Tuesday, September 7, 2010

The Case for the Condor

While the successful bullish defense of the 1040 level may have been met with derision from directional traders and anyone looking for a continuation of August's downtrend, there were no doubt traders who welcomed the bounce off of 1040 with open arms. Those positioning themselves to profit from range-bound action likely feel anything from calm satisfaction to extreme exhilaration on each successive failure of the bulls and bears to bust out of their range-bound prison.

We're running on about four months of ping pong action between the 1130 and 1040 key price thresholds. One of the aforementioned satisfied parties are condor traders. Condors excel in range-bound, declining volatility environments, which sums up the majority of the last few months. Though the condor initiates its profit seeking existence with a delta neutral, non-directional type personality, it can quickly become a directional player. This is due largely to its negative gamma nature.

The negative gamma aspect of condors has the effect of getting you shorter the market as it rises and longer as it falls. While this type of behavior shines when mean reversion rules the day, in trending environments where weakness begets more weakness, getting longer into dips that keep on dipping can be quite painful. Within a risk graph, delta neutral negative gamma positions, such as the condor, show up as an upside down parabola (click image to enlarge).
[Source: MachTrader]

In later posts, we'll flesh out a few more details on our flying friends.

For related content, readers can checkout:
Strangles vs. Iron Condors
Saved By The Wings
Gamma Facts

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