By Derek Moore
After a rough fourth quarter equity and high yield bond markets are undergoing a resurgence year to date. After much doom and gloom around the holiday season, markets have shaken off those fears. This has provided a split verdict for investors using both our hedged equity and HIPOS short volatility strategies.
For equity investors invested in Buy and Hedge, they have enjoyed both a move higher in their underlying S&P 500 Index positions and their holdings of short duration high yield ETFs. As bond spreads have narrowed between high yield and treasuries, prices have rebounded as markets stabilized.
On the HIPOS position, the markets moving higher has put pressure on the prices of our short call spreads. As of this morning, the market has moved up and is sitting roughly 4% under our short strike price. Remember, if we are short put spreads you want the market to remain above the short put strike.
With a short call spread it’s the opposite. You are rooting for markets to remain below the short strike. A nuance we mentioned in our original post on this trade is that being short call spreads when markets are moving against a position act differently. Specifically, with regard to volatility, HIPOS is short volatility. When markets move lower, generally volatility increasing which is a negative for a short spread position.
However, as markets are moving higher and fear subsides, volatility is shrinking and thus is helping somewhat on the prices of our short call spreads. This is one of the components, and a major one, of how options are priced. In addition, time has continued to tick off towards our February 1st expiration date.
With the market holiday Monday, there will be no trading and thus the position will enjoy three days of time decay while the markets are closed this weekend. After today we have only 9 trading days left including expiration day in the trade.
Moving forward, the trading team at ZEGA continues to monitor the position. Should more defensive action be warranted we will come back with another update for everyone. Until next week, enjoy the holiday!