What Is an Iron Condor. You sell a put at 735 and a call at 790 and collect 635 dollars per contract from traders who bet on a big move. You buy a put at 720 and a call at 805 as insurance, so the worst case is fixed at 865 dollars.
Enter all four legs as one order at the mid, net credit, day order. A few cents less credit is fine to get filled.
The Setup
On Friday, October 16, traders bought more index puts on the Cboe than on any day since 2015, by Goldman's count, and the VIX closed just under 20. The index fell 1 percent that day and 2 percent on the week. SPY, the big S&P 500 fund, closed on Monday 1.6 percent below its record of October 6.
That panic buying is what we sell. SPY has moved like a calm fund lately, far calmer than its December options price. So I sell an iron condor into December: four options that pay me up front for fencing a range around today's price. The fence is not centred. It leans bearish: it wins most if the market drifts a little lower or goes nowhere, and it has less room on the upside. That suits a reader who already owns plenty of stocks and wants one position that pays if the rally pauses.
Where You Win, Where You Lose
SPY iron condor, 6.35 credit: the grey line is the profit or loss at expiry, the orange curve on Nov 27, the exit day, with breakevens at 727.80 and 788.30. Max loss $865, max gain $635 per contract.
What you are betting. You are betting that SPY stays between the two break-evens until November 27, about 5 percent below Monday's close to 3 percent above, more room down than up. Near today's price that pays about 40 percent on the money at risk.
When we are wrong, and what we do then. The story breaks if the range breaks: a sweep scare or credit accident that sends SPY below the lower break-even, about 5 percent down, or a relief rally past the upper one, 3 percent up, before November 27. The rally is the nearer danger. Half the stake lost is where I stop. The exit rule: out by November 27, three weeks before expiry; sitting in the middle of the range, I may hold longer. Earlier only if a fast move costs about half the stake and the story has changed.
The Chart
S&P 500 (SPY), daily candles over six months with the 40, 50 and 200 day averages. The box is where the whole credit is kept, the band between 727.80 and 788.30 is the profit zone on Nov 27.
Trend: up 12 percent this year and 1.6 percent under the record close of October 6, back above its 40 and 50 day averages after one close below on October 16 (EMA40 and EMA50 as drawn).
Levels: the lower break-even sits under the September low and the put wall near 745; the upper one above the record high, under the call wall near 795.
The Big Picture
The range is the market's own. The options price a move of about 5 percent either way by November 27; we fence the inside, top rail closer than the bottom one. Goldman's year-end target sits only 3 percent above Friday's close, about where our top rail is.
The big houses disagree, which is what a range trade wants. Bank of America's Michael Hartnett leans risk-off for three to four weeks; Goldman's Tony Pasquariello expects strength in November as buybacks return; JPMorgan counts an average 5 percent gain in the three months after a midterm. Hedge funds have already cut their exposure to a five-year low. Each has placed its bet; we collect from all three, leaning a little to Hartnett's side.
Three Things That Matter Before Nov 27
Four dates sit inside: the Fed on October 28, the midterms on November 3, the refunding on November 4 and 44 percent of the S&P reporting next week. With SPY near a break-even into any of them, I close early.
The upside is the thin side. Over the past year a box like this held about half the time, and nearly every break went up. The rally phase has to pause for the top rail to hold; that is the bearish lean.
Hartnett expects a skid of more than 10 percent on a Democratic sweep, priced at 64 percent, and a 5 percent gain on a split Congress. Goldman's history says less: a median 3.5 percent drop into a midterm since 1974.
Sources: Goldman, Oct 19. market wrap, Oct 19. BofA, Oct 18. Federal Reserve, Oct 1. market wrap, Oct 18. Goldman, Oct 16. Goldman, Oct 18. JPMorgan, Oct 16. Prices: mid quotes, Oct 20.
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