HiPOS Trade Update: Today’s Selloff Creates Opportunity to Sell Volatility

Today ZEGA’s traders identified a short volatility trade on the put side that qualified for entry.

The opportunity was due in part by the market moving lower and implied volatility levels moving higher. In other words, we were able to sell a short put spread that brought in enough premium to meet our requisite target. Plus, due to the higher volatility, we were able to get around 14.5% below the current market.

So, what are things you need to know to help your clients understand the why and how the position makes money?

Why Sell Put Side Volatility Below the Market at During a Selloff?

HiPOS is a non-directional strategy that relies on ZEGA’s stringent rules for entry and the calculus to pinpoint market levels that give us the right combination of return vs risk.

We are not making directional bets on a market bounce. HiPOS can make money if the markets stay flat, go up, or go down. By selling out of the money spreads, we are using probabilities to help inform our decisions. The risk for this trade is a sharp outsized down move earlier, rather than later, in the life of the position.

More on that aspect later as we discuss our market graph.

Explaining the Graph and What to Root For

Above, you can see the graph of the market along with both the expiration date of January 28th (vertical line) and short 4030 put strike.

You can also see the purple curved defensive posture line. This is the level should markets move below, our traders may take more defensive action on the positions. Notice how it continues to drop lower and to the right as we move towards expiration day.

Earlier in the trade, the market has less room to maneuver and why from an unrealized profit and loss standpoint, has more pricing risk than earlier on.

You and your clients are rooting for price not to go down too far too fast.

Plus, since we are sellers of volatility, time decay is in our favor. While none of us wants to get older faster, as investors utilizing a short volatility strategy, you want the days to tick off and move closer and closer to January 28th.

Any Chance You Can Also Sell a Short Call Spread to Create an Iron Condor?

Yes, should the call side meet our stringent entry rules.

Because there is enough time to expiration, this is something the ZEGA trading team will be on the lookout for. This would provide an opportunity to add additional premium and thus potential profit to the existing trade. The closer we get to expiration, the less likely the opportunity develops.

Most likely you would need to see the market recover and move to a higher high while elevated volatility sticks around for that to happen.

Now for the Particulars:

Index: S&P 500 Index
Position type: Short Vertical Put Spread
Short strike: 4030
Long strike: 3980
Risk (prob. ITM): ~1% at time of entry
Targeted return: ~1%
Distance OTM: ~14.4% at time of entry
Expiration: January 28th or 16 trading days until expiration