Condor Options

In our August monthly review, we expected that “the next phase of this bear market will likely be driven not by U.S. financial companies or by energy prices per se, but rather by the effects of the American slowdown being felt by the rest of the world.”  See, that’s why we’re traders and not economists.  Although in our defense, the reason AIG was nationalized was partly because of the effect its failure would have had on European and other counterparties.  And we do still expect another shoe to drop and for that footfall to originate somewhere other than here in the U.S.  For instance, if we were managing a nervous sovereign wealth fund, while we might do some nibbling on the stocks of sound American smallcaps, we would be overall short U.S. equities, even 20% off their highs, and we certainly would be more circumspect about lending to Americans.

Think about it: the U.S. Federal Government is now essentially the world’s largest hedge fund, investment bank, and insurance company.  Foreign lenders are faced with the same “lock box” that Gore talked so much about in 2000, except instead of a record surplus, that shiny black box has a white question mark painted on it, and nobody really knows precisely how much toxic mortgage paper is inside.  Is that a fund where you really want to park your cash?  Foreign investors, unlike U.S. taxpayers, still have the choice to opt out.

Performance Comparison

Here’s how the major market indexes, the S&P 500 Covered Call Fund (BEP), and the Condor Options trades performed over the past month:

• S&P 500: (3.32)%
• Dow Jones Industrials: (2.32)%
• Russell 2000: 0.13%
• S&P 500 Covered Call Fund: (8.69)%
• Condor Options: 14.07%
• Note: the period measured is from expiration to expiration, rather than from the start of the month.

Another winning month – we beat our chosen benchmark (BEP) handily.  Skewing trades with some slight downside bias hasn’t been a bad way to go, although of course, sitting in cash isn’t a bad strategy in this market either (assuming your dollar exposure is hedged).

September Iron Condors

• IWM 64/66/76/78: 21.80% return.  We exited this trade about two weeks before expiration to protect gains and reduce our exposure.  Now, technically, we could’ve held this position through to expiration and been okay.  But pull up a chart of IWM over the past week, and you’ll notice that both of the breakeven points on this trade were threatened during expiration week, and that at Friday’s open this would’ve looked like a 100% loss.  Exiting our positions early allowed us to remain relatively detached (we do have some October positions on) during last week’s volatility.  Panic and ulcers are both to be avoided, but they always seem to accompany holding trades during expiration week.
• IWM 67/69/80/82: 16.99% return.  IWM moved higher into August expiration (when we were still opening September trades), so we put on this second position to balance out our directional exposure.  We also closed this trade slightly on the early side, and again, saved ourselves a lot of hassle and worry.  It’s not just a question of psychological pain – when a position moves against you during expiration week, many trades will take the medium-sized loss to avoid a bigger one, even if their original intent was to hold through to expiration.  Covering short positions before the negative gamma gets too severe reduces the risk of emotion-driven decisions.
• SPY 122/124/138/140: 3.44% return. The trade was opened primarily as a hedge against the upside risk that had developed in the IWM positions.  When the markets moved back down and some time had passed, the hedge was no longer needed so we closed it out for a negligible profit.

September Reading

Here are some posts from the past month that are worth checking out if you didn’t catch them the first time around:

• Random Walks and Random Jumps: Taleb on Volatility
  
• Volatility and Calendar Spreads
  
• Is a Volatility ETF a Good Idea?
  
• Trading Volatility at the Extremes
• Trading Against Low Volume Rallies