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HIPOS Weekly Update: The Song Remains the Same

By Derek Moore

After quite a bit of downside volatility, the markets seemed to forget they were ever worried at all after several up days. Monday saw the S&P 500 Index fall back a bit yet the index itself is just around where it was prior to the series of drawdowns.

This is positive since now we have moved further along the line to expiration. You might remember each day that passes, our purple curved line drops lower allowing more room to breathe for the position. This is a key benefit of time decay where each day that passes sees more “time value” comes out of the value of the positions. You can see this relationship above on our usual HIPOS position graph.

We now have only 8 trading days left until we reach the end of the road for this expiration of our HIPOS strategy on May 31st. The weekend coming up includes the Memorial Day holiday where the market will not be open for three straight days. Keep that in mind when you are pulling your hotdogs, hamburgers, or whatever else off the grill, as time decay will still be eroding as a benefit for your HIPOS position.

In the latter part of the trade you might not see too much movement in the value of the spreads provided the market stays right around its current level or moves back higher. The reason is that a spread position, although further out of the money, retains some value even right up to expiration.  Moving ahead you’ll want time to tick by but also for the market to remain sideways or better yet, move higher.

One question I received before our last three-day market holiday was if everyone knows that options will lose time value, why not just sell them prior to the start of the long weekend.  Well, it’s a good question and one that I don’t believe I answered in the post last time so here is a brief answer to a complicated topic. Options price in time decay, but they also price in implied volatility among other things. The reality is that while it is true that something like a short spread position will experience time decay, its only one component. When markets are closed for three straight days sometimes that prices in some extra risk premium right prior to it.

The way to think about this extra component of the additional market holiday is that it gets you one day closer to the finish line and lowers the probabilities further of an underlying market can potentially reach the short strike component of the short put spread. When the market is closed you aren’t at risk for that day.

Unless anything changes, we’ll plan on another update next week. Until then enjoy the Memorial Day Holiday!