The Kite Spread: Coming to the Rescue

I haven't written about the kite spread in awhile, but I made some trades on Monday March 1, that are worth mentioning.

Here's the situation:

1) Much earlier I bought 4 Apr 630 C3 kites.  That means:

Bought 4 RUT Apr 630 calls

Sold 12 RUT Apr 650/660 call spreads

2) That position profits on rallies, but the iron condor portion of my portfolio could look better (i.e., I'd like the risk graph to show less loss in the 670-680 range)

3) By owning the kite spread, I was able to buy upside protection at essentially no cost.

Trade ONE

Sell 4 RUT 630/640 C spreads.  Collect $610 each

This trade brings in cash and makes the upside a bit worse.  I know the objective is to make the upside better, but when selling this spread and collecting more than $600, the potential upside that I sacrifice is less than $400 per spread. 

Because I still own 4 naked long calls (now the Apr 640s instead of the 630s), that provides decent upside potential.  When I complete the trades below, the upside will look even better.

I used the >$2,400 cash to buy 4 more kite spreads, paying just over $610 each [Thus, the spread cost a small debit]


Trade TWO

Buy 4 RUT Apr 650 C3 Kite spreads.  Specifically,

Buy 4 RUT Apr 650 calls (to close)

Sell 12 RUT Apr 670/680C spreads


Typically, it costs a significant debit to buy the protection afforded by the kite spread, but once you have that protection in place, it can used to make suitable position adjustments.

In this example, I rolled part of the original kite spread to higher strike prices, gained upside protection, and paid almost nothing.

Before

Orig_kite

After

After_trade

The graphs may look similar, but a glance at the numbers on the y axis (left) shows that the upside is much better with the added kites.

This graphs were made after the market closed, At that time the cost of the four kites spreads would have been higher.  That's the reason the 'after' graph shows a larger loss – on a big decline.

630


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8 Responses to The Kite Spread: Coming to the Rescue

  1. Brian 03/04/2010 at 5:17 AM #

    Mark,
    You say: … but the iron condor portion of my portfolio could look better (i.e., I’d like the risk graph to show less loss in the 670-680 range)
    In your example here, what is the original IC call spread that you are protecting? From the quote, I would guess it’s a 670-680 spread. Correct? This is a question I’ve had in using the kite spread: what kite strikes to use in relation to the IC spread.
    thanks as always.

  2. Mark Wolfinger 03/04/2010 at 7:42 AM #

    Hi Brian,
    I’m protecting more than one iron condor position. I have short call spreads, pretty much all in April: 650/660 (I have move almost all of these to higher strikes); 660/670 (in a different account); and 670/680; 690/700
    It’s a whole portfolio of positions.
    Yes, choosing the strike is always an issue. CTM (close to the money) strikes cost a significant amount of cash.

  3. Brian 03/04/2010 at 11:15 AM #

    Thanks for the response. As usual there isn’t a “simple answer” 🙂 I suppose this also relates to your recent “should you always be delta neutral” post.
    An interesting (to me, anyway) topic for your newsletter might be some rules of thumb for how to choose kite strikes to protect an IC portfolio. (with some risk graphs to show the tradeoffs of different options).

  4. Mark Wolfinger 03/04/2010 at 11:18 AM #

    Excellent idea for Expiring Monthly.
    I would have to introduce kite spreads first. But it can be done.
    Thanks
    Mark

  5. jacob 03/04/2010 at 12:50 PM #

    Hi Mark,
    This is unrelated to your post, but I was wondering if you’d ever got a chance to get to my question about implied volatility and supply/demand that I emailed you about a few weeks ago. I’m still curious about your opinion on the matter. Thanks.

  6. Mark Wolfinger 03/04/2010 at 1:06 PM #

    Jacob:
    Reply posted on Februaray 18, 2010
    You had me concerned for a minute.
    Regards.

  7. Peter 03/04/2010 at 3:55 PM #

    Mark, I don’t know what your positions are exactly, but let’s say you have a few kite spreads of 650/670/680 and most of your credit spreads are at 670/680. If RUT continues its march upwards near 670, the kite spread hasn’t reached its full potential yet (I’m not considering at expiration – assuming there’s like 30 days left). Do you plan to roll the 670/680 position, buy back the credit spreads, or what? In general, what is the plan with purchasing the kite spreads with strike close to the credit spread strike. Thanks.

  8. Mark Wolfinger 03/04/2010 at 7:05 PM #

    Full post on this Q&A 3/5/2010