With 29 days left to expiration our current HIPOS trade utilizing a call spread on the Russell 2000 Index is in its early stages. Currently the underlying index sits roughly 4.1% below our short strike price of 1575. It also remains below our defensive purple curve line shown in the graph above. We entered the trade after an outsized-up day in the market, although the Russell 2000 Index has continued to move higher.

We have talked before on the blog around how moves against our position very early on can cause the values of the spreads to move against us. This trade provides a good example of this. Remember, the more time a trade is on, the closer it gets to expiration day. The more time that passes also give the trade more breathing room before potential defensive measures may be taken. Since we are in the early stages of the position, positive time decay has not yet taken much effect.

As a seller of option premium, time decay works in our favor since each and every day that passes sees more of the time value in the spreads decline. We’ve also referenced in our articles how even on holidays and weekends time passes thus reducing some of the spreads values. Since we eventually want the position to expire worthless to realize a full profit, the value of the position going closer to zero is what we are shooting for.

It is worth noting that this original position was put on only using half the available funds in your clients’ accounts. This gives us “options” (pun absolutely intended!). We can look to add an additional tranche should our analytics show other strike prices that match our criteria. We also can add the bull side by selling put spreads which would result in spreads both above and below the index. If any of that happens we will be updating the blog with details.

Finally, we had a few questions about whether this meant the team at ZEGA is turning bearish on the market? We realize that using call spreads has been infrequent in the past few years. This was not designed as a market call. Instead our process involves evaluating both the call and put side for each trade we do. We then place the one (if any) that qualifies based on our rules to provide the best return versus risk scenario.

With volatility so low and interest rates so low the premium available on the call side has been non-existent. However, in this instance, we did find that the call side qualified. As always hit us up with any questions.

Check the background of these investment professionals on FINRA's BrokerCheck »