By Jay Pestrichelli
After Friday’s successful expiration, the market has given us another opportunity to sell calls on the S&P 500 Index. This is the 3rd consecutive call spread placed in our HiPOS Conservative strategy; and that is unusual. There have been some years when we can’t find a single call spread that met our rules, but in today’s unique environment we’re finding those opportunities.
Before explaining the market dynamics causing this, here’s a little reminder about the qualities of short call spreads. The call spreads that HiPOS deploys are considered to be neutral to bearish in bias. As we’ve said before on this blog post, it’s ok that the market moves directionally against the bias as long as it doesn’t do it too quickly. Picking strikes far enough away from the market are one of the keys to the success of HiPOS. Last month is a perfect example; the short call spread trade worked out despite the market going up 6% after entry.
Typically, we like selling calls vs. selling puts. Many of you have heard me say, “Given the choice, I’d sell calls over puts for every trade if we can.” The reason for this has to do with the speed and magnitude of market changes during up vs. down moves. Typically markets drop quicker and more dramatically than they rise, which can be more risky for put spreads that have a bullish bias. The challenge is that call spreads usually don’t have enough premium in them to meet our rules and the reward isn’t worth the risk.
Why have we been able to sell calls so frequently? The answer lies in the volatility impeded in option prices right now. At the time of today’s trade, the VIX was marked at about 25. We’ve talked a lot about the VIX on this blog before, so I won’t discuss the VIX in detail at this time. What’s relevant now is that we recognize the VIX is elevated while the market is pressing to new highs. If the market closes higher today, it will be 7 consecutive days of higher all-time highs. This, along with other factors, is driving option traders to bet on a retracement and sending option values higher. The impact of this is a higher VIX and giving us the chance to sell call spreads at prices and distances that meet our rules.
Now for the Particulars:
- Index: S&P 500 Index
- Position type: Short Vertical Call Spread
- Short call strike:3750
- Long call strike: 3800
- Risk (prob. ITM): 1% at time of entry
- Targeted return: ~ 1.7%
- Call Spread Distance OTM: ~ 6.8% at time of entry
- Expiration: September 18th or 14 trading days to expiration