SPX Iron Condor + Put Calendar

 

This is an idea that we heard about today.  The structure involves selling an Iron Condor and then hedging risk using a Put Calendar.

An Iron Condor is a neutral strategy where you write and sell option contracts to a buyer.  Meaning you are betting that the stock will stay between two points until the options expire.  In this example we would do the following:

Sell 1390 Call
Buy 1410 Call
Sell 1280 Put
Buy 1270 Put

As long as the SPX stays between 1280 and 1390 on 5/20/2011 we will make money. We are asking for $435 per contract.  Our maximum profit on 4 contracts of SPX is $1740.  Our maximum loss is $6260 which occurs if SPX is below 1270 or above 1410.  This can be seen in the risk profile screen below.  The break even line at 0 intersects with the red risk plot for the date 5/20/2011.  Today is illustrated by the white line. There is a lot of upside risk in this trade, but the market starting to get tired so a pull back for a short amount of time is likely.

Stock-Analyze---SPX-2011-04-06

 

To take some of the downside risk off we can buy a Put Calendar.  This will make money as SPX drops in value. This would be done by:
Sell May 1275 Put
Buy June 1275 Put

By selling the May Put, we reduce the cost of buying the June Put.  Since Calendar options tend to gain value with an increase in volatility (an increase in the VIX) we only need to buy 1 contract for roughly $935. This also skews the P/L curve. In the picture below we have added a Vol Adj of +20% to simulate the VIX at at 36.90.  This is no too far out of line since the VIX was at 31.50 two weeks ago.  I have also changed the simulated stock price to 1270.08, which is close enough to our maximum loss.  Notice the P/L Open column.  If SPX is near 1270 which would be the maximum loss of $6260 had we simply sold the four Iron Condors.  However due to the spike in volatility and the appreciation of the Put Calendar our position would be worth $3143.  That’s roughly a $9000 swing from loss to profit, assuming everything shakes out this way.  Of course the VIX could move more or less than what we projected if things go bad.  That is the disadvantage of Calendar Options, since we have to guess where the VIX might be in a worst case scenario. 

By combining the Iron Condor and the Put Calendar we have collected

Iron Condor $1740 Credit
Put Calendar $935 Debit
Total: $805 Credit.

By submitting this order we immediately receive $805 deposited into our brokerage account and we get to keep all of it if SPX is between 1270 and 1390. The Put Calendar protects us if the market suddenly crashes and we actually end up making more if it does crash.  Buying Put Options is a great insurance strategy.

Stock-Analyze---SPX-2011-04-06

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