HiPOS Conservative Update: New Turkey Week Trade

By Derek Moore

Today the ZEGA trading team found an interesting shorter in duration HiPOS Conservative trade. For this one we went to the Russell 2000 Index where a short call spread utilizing the 1930/1980 strikes qualified under our strict criteria. How short in duration? Well, only 8.5 trading days considering Friday’s half day session.

Typically, we go further out in expiration but the market, especially small cap stocks, has an extra embedded call side premium. Small caps via the Russell 200 (RUT) have continued to put in new highs. Its relative performance against the NDX and SPX has also been outsized of late. Simply, this means the RUT has moved higher at a greater clip compared to the other two indexes.

Despite the reduced time to expiration (December 4^th), we still were able to sell premium ~ 7% above the current market price of the RUT at the time of entry. This trade also saw a greater premium received (~1.8% target profit) than we have been pulling in our more recent conservative trades.

Until recently, while the S&P 500 has made several new highs, the Russell 2000 has been hard press to march beyond the January 2020 (early this year) highs or even the August of 2018 highs. While we do not publicly talk about most of our rules, we do have internal calculations about probabilities of reaching further highs once a new high has been met. This all works its way into the ZEGA computations.

Above we can see the chart of the Russell 2000 index with the expiration date, short call strike, and purple curved line. As a reminder, the purple line is above the market since we are short the call side. This line represents areas where the ZEGA team will potentially take a more defensive posture to manage risk for your clients.

You want the market to drift upward, trade sideways, or go down as much as it wants. Now, since many of your clients utilized HiPOS for 10%-20% where appropriate for a slice of the portfolio, you probably would root for a drift upward so the hedged long equity market portfolios get a lift as well.

Finally, before we get to the usual particulars, there is a potential opportunity should we see a material selloff to also do a short put spread trade to form an Iron Condor position. This would add additional premium and raise the total target profit. Given the shorter duration to expiration, this type of move would most likely need to materialize earlier in the trade for it to become viable. We will update all of you with any news.

Now for the HiPOS Conservative Particulars:

Index: Russell 2000 Index
Position type: Short Call Spread
Short call strike: 1930
Long call strike: 1980
Call Spread Risk (prob. ITM): 1.5% at time of entry
Targeted return: ~ 1.8%
Call Spread Distance OTM: ~ 6.8% at time of entry
Expiration: December 4th or 8.5 trading days to expiration