Choose an appropriate kite spread

Mark,

I assume the credit spreads that make up the initial iron condor that you are protecting are further OTM than the strikes used in the kite; true?

How much further OTM are the IC spreads in the above kite examples?

Thanks,

Jeff

***

The question above refers to this introductory post on the kite spread.

Jeff,

Yes, the kite is intended to protect credit spreads that are farther out of the money.

When choosing strike prices for the kite spread, there are two possibilities.

1) the Iron condor options are no longer far OTM and there is not much choice. The kite is more expensive when the option you buy (the kite string) is only a strike or two out of the money.

EXAMPLES:  You are short the 890/900 call spread.

 If the underlying is 840 to 850, and if you want a kite position whose strike prices do not overlap those of the iron condor (recommended), your choices are limited.  The only kite spread that fits is buying the 850C and selling the 870/880 call spread.

 

2) When the IC options are farther OTM, you have more choices.  If the underlying is 820, then your choice depends on your goal.

You can choose a kite with a good chance to earn a profit on a rally (lower strike prices, but more costly). 

Or, when all you want is protection (higher strike prices, less costly), there is flexibility.

i) Profit opportunity: Buy 830 call and sell three 850/860 spreads or four 860/870 spreads.

ii) Intermediate: Buy 840 call and sell three 860/870 spreads.

iii) Protection: All you need to protect the iron condor is buying 850 call and sell three 870/880 spreads.  This is the same kite as you would buy if waiting for the underlying to rise before owning insurance.  But it's significantly less expensive to buy it now, when the 850 call is 20 to 30 points farther OTM,

The kite spread is a flexible strategy, and is a topic I plan to discuss more frequently.

543

4 Responses to Choose an appropriate kite spread

  1. Mark 12/08/2009 at 10:01 AM #

    Hi, Mark. Just so I’m sure I’ve got it clearly: in today’s post following the sentence “…there are two possibilities”, you describe “possibility 1)” but no possibility 2) is described. I’m guessing possibility 2) is when the IC options are still farther OTM, and also that possibility 2) corresponds to example b). Correct?

  2. Mark Wolfinger 12/08/2009 at 10:16 AM #

    Sorry.
    Yes, you are correct on both counts.
    Thank you. I made the change.

  3. Lloyd 12/08/2009 at 5:15 PM #

    Thanks for the more extensive discussion on the kite spread, which I understood for the first time today. Looking forward to more of your insights on this type of protection. And graphs! I think you mentioned Hoadley’s graphing program a while back. Is that a good way to go to visualize different scenarios?

  4. Mark Wolfinger 12/08/2009 at 6:40 PM #

    I’m working on more material discussing kite spreads.
    Hoadley’s program seemed to be just what I was looking for, but I’ve had difficulty using it. Thus, the jury is still out.
    But, OSET is free and is worth your time to see how well it works.