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HIPOS Weekly Update: Cash is King

Source: Yahoo Finance

By Derek Moore

After our last successful expiration of our primary HIPOS trade the ZEGA trading team is at work crunching the numbers looking for another position that qualifies under our stringent rules for entry. Whenever we do not identify a short spread, rather that force a position that doesn’t meet our criteria, we like to wait and be ready to pounce and be opportunistic.

While many long time HIPOS strategy users know that on average we’ve been in cash for 100 plus days a year, those newer might have some questions. Unlike some volatility strategies, which always must be in the market, we are able to be patient and pick our spots.

How long can it be between a last successful expiration for full target profit and the next entry? Historically we’ve seen anywhere from a few days to weeks. It all depends on the options market. For example, often a short put spread opportunity arises after some short-term spike in volatility. HIPOS typically has looked to have 10-12 trades a year give or take.

If we look above at the chart of the VIX Index which measures implied volatility in S&P 500 Index options, its clear that post December, volatility has been on the decline as we reach back towards the old market highs. The higher the volatility, the easier it is to find trades that match up. When volatility was elevated you probably noticed we were able to seamlessly roll to a new trade right away.

Why Do Taxable Accounts Show Interest Paid in Performance Report?

Another question that came up this week dealt with a newer wrinkle ZEGA has instituted for many taxable accounts using HIPOS. In those accounts we have purchased short duration treasury bonds or bills to enhance the overall yield as short spreads are overlaid on top of the treasury bond. This has been done with an expectation to boost returns by 1% to 1.5% per year. 

The question related to why some of your clients noticed what looked like interest paid on their performance statements. The reason is due to something called accrued interest. When you purchase a treasury bond, often it almost always occurs between the last coupon payment (usually twice a year) and the next one. For example, let’s say a treasury paid interest on December 31st and scheduled to pay again June 30th

If the treasury is purchased midway between, it has already accumulated three months of interest. The buyer of the treasury theoretically owes the seller that accrued interest. So, until the next coupon your clients will see what looks like an entry for interest paid. Once the coupon payment comes through, that will take care of itself. Not only will they get the interest earned from the time of purchase, but also they get back the interest they paid the seller mid-cycle. Reach out to us if you have questions but just in case it comes up wanted to give a little information on it.