higher or not and even if it does go higher I certainly can’t predict how soon that might happen. As long as the chart setup continues to be bullish I’ll continue to add more of these stacked positions as soon as I’ve eliminated all of my original investment in the current ‘property’.
Below is the risk profile of the two stacked positions *if* I’m able to get to zero cost on the Sep position. I’ll then be looking to add another position to the mix based on the chart. If the chart causes me to expect a move lower in FB I won’t exit these Call Condors but instead I’ll add a bearish Put position (perhaps a Condor or Diagonal) to hedge my downside risk while keeping the upside potential and I’ll look to DH that if price follows thru lower. Rinse and repeat in an ongoing process in one of my favored trading stocks.
If you have any questions or comments tweet them at me.
this is something i will simulate this week and see what the results are like