By Derek Moore
Today the ZEGA Traders were busy putting on a new short call spread position in the S&P 500 Index (SPX). Above we have our typical graph showing the underlying index along with the purple curve line and short strike area at the 4075 level. More on that in a bit.
This is a short 4075/4150 call spread where we look to target ≈ 1% with an expiration date of January 29th which is a Friday. Given the market holiday for Martin Luther King on the 18th, this leaves 15 trading days after the close Thursday to go.
We continue to see elevated volatility levels that is present in not only the put side but also the call side. Long time HiPOS followers probably remember several years where no short call trades met the ZEGA trading rules. Today, we continue to see opportunities on this side of the market. When you are short a call spread, you are rooting for the market to go down, sideways, or slightly up. So long as the up move is not too far and too fast.
This is where we can point back to the graph. You’ll notice that the purple curve line moves higher and higher the closer we get to expiration day. This illustrates how as time passes, the trade has more room it can move without adverse effects on the value of the spreads. Time decay is your friend in this type of a short volatility strategy. As a reminder, this line represents areas where if breached by the SPX, our traders may institute some additional measures to control risk.
Now for the HiPOS Conservative Particulars:
- Index: S&P 500 Index
- Position type: Short Call Spread
- Short call strike: 4075
- Long call strike: 4150
- Call Spread Risk (prob. ITM): 1.5% at time of entry
- Targeted return: ~ 1%
- Call Spread Distance OTM: ~ 7.1% at time of entry
- Expiration: January 29th or 15 trading days to expiration
Tuesday in the Aggressive version of HiPOS, the ZEGA traders found a short duration trade in the Russell 2000 Index (RUT). By short duration we mean expiration is tomorrow Friday January 8th to be exact. This means that after the close Thursday, only 1 trading day remains until the Friday afternoon expiration.
At the time of entry, the short 2090 call strike (we utilized the 2090/2120 short call spread) was roughly 5.3% out of the money. This type of trade is partially possible due to the heightened volatility across the market. In particular, the RVX (Russell VIX equivalent), has been above the 30 level of late.
You may have noticed that the RUT has surged higher thus threatening the position and posting unrealized losses to accounts. We have talked in the past about how with a short call spread you are rooting for the market to remain sideways, go down a little or go down a lot, and if it moves higher that is ok so long as it is not too far or fast. The RUT movement was too fast for this trade, which is why positions have reacted by moving higher in value instead of closer to zero.
This trade is a good reminder of what can cause adverse effects on the position. So, what now? Today we took defensive action to roll the position out a week in expiration. In addition, we also moved the strikes up a little bit to the 2100/2130 and took in a small credit in the process.
This move does a few things. It offers additional flexibility should we need to adjust in the future. This gives us 6 trading days to make adjustments versus only one day (tomorrow only). The small credit adds to the overall potential profit. It also gives the market some time to level off and retrace from these all-time highs.
Sometimes when trading volatility we put on trades and watch them get to expiration with no additional need for action. Other times the ZEGA team needs to utilize our expertise in managing positions and this is one of those times.
Stay tuned to the blog for more updates.