Condor Options

Last month we faced what just might be the worst possible scenario for a calendar-spread strategy—a v-shaped bottom late in the cycle. And yet our trading rules not only kept us from a loss, but produced a significant profit that handily outperformed the market.

Performance Comparison

• S&P 500: –0.20%
• Dow Jones Industrials: –1.19%
• Russell 2000: –2.64%
• S&P 500 Covered Call Fund: +6.92%
• Calendar Options: +2.52%
• Note: The period measured is from expiration to expiration.

We calculate Calendar Options returns based on a model portfolio allocation. We initially size each hypothetical position at 25% of the total portfolio value at the beginning of the cycle; with a maximum of three trades per month, this leaves at least 25% initially in cash for adjustments, if needed. Note that the model portfolio is not intended as a recommended allocation or as investment advice.

To see how the performance of our model portfolio since inception compares to a portfolio that’s 100% long the S&P 500, take a look at our Performance page.

March Trades

• IBM March/April Double-Diagonal: 19.84% return – We opened this position as IBM was entering a consolidation pattern after a strong advance—but that consolidation turned into an intermediate-term reversal days later when the stock gapped down. Because we took a bearish-leaning stance initially, that first breakdown did little damage…but things started to get ugly the following week, when a one-day drop of 5% kicked off a period of extreme volatility. Nevertheless, IBM never closed below our lower adjustment threshold. We took advantage of an upswing to roll down the call side of the position and grab a little more premium, and despite a sharp reaction rally (the stock’s range for the week of February 23 was more than $10) and another, equally sharp sell-off the following week, we didn’t need to take any defensive measures. The adjusted position reached our 20% profit target 10 days before expiration. (We couldn’t chalk up that nice round number because we had to lower our asking price to get our closing order filled—but what’s 0.16% here or there?).
• PG March/April Double-Diagonal: –6.49% return – We structured this trade very wide, for two reasons: 1) The market was becoming increasingly volatile, so we wanted to give ourselves a lot of room between the short strikes, and 2) we wanted our vertical spreads wide enough to generate a credit, and thus make our initial position immune to any loss purely from a drop in implied volatility (a net credit means that the premium we sold more than paid for the premium we bought, eliminating the risk of a loss due to a decline in the extrinsic value of our long contracts alone). But we paid for these advantages with a couple of trade-offs—namely, less theta and a weaker foundation for adjusting the position.The latter proved to be the trade’s undoing, as an accelerating downtrend forced us to manage our risk by adjusting into a double-calendar that had marginal profit potential to begin with and was crushed a week later by a sharp rally and the accompanying drop in implied volatility. Still, as any professional trader knows, we aren’t going to win every time (despite what some newsletters’ marketing hype might want you to believe)—the way we stay in business is by keeping our losses smaller than our gains, and by that measure, March was a very successful month.

Here and now

In spite of the strong rally that started just after we opened our April positions, they’re in great shape, thanks to our risk-management rules. We’re planning to enter our first trade for May expiration tomorrow morning, and if the market holds onto support, we should be able to book a 15% profit on our DIA April/May double-calendar before the holiday weekend.