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HIPOS Called into Action: New Position Established

HiPOS (High Probability Options Strategy) Volatility S&P 500/SPX Option Trading

By Derek Moore

As the market has rebounded from the December lows, today we found a short call spread going out to February 1st that qualified under our entry rules. For some of you it might be a new concept selling call spreads instead of put spreads. The put side generally is more prevalent due to higher options premiums that reflect more risk to the downside as opposed to the upside.

Most people are hedging and bidding up the put options for protection as opposed to hedging upside moves. While selling calls does not happen often, when it does, it provides an interesting dynamic for HIPOS accounts. First, markets generally have a fear of black swan downside moves. Significant downside risk is much less prevalent than significant upside movement. Ask yourself, how often historically have markets gapped up overnight with the same magnitude of a black swan gap down? 

Second, many of your clients are utilizing our long equity strategies such as Buy and Hedge or ZEGA Buffered Indexed Growth (ZBIG) where they are rooting for markets to go higher. Being short call spreads in your HIPOS allocation would provide some positive non-correlation. Off course it’s alright if markets move higher against HIPOS, provided it’s not too fast and too big of a move.

For this iteration we are using the 2775 by 2825 short S&P 500 Index call spread. When established, the underlying S&P 500 Index was a little over 7.8% away from the short strike. Some seasoned HIPOS watchers might be wondering why the call side is closer to the short 2775 strike. We do have different rules when executing call spreads. This is partly due to how implied volatility would tend to react to call spreads compared to a short put spread. When markets move higher, typically volatility levels drop so our ability to defend this position around volatility spikes is easier as opposed of what we would experience on the put side.

For this trade we have a gross profit target of 1.05%. Expiration day (Feb 1st) is 23 calendar days away. With one holiday between now and then it leaves only 15 trading days until expiration. 

Normally new clients ask what they are supposed to be rooting for with a HIPOS trade. On the put side you hope the underlying index moves higher, sideways, or down a little. With a short call spread its lower, sideways, or slightly higher. Off course those with long hedged positions will be rooting for higher, but not too high!

Our normal HIPOS graph illustrates the purple defensive posture line (above the market) as well as expiration day and the short call strike line. That purple line represents the area on a certain day ZEGA may need to take more defensive action on your client behalf to manage risk.

The details of the trade are as follows:

  • Index: S&P 500 Index
  • Position type: Vertical spread
  • Short strike: 2775
  • Long strike: 2825
  • Risk (prob. ITM): 1% at time of      entry
  • Targeted return: 1.05%
  • Distance OTM: 7.8% at time of      entry
  • Expiration: Feb 1st  2019 or 23 calendar days to expiration at time of entry