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HiPOS Trade Update: What Selling Call Volatility at All-Time Highs Means for Your Clients

By Derek Moore

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

This involves selling a call spread above the current market as opposed to below. While still out of the money, there are some nuances we’ll explore below.

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

Why Sell Volatility Above the Market at All-Time Highs?

Part of the process in identifying new trades is looking at both the short call and short put opportunities.

Some internal research has identified probabilities for subsequent highs once markets make a new high. This adds an additional checkpoint into the calculus that also includes things like return vs risk. It also looks at the time and distance out of the money strike prices are relative to markets.

Much like we tend to enter short call positions after short-term pullbacks, enter in this direction provides a bit more of a buffer on the trade.

Is ZEGA Calling a Top in Markets?

No, HIPOS is a non-directional short volatility strategy.

Its advantage for the right client at the right size in a portfolio is providing a non-directional opportunity to profit in markets. This includes markets that move higher, lower, or sideways.

ZEGA is not calling tops or bottoms but rather measuring risk and return commensurate with a high probability of success.

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

Yes, as we mentioned we typically enter short put spreads around pullbacks in the market.

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

Short call trades, while more frequent over the past year, have been less available historically as many long-time users of the HIPOS strategy know.

This Trades Seems Like It Has Less OTM (Out of the Money) Distance 

You are correct and that is a part of our long list of rules we have for the strategy.

The call side can be closer in at entry. Part of the reason is that if this trade gets threatened, volatility typically will stay the same or drop. This means on the volatility only component, this tends to not have an adverse impact on the position.

At the same time, it is easier to roll the trade if it gets into trouble in part due to the volatility component changes we’d expect. 

Explaining the Graph and What to Root For

You’ll notice that the graph is flipped above with the purple defensive posture cure and short strike line above instead of below the markets.

You and your clients want price to remain well below the short 4900 level. They also want price not to accelerate too fast too soon into the trade. You also want time to tick by thus taking out some of the time premium embedded in the premium you sold.

At the same time, a sharp drop with an increase in volatility would set up that potential addition of the short put side of a potential iron condor.

Now for the Particulars:

  • Index: S&P 500 Index
  • Position type: Short Vertical Call Spread
  • Short strike: 4900
  • Long strike: 4950
  • Risk (prob. ITM): ~2.5% at time of entry
  • Targeted return: ~1%
  • Distance OTM: ~6.5% at time of entry
  • Expiration: December 3rd or 20 1/2 trading days until expiration