A Condor Takes Flight

May 2, 2021 by Paul

This post is going to demonstrate how I use Call Condors to initiate longer-term (typically 3 months to
1 year) positions with relatively little directional risk when the trade is first placed. It is a trade that is
designed to profit from a trending stock.

If you look at the Thinkback chart and risk profile of Home Depot (HD) below you’ll see how the stock
began a steady uptrend on Mar9. It’s easy to now admire the uptrend but on Mar10 it was very early
on in the trend and impossible to know how long that trend might last. It could’ve ended on Mar11.

The key is structuring a position to provide a reward if a trend does persist without a large drawdown if
the stock turns lower immediately after I place the trade.

First, take a close look at the chart below and see how I chart an instrument to allow myself to stay
with a trend and not get shaken out by a small pullback.

Next, let’s see how those two Call Condors would’ve worked had I placed the orders on Mar10. These
were not actual orders that I placed.

They were from ThinkorSwim’s ThinkBack feature. Below is the current risk profile for one of the
Condors using the price that the Condor could’ve been purchased for on Mar10.

Because price has rallied well beyond the target price at trade initiation, the position is actually short
(negative) 11 Deltas meaning it’ll actually now benefit from a pullback in the price of HD.

The current open profit would be a 200% return on risk.

This Call Condor (below) was structured to benefit from a larger move up in the price of HD. This
position would have a smaller 137% open profit but will continue to benefit from a move higher as it is
long (positive) 6 Deltas. Both trades were nicely profitable and can finish with a greater than 400%
return on risk.

One important warning about being short Calls in any type of option structure on a dividend paying
stock. If the stock goes ex-dividend while I’m holding in the money (ITM) short Calls there is the
possibility that I can be assigned short stock which means I’d then be responsible for paying the
dividend out of my account!

If the extrinsic value of the short Call is much greater than the dividend it reduces the dividend risk
considerably but any trader who is short ITM Calls on an ex-dividend date needs to understand the
risk!

One way around that risk is to use a non-dividend paying stock or, my favorite, the SPX index options.
There is zero risk of any early assignment or dividend risk there. Let’s consider an SPX Call Condor next!
This is the current risk profile of a SPX Call Condor as of the prior day’s close. I could’ve added a 1-lot
position for $940. That’s a lot of risk for a smaller account! While that’s true let’s consider that the
position only has 2.78 Deltas of directional risk and virtually 0 gamma risk.

What does that mean?

If SPX moves lower then this position will lose approximately $2.78 per point that SPX drops.
If SPX is 20 points lower tomorrow the position will lose about $55.60.

A 40 point drop will cause a loss of approximately $110-$120.

So, while the potential risk of this position is $940, the likely risk is less than $150. Still, if I can’t afford
to lose the entire $940, as unpleasant as that may be, I’ll not place this trade. I’d use the SPY to place a
trade 10% of the size of this one.

Unfortunately, SPY pays a dividend so we bring back that risk again! Since I can afford a $940 loss
without damaging my risk capital too badly I’m comfortable with this trade. See the risk profile below
for all of the details.

One of the important details I hope you noticed from the previous risk profile is the Vega. Vega
represents the risk from changes in implied volatility (IV).

The structure of a Call Condor is such that the position makes more profit from a drop in IV as the price
of SPX moves higher and loses less if the price of SPX moves lower. That’s quite convenient since that is
most likely how the VIX (the IV of SPX) will act.

Below is the projected risk profile as of Jun30. Remember that this position would be initiated on the
assumption that SPX will be trending higher from now into September. If price is lower than the
current price on Jun30, why would I still be holding this position? Clearly, if SPX is going to trend higher
it can’t be lower than it is now.
In other words, if SPX doesn’t trend higher almost immediately, I’m out! I can always take another shot
at it if it does start to trend but I don’t hang onto these positions based on hope! It needs to trend now
or it’s over.

That’s also why I don’t place this type of trade unless price is in a confirmed trend on the daily chart.
Refer back to the HD chart at the top of the post for a good example of that.

One of the important details I hope you noticed from the previous risk profile is the Vega. Vega
represents the risk from changes in implied volatility (IV).

The structure of a Call Condor is such that the position makes more profit from a drop in IV as the price
of SPX moves higher and loses less if the price of SPX moves lower. That’s quite convenient since that is
most likely how the VIX (the IV of SPX) will act.

Below is the projected risk profile as of Jun30. Remember that this position would be initiated on the
assumption that SPX will be trending higher from now into September.

If price is lower than the current price on Jun30, why would I still be holding this position? Clearly, if
SPX is going to trend higher it can’t be lower than it is now.

In other words, if SPX doesn’t trend higher almost immediately, I’m out! I can always take another shot
at it if it does start to trend but I don’t hang onto these positions based on hope! It needs to trend now
or it’s over.

That’s also why I don’t place this type of trade unless price is in a confirmed trend on the daily chart.
Refer back to the HD chart at the top of the post for a good example of that.
Below is the projected risk profile as of Jul30. Again, there’s little sense in showing what my loss would
be if the SPX price on Jul30 is the same as the current price. SPX would have to be moving higher to still
be in the trade at that point.

Finally, below is the projected risk profile as of Sep17 expiration. One more time, it doesn’t make sense
to be showing the loss if SPX is ‘only’ 5% higher by expiry because I would be out of the trade unless
SPX is at least 8-10% higher.

I’ve got the answer for everything, don’t I? But wait, you say, what if SPX moved higher by 5% or more
during the trend but then, in a really ugly day or two, gave back much of those gains? Ah, you’ve found
the flaw in the trade structure, haven’t you? Not quite!

My whole system of trading revolves around the concept of Delta Hedging (DH’ing) my positions. If
you’re not familiar with the concept you can find plenty of details about it elsewhere in this blog as
well as my twitter feed. It’s precisely that scenario that I’ve suffered through in the past that caused
me to develop the DH trading system that I use. Read on!
If SPX price has advanced by approximately 5% as of, for example, Jun30, I’ll likely be able to Delta
Hedge the original Call Condor by selling a slightly different Condor in the same Sep expiry for around a
$7.40 Credit.

That would take the position’s net cost down from $940 to just $200. The directional risk of the
position at that point would be less than 2 Deltas!
With virtually no directional risk I could deploy the $740 in reduced capital risk into another position to
leverage my portfolio without adding to my initial at-risk capital.

That reduced cost also allows me to stick with the position even if there’s a nasty 1-2 day drawdown
while the uptrend is still intact. So this is all theoretical, how do I know it even works?
I’ve been using the DH method for many years now. Below is my actual current SPX position. I’ve been
accumulating Call positions in the May, Jun, Sep, and Dec expirys for several months.

Each position started with long Calls before being Delta Hedged by selling further OTM Calls to lock in a
profit. The exception to that is the Call Condors I added on Friday to demonstrate the theoretical
position I have just described in this post.

You’ll notice I also sold some Call Vertical Credit spreads to reduce my Delta risk going into the
weekend. It’s a reasonably large position but it only has -32.45 Deltas and -.95 Gamma risk.
For every point higher SPX goes I’ll lose $32 and every point lower I’ll make $32.

More importantly, I’ll make over $478/day in Theta and that number will continue to rise thru May21
expiry. It does have a $75K margin requirement so this particular position couldn’t be held by a small
account but I have many positions which require no margin at all. So this position helps take this
discussion out of the theoretical world and places it squarely in the real world.

As usual, I hope that this post has given you some understanding of the Call Condor strategy and how it
can be useful for betting on a strong uptrend without risking too much capital if that trend fails to
follow thru.

If you have any questions or comments, let me know on the twitter feed.