Positive alpha, negative beta in all markets

Trading in today’s stagnant, low-volatility markets tests the nerves and patience of many traditional traders and investors. Disappointed with recent performance, these traders are seeking new strategies that provide higher returns in trading-range markets.

At least one strategy is designed for these types of markets. The “calendar condor” exploits the unique pricing structure that options offer.

The calendar condor is a combination of two separate strategies that together create high alpha, negative beta, manageable risk and the ability to profit in almost all market conditions — when managed correctly.


The purpose of the calendar condor is to provide investors with a long-term profit objective: returns that are equal to or better than the market returns when the market rises and positive performance when markets are falling or in a range.

It does this first by creating better-than-market returns, which is called positive alpha, in a rising market. Second, the structure of the options positions allows the trade to work in falling or trading-range markets.

The success of this strategy is available only with the unique pricing structure associated with options. You can buy puts or calls and have the market move in the direction you expect, yet still lose money due to theta. Theta is the daily loss of value of an option due to the passage of time. It is this option pricing phenomenon, when combined with a hedge that allows the strategy to become profitable in both up and down markets, which creates the calendar condor.

By combining a calendar spread with an iron condor, we effectively have an adjustable calendar spread — selling the near-term and closer-to-the-money puts and calls while simultaneously buying out-of-the-money deferred month puts and calls as a hedge against dramatic moves in either direction. This strategy must be managed with a slightly negative bias, or slightly negative delta, to produce positive results in down markets.

A profit/loss analysis of a hypothetical trade generated in late 2005 is shown in “Taking flight” (below). The trade begins as a net debit spread (the debit is the difference between buying the long options and selling the short options). Through time, the trade becomes a net credit spread as you roll inside positions into later months and collect more premium each month you roll. Thus, a trader of this strategy can be described as a net seller of premium.

As a seller of premium, risk is mitigated in two ways. First, by taking positions on both sides of the market, the true risk exists on only one side of the trade because no matter the direction of the market, one trade will be a winner. Second, purchasing options in the deferred months (“wings”) mitigates risk on the short options. These long positions generally provide a comfort level to maintain current positions for a longer period while the market vacillates in some unknown direction.


Producing alpha while maintaining a negative beta in a rising market environment seems as though it should be impossible. Mathematically, it is if you use traditional securities.

Futures, stocks and mutual funds are assets that either appreciate in value or decline in value because of the markets’ view of the assets. Options, however, are always depreciating assets. Options are priced three-dimensionally: time, volatility and price of the underlying. This makes them unique compared to other market instruments. These pricing characteristics coupled with the undeniable fact that options finishing out-of-the-money at expiration have a value of zero, provides the secret to this strategy.

Taking advantage of a depreciating asset such as an option, and profiting from it, is key to creating higher alpha. We can say that “alpha” is Greek for any performance generated above market return. Beta is the measure of volatility relative to the market. A beta greater than 1.00 indicates the instrument is more volatile than the market.

By definition, a negative beta strategy should not have a positive return in an up market. However, by exploiting the dynamics of options pricing, the calendar condor may profit. As mentioned before, taking advantage of the time premium of an option allows a strategy to have a negative beta, yet profit in up markets at the same time


Several factors have altered options pricing recently. First, premiums on options generally are much lower today than they were three to four years ago because of lower volatility, which is often measured by the Volatility Index (or VIX). Therefore, you cannot collect as much premium from selling an option as you could several years ago. Second, the VIX — an index of market volatility calculated and published by the Chicago Board Options Exchange — has been trading near 10-year lows for the past two years (see “Volatility crunch,” below).

To illustrate, assume the S&P 500 is trading at 1200. In 2001, when volatility was much higher, an out-of-the-money 1250 call might have sold for around $25 with 60 days to expiration. Today, that same option may sell for $17.50. To collect the same premium, you sell options that are much closer-to-the-money, assuming more risk.

Volatility shrunk and the daily range decreased. The average daily trading range from 2000-02 was 22.02 points. The average daily trading range from 2004-05 was 10.39 points.

When the VIX is high, time premiums are inflated and tend to favor the premium seller. When the VIX is low, time premiums are low and tend to favor the premium buyer.


Now that we have grasped the basic understandings of beta, alpha and the VIX, we can indulge in the entire Greek soup and look at managing the positions involved in the calendar condor.

When trading this strategy it is best to maintain a delta negative position. This is Greek for “maintaining a bias to the downside.” A delta negative position theoretically makes a profit when the underlying asset moves lower. The delta remains negative by adjusting the short option positions up or down depending on market direction.

It’s important to maintain this bias because markets tend to fall more rapidly than they move upward. History is the greatest teacher the markets have and it has proved the market can move down faster and farther than it can move up; so, it is safer to remain slightly short biased and adjust the positions to the upside when necessary.

The negative bias can work against us when the market makes large, consecutive moves in one direction and then follows with a strong move in the opposite direction — in effect, getting whipsawed out of a position. This will negate or defer the strategies’ performance to a later date because the short positions must be altered from the current month to maintain a slightly delta-negative bias.

Remember, this strategy is successful when traded each and every month throughout the long term and investors should not get frustrated by one month’s poor performance.


What makes the calendar condor so profitable throughout the long term is the entire position’s theta. The higher theta an option has, the more time value it will lose on a single day (assuming all else is held constant). The strategy takes advantage of theta by selling out-of-the-money and close-to-expiration options with higher thetas. Options that are close to expiration mathematically lose more time premium on a daily basis than options that are held further from expiration. “Theta at work” (below) shows an example of a calendar condor position.

Here are the components:

• Buy 10 Sep ‘06 1325 Calls @ $29.30

• Buy 10 Sep ‘06 1200 Puts @ $29.80

• Sell 10 Feb ‘06 1300 Calls @ $8.60

• Sell 10 Feb ‘06 1250 Puts @ $14.60

If the market fell below 1255 and moved closer to the strike prices on the short option positions, then it would be necessary to implement a position roll. This is accomplished by buying back the short calls and puts while selling another option further out of the money and away from the market. In this example, if the market went to 1250, we would need to roll the put positions to protect any acquired gains.

We would roll the February 1250’s down and out using a spread: buy February 1250 puts and sell March 1225 puts. This allows you to reduce the risk exposure to the direction the market may be trending. The positions have been adjusted slightly to account for the markets current trend. The same position roll would have to be implemented if the market were to move closer to our short call positions.


The calendar condor is an options strategy that has a negative bias to the underlying asset, yet when managed properly it provides consistent profits in all types of markets throughout the long term. The negative beta is created by remaining slightly delta negative and managing the short positions throughout the trade. In turn, the negative delta position provides positive returns in down markets. The strategy’s performance in all types of markets cannot be discounted nor can it be duplicated without the use of options.

Although no one can accurately predict the direction of the market, there are ways to capture profits in all types of markets. Alternative asset managers using sophisticated tools and alternative strategies such as the calendar condor attempt to outperform stagnant markets on a consistent basis to create alpha. The key is the investor’s ability to manage risk. Without managing the risk parameters, the strategy may not be as successful.

Positive alpha is achievable with a negative beta trading strategy in both up and down markets. However, it’s necessary to maintain a slightly delta negative position to preserve negative beta and then be a net seller of time premium.

Note: Definitions of certain option terms can be found on our Website at www.futuresmag.com/additional_copy/optionsglossary.htm.

Jes Santaularia is the managing principal and Charlie Santaularia is the managing director at Parrot Trading Partners LLC in Lawrence, Kan., and Sarasota, Fla. E-mail them at jes@parrottrading.com or charlie@parrottrading.com, or visit www.parrottrading.com.

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