HiPOS Weekly Update: Downturn Pauses as Time Decay Kicks In
By Derek Moore
HiPOS Conservative Trade Update
As of the late afternoon trading session Tuesday, the market moved off the lows and for the past two days abated the drive to a lower low.
The distance between the S&P 500 Index (SPX) and the short 4900 leg in the put spread stood at ~ 11%. This is what is called the distance out-of-the-money or OTM. While the market has come down post trade entry, it is still a healthy distance OTM. With 13 trading days left until expiration on September 27th, time decay is kicking in which has helped bring the value of the short spread right around where it was when entered.
As the days tick by, this positive reduction in extrinsic time premium should help to erode the value of the spread which we eventually would like to get to zero thus expiring worthless.
The other benefit for the existing trade is volatility coming down off the most recent highs. Volatility is a huge component of option prices so lower volatility also helps the value of the spread move lower which we want.
Reviewing the HiPOS Graph
We mentioned the distance OTM above and you can see that represented by the distance between the most recent price bar on the SPX and the short put strike of 4900 illustrated by the dotted papaya line.
Yup, went with papaya instead of orange. Some F1 (Formula One) racing fans will get that one. The blue vertical dotted line represents the Sep 27th expiration date.. Then of course our typical ZEGA Risk Curve.
This is where should the price of SPX move below it, ZEGA’s traders may take a more defensive posture to further manage risk.
You want the market to remain above that curved line as well. As time goes by on the trade, it moves down and to the right which represents the additional breathing room due to that time decay and probably component referenced earlier.
What Are You Rooting For?
Price, time, and volatility to all move (or stay) in your favor.
- Price: Ideally markets are sideways or move higher from here to keep a comfortable OTM %
- Time: You want the calendar to tick by as each day represents more positive time decay
- Volatility: You want it to be stable or moving lower as that lowers option premiums
The probability of expiring worthless is a derivative primarily of those inputs and you want the probability of the SPX expiring below 4900 to stay low and eventually zero.
We’ll leave it there this week but as always check out our website for more information on the risks and benefits of the HIPOS strategy https://zegainvestments.com/products/hipos