After several days of selling the S&P 500 Index firmed up a towards the 2910 level on Thursday’s close. With 10 trading days left until expiration day, the index remains about 8.5% above the short out of the money 2650 put strike price. It also is still above the purple curved defensive posture line seen on the chart above.
HiPOS positions are a study of price, time, and volatility. With almost half the trading days gone until expiration from the initiation of the position, we have seen the positive time decay function as it should. Each day that passes means the spreads have less time and probability of reaching various market levels including the short 2650 area.
While time is working for us, the increase in volatility has caused an expansion of the current spread premium. Simply put, spreads have increased in value due to volatility in the markets. Since we are net sellers of volatility, we want prices to eventually move to zero to capture a full profit. Should volatility subside in the market, we would expect to see prices in the options to drop as well.
Moving forward you will want the S&P 500 Index to drift higher a bit along with the passage of time. While any profits or losses are unrealized until expiration day (or closing/rolling positions), a drop of volatility would also help to reduce the value of the spreads.
One of the things we mentioned in the initial post announcing the trade was how our internal risk analysis showed that there was more risk than the market was illustrating. Due to this ZEGA determined to conservatively move further away from the market. Given the recent moves in the S&P 500 thus far this appears to have given the position additional wiggle room.
One question that comes up often is the idea of selling call spreads instead of put spreads. The reality is, the call side does not qualify under our strict entry rule criteria. Most of the risk premium is contained in puts, not the calls. Especially when you go further out of the money like we typically do for HiPOS. HiPOS is a non-directional strategy so we are not trying to time the market or estimate which direction is more likely.
ZEGA’s traders are always looking at both sides. If a call spread were to materialize in the same expiration as our current put spread, we have the choice to initiate as well creating short spreads on both sides of the market. For now nothing is imminent, but should that change we’ll be back on the blog with an update.