HIPOS Weekly Update: Increased Implied Volatility Pricing at Work
Lately some advisors and their clients have been checking in to see the status of the current HiPOS Conservative trade. Most are surprised that we currently still sit around 18% above our short 5500 NDX put strike despite all the volatility in markets. The common refrain is “I thought the market would be much closer to threatening the short strike”.
This is the result of increased implied volatility in the market. When we entered the trade, we found a position that met our stringent rules for entry and provided the required return even though it close to 20% out of the money at the time of entry. The higher implied volatility is, the further away we can get from an underlying index and still meet our target expected return.
What might also surprise people is that even though there are only 9 trading days left until expiration on December 21st, the spread position still has a residual value of about .40%. You might remember in our initial post, the trade the targeted a gross profit of 1.5%. The fact the spread position holds that much value this close to expiration and this far away from the current market illustrates the risk premium option markets are pricing in right now.
I’ve already mentioned some of the particulars; such as 9 trading days until expiration, 18% out of the money. Referring to our normal graph above, we can see that while markets have come off the highs, the distance above both the short strike and the purple defensive posture line remain in good position.
Moving forward there are a couple things to root for. The obvious one is the market to remain safely above our levels mentioned. Time decay as days tick off towards expiration coupled with a reduction in implied volatility would result in the remaining premium left in the trading moving closer to zero.
Remember, as net sellers of volatility, we sell premium and then realize a full profit when it expires at zero. Should anything change materially we will be back on the blog with updates. Otherwise, we will plan on checking in during expiration week.