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HiPOS New Trade Update: The Waiting Is Over

By Derek Moore

New HiPOS Conservative Trade Initiated

Right after I wrote an article explaining why being in cash between trades is normal https://zegafinancial.com/blog/hipos-update-why-being-in-cash-between-trades-is-normal-and-how-to-set-expectations-for-a-short-volatility-strategy , ZEGA’s traders were able to identify a new short put spread position that qualified under our strict rules for entry.

What do they say, Murphy’s Law? At any rate, some Fed Meeting volatility greased the wheels and off we go. This vintage used about a 13% out of the money (OTM) short leg. You notice the expiration date is August 31st which is within range of a normal HiPOS trade time to expiration.

Albeit on the longer end coming in with 25 days left until expiration day.

When volatility is lower, you should expect the time to expiry to lengthen to historical norms compared to when volatility is higher.

 Reviewing Our HiPOS Graph Above

Above you’ll notice our normal display where you see the underlying chart of the S&P 500 Index (SPX), the purple curve, expiration line, and our short leg of the spread.

I referenced the OTM amount earlier, and you can see that visually represented as the distance between the market (SPX), and the short 3975 dotted line below. The purple curved line represents levels should the SPX break below, our traders may take additional steps to further manage risk.

This curve slopes down and to the right reflects how each day that passes, more time value is siphoned out of the value of the positions.

Time decay is a benefit for short volatility sellers as we eventually want the premium to erode and expire at $0 for a full profit at expiration.

The other reason why it slopes down and to the right is that each day that passes, the probability of a market reaching that short put strike level decreases. Early on in a trade, if a market drops the probability of going to that level increases. Later, a market coming down to that same level may have a lower probability of reaching 3975 because there is less time.

For some additional detail on this aspect of option volatility expectations, see that same link posted above.

There is a little math, but not too much!

What Are You Rooting For?

The market can go up, sideways, or down.

So long as it doesn’t move down too sharply or too soon in the trade. Early on in a trade, there is less room to breathe so to speak (see the purple curved line). This is a benefit of HiPOS in that you don’t need the market to move higher to potentially profit. So, what else do you want?

Simple, the calendar to tick by.

Selling volatility is a lot like holding an ice cube.

The longer you hold it, the more it melts away. Time decay erodes and melts that spread premium every day. In a sense, time is working for you and on your side.

So that’s it for this edition of the HiPOS update. As always don’t hesitate to reach out to a ZEGA team member with questions.

Now for the Particulars: 

  • Index: S&P 500 Index
  • Position type: Short Put Spread
  • Short put strike: 3975
  • Long put strike: 3925
  • Put Spread Risk (prob. ITM): < 1% at time of entry
  • Targeted total return: ~0.8%
  • Distance Put Strike OTM: ~13% at time of entry
  • Expiration: August 31st , or 25 trading days until expiration