By Derek Moore
HiPOS Conservative Position Update
Today ZEGA’s traders took off some of the risk within the HiPOS conservative strategy.
This involved buying back to close half of the existing position. Since we sold the 4850/4900 call spread on the S&P 500 Index for about 50 cents and bought it back for about 30 cents, we realized a profit on that tranche. The reason to take a little off is given the market is less than 2% out-of-the-money or OTM, closing out a portion early while still realizing a profit makes sense.
On a percentage basis it means that portion of the trade only made 0.4% instead of the target of 1% when initially put on.
The piece that remains has an expiration of this Friday December 22nd.
How Volatility Impacts Short Call Spread Trades Differently
Source: Charles Schwab ThinkPipes
Above is the implied volatility on the S&P 500 Index since the initial entry on the short call spread.
As markets have moved higher and pushed towards the short strike, volatility has remained low and dropped from where we entered. What this means is that the premiums didn’t expand (rise) due to an increase in volatility. If this were a short put spread below the market and the S&P 500 was falling, you’d expect volatility to rise and cause the cost to buy back the spread to move higher.
The point being when the call side of a HiPOS trade gets threatened, it acts a little differently and, in this case, due to volatility dropping and time decay, we could exit at a profit still on half of the position prior to expiration.
Reviewing the HiPOS Graph
At the top of the article, you’ll notice our usual HiPOS graph.
This shows how the price of the S&P 500 Index has moved up quite a bit since entry. At the same time the purple curved line also moves up and to the right which illustrates how time decay kicks in and allows the underlying to move more before it becomes problematic for the price of the short spread positions.
As a reminder, should prices move above the purple curved line our traders may take a more defensive posture.
Price and time are what we always point to with HiPOS.
While this has been a march higher, it has been relatively calm. What we always say in the initial trade write-up is we don’t want markets to move too far too fast against our short strikes. Certainly, given the market is only about 1.8% OTM, it moved against us.
Yet, it has taken its time to do so which lets the positive effect of time decay do its thing.
What Are You Rooting For?
You want the market to turn lower or at least stop moving higher.
You also want to get to expiration day as all the ‘time premium’ will be out of the positions for the most part. Because the original position was only on half the account, and we took off half of the half, what you have left is risk on a ¼ of the account. Simply put, the amount at risk is smaller.
Will you have to make more adjustments?
Maybe, should the market get too close to the short 4850 strike this week.
This might include closing out early or rolling positions out and up (out in time and up in strikes). Nothing is imminent but if we make any adjustments, we’ll be back on here to update all of you.
Since this may be the last update until Christmas, we wanted to wish everyone a Merry Christmas and Happy Holidays!