HiPOS Weekly Update: Performing in Sideways to Down Markets

By Derek Moore

How HiPOS Profited While the S&P 500 Index Dropped in August

The S&P 500 Index dropped -1.78% in August while our HiPOS Conservative short put spread was exited at a profit.

I’ll point out this is a good example of how HiPOS doesn’t need the market to go up to potentially profit. Sideways and down markets also work provided a move too far too fast doesn’t happen. HiPOS tends to be non-correlated over the long term to the overall markets and interest rates.

The reason why markets can move lower (or higher in the case of a short call spread position), is that we sell deep out of the money options that have a low probability of market reaching.

The amount out-of-the-money is part of our calculus when deciding a) whether a position qualifies under our rules and b) whether the requisite distance criteria is met.

The underlying market has room to breathe and is perfectly fine to oscillate up, down, or sideways in most cases.

Reviewing Our HiPOS Graph

Above we can see the relationship between the S&P 500 Index (the underlying), and our short put spread below the market.

You’ll notice how despite a move lower, price stayed comfortably above the short strike and the curved purple line. As a refresher, that line demonstrates areas that our traders may take a more defensive posture should price break below it. As time decay kicks in, you’ll see that line move down and to the right. When you are in a short put spread, you want the price to remain above that.

This “more room to breathe” concept is part of why I mentioned above not wanting the market to move too far too fast. Earlier on in the trade, adverse moves against our positions may result in spreads gaining in value against our target of them going to zero.

In the end the strategy produced a profit despite the market being down for the month.

What’s Next?

ZEGA’s traders are already crunching the numbers to identify new candidates for entry as this trade finishes.

A quick note as well as you might have noticed above, I said exited vs expired. While we don’t anticipate any issues with the transition this weekend from TD to Schwab for advisors and their clients, we closed out the short leg of the spread early at a nickel. From time to time, we may exit positions early either due to making most of the potential profit, to free up cash for a new trade, or to roll into a new position defensively or opportunistically.

Part of the opportunities for the next HiPOS trade will result from the implied volatility in the market across the volatility surface of the option chains.

Once we have a new trade on, we’ll be back to update everyone right here.

Have a nice 3-day holiday weekend!