HiPOS Trade Update: Defensive Roll to Manage Risk

By Derek Moore

HiPOS Conservative Close and Roll Trade Update

Today we executed a close of the existing short put spread and simultaneously rolled to a new open short spread a week later and further down out of the money.

This trade moves the expiration out a week to August 23rd while moving the short put spread down to the 4550 by 4500 strike level. At the time of entry, the 4550 short leg was close to 16% out-of-the-money (OTM). The new trade has a potential profit target of about 1.4%. The reason why this action was taken today was the original trade fell outside some of our risk metrics.

HiPOS follows strict rules for entry and exit and taking a smaller loss to further manage risk makes sense and is a benefit for you and your clients.

The loss on the spread we closed out today will be right around 4% while the new position has a potential profit of about 1.4%.

While the price of the underlying S&P 500 Index (SPX) never went below the previous 5000 short put strike level and remained OTM, the distance started to get too close given the amount of time left until the August 16th expiration. This coincided with a VIX Index that almost crested 30 today which both helped (with the new trade) and hurt (with the old trade).

Taking small losses means the amount of future potential gains to cover that loss are much less than if the trade continued to move against us and that amount widened.

Of course ,future gains are not guaranteed, but to make up for that loss (4%) we’d need about 4.17% in potential future gains to recover.

It has been quite a long time since we had to exit a trade early in HiPOS Conservative. The strategy has enjoyed a nice stream of returns that have been consistent but with any investment strategy, there are risks.

Explaining the HiPOS Graph

Above we can see the graph of the new position.

The ZEGA risk curve represents areas should the underlying market move under it; our traders may take a more defensive posture. This was part of the decision today to roll out the trade. You probably are wondering why the risk curve looks so steep. Well, it looks that way because implied volatility shot up which allowed for a trade that far OTM with only 15 trading days until expiration.

Also represented by the vertical orange line is the August 23rd expiration, the horizonal blue line the 4950 short strike level, and the SPX price at entry.

What Are You Rooting For?

Sticking with the volatility aspect, when we sell deep OTM spreads, we sell volatility.

What this means is if volatility moves lower, it helps the value of the spread we’ve sold go lower. Conversely (what happened this week), if it shoots up, the value of the spread gets more expensive. We eventually want the value to melt away to zero. That said, we’d like volatility to ease back down or collapse as a lot of the volatility premium would get sucked out of the position.

Directionally, you want the market to firm up here or go higher.

It has room to move lower, but too much too soon would not be constructive for the position.

The other aspect is time. The closer we get to expiration, the more time value that gets eroded on the position. We want that!

To sum up for you:

We closed the existing HiPOS position early at a small loss to manage risk
A new trade was put on at a higher than normal potential target profit
By closing HiPOS early at a small loss, you live to fight another day
Small losses are easier to recover.
The new position is further OTM and put on when volatility was high

Ok, a little longer update than usual but we wanted to make sure and cover the details since many of you may not have seen this before. You can check out the HiPOS presentation on our website https://zegafinancial.com/products/hipos which covers the risks inherent in the strategy.

We’ll be back next week with another update.