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HiPOS Weekly Update: Positive Time Decay and Direction Drive Price

By Derek Moore

HiPOS Conservative Weekly Update

With 13 trading days left until expiration on December 22nd, a combination of time decay and markets easing this week have helped the short call spreads to diminish in value.

As premium sellers we sell for a credit and eventually want them to expire worthless. Currently you’ll notice the position with an unrealized gain. Each day that passes less time value is contained in the premium. With the markets retreating from Friday’s high, the distance out-of-the-money (OTM) is about 6.2%.

This is the space between where the underlying S&P 500 Index (SPX) closed at and the short call strike of 4850 in the spread position.

Evaluating the HiPOS Graph

Above we can see the relationship between the current chart of the SPX and the short leg of the spread above the market.

We mentioned that long time HiPOS watchers are more familiar with a short put spread position below the market. It’s the same concept but just flipped where you want the market to remain BELOW the strike price instead of above it as the case with put spreads. You’ll notice the gap closing between today’s price bar and the vertical expiration date line.

The usual purple curved line now goes up and to the right.

This represents areas should the SPX close above, ZEGA’s traders may take a more defensive posture.

As the trade progresses along in time, it has more room to breathe. The reason why is the less time to expiration, the lower the probability it must touch or go above the short 4850 strike price. Of course, should the market get too close, the probabilities would skew a little higher (what we don’t want) of it touching that level.

The graph gives you a sense of where the trade stands at any point.

What Are You Rooting For?

Well, normally you only want markets to shoot higher.

Not so much this time as the trade would get better the further down the market moves away from the short strike price. It’s ok if the market moves higher, so long as it doesn’t make a sharp move up. One of the benefits of HiPOS is it can potentially return a profit during up, down, and sideways markets.

Speaking of sideways, that would work just fine.

On the call side of the trade, we don't expect as much of a change in the level of implied volatility. Especially how low the VIX Index has gotten. Volatility dropping is a positive while the opposite makes premiums more expensive.

Given where volatility is currently, we wouldn’t change to implied volatility to result in as much difference in the value of the spread.

All that aside, you want the market to stay sideways, move down, or just not move up too much. And you want time to tick by towards expiration day.

We’ll leave it there for this week but we’ll be back on next week with another update.