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HiPOS Trade Update: Riding the Volatility Wave

By Derek Moore

New HiPOS Conservative Trade

Today, fresh of a successful expiration Friday, ZEGA’s traders identified a fresh new short put spread on the S&P 500 Index.

This one stays on the shorter side with only 14 days until expiration. When implied volatility is on the higher side it opens the opportunity to grab the required premium but with less time to expiration. Trades with shorter days to expiration have the potential to experience positive time decay at a more rapid pace.

In theory, it also lets us fit in more trades.

 Reviewing the HiPOS Graph

Above we see the underlying chart of the S&P 500 Index along with the vertical expiration day (November 10th), the horizontal short 3700 strike, and the purple curved line.

The distance between the price of the S&P and the 3700 short strike is the distance out-of-the-money (OTM). At the onset, the OTM % was 13%. The purple curve represents an area should the price of the underlying dip below, ZEGA’s traders may take a more defensive posture to further manage risk.

We’ve said previously the period early in the trade is of interest because the market has less room to breathe than it does later in the trade when the number of days to expiration lessons and time decay kicks in.

The purple curved line shows this as early it is closer to the entry price where later it moves down and to the right. This displays the relationship between time decay and the probability a market will get to the short strike. The less time to expiry given a percent OTM, the lower the probability.

HiPOS trades start out with a high probability of expiring worthless (what you want!).

As time ticks by, provided markets haven’t moved too far too fast towards that short strike, the probability of expiring worthless remains high.

What Are You Rooting For?

Ideally, you want markets to hang around (or go higher) in the first part of the trade.

As time moves forward up, down, or sideways all works. You don’t want the S&P 500 to move materially lower, that would reduce the probability of expiring worthless. You also want time decay to do its thing. No one wants to get older, but in this case, you want the calendar to speed up.

Since we sold premium when volatility was higher at entry, you’d enjoy seeing it drop which would help to move the trade to an unrealized gain as lower volatility would mean premiums shrink.

We’ll leave the details of the trade below and be back with more updates in the coming weeks.

Now for the Particulars: 

  • Index: S&P 500 Index
  • Position type: Short Put Spread
  • Short put strike: 3700
  • Long put strike: 3650
  • Put Spread Risk (prob. ITM): < 1% at time of entry
  • Targeted total return: ~1%
  • Distance Put Strike OTM: ~13% at time of entry
  • Expiration: November 10th, or 14 trading days until expiration