Ok – I’m back from vacation and it’s time to review the current Hawking Hedge position (Jan 2nd Post – https://itawealth.com/2015/01/02/hawking-portfolio-hedge-january-2015/). This position has a maximum profit of $10,000 with SPX closing below 2035 at expiry next Friday.
Since placing this trade on Jan 2nd the US equity markets have been quite volatile but prices are now essentially at the same place they were 3 weeks ago:
The dilemma is now to decide what to do with 5 days left to expiration and time decay (theta) really coming into play. At the present time this position could be closed out with ~$3,000 profit:
As mentioned above, the maximum profit on this position is $10,000 (i.e. $7,000 more than the present value) with SPX below 2035 at expiration. A week ago, with SPX at ~ 1993 the position could have been closed out for a ~$6,000 profit. To the downside, the profit is ~zero with SPX between 2055 and 2085 and a potential maximum loss of ~$5,000 with SPX above 2090.
Looking at the above figure we can see that the position Theta (time decay), with SPX at it’s current price of 2051.82, is working for us at 91.81 (i.e. $91.81/day) and this decay will accelerate as expiration approaches. However, should SPX increase in value, we go through an inflection point at ~2060-2065 where the time decay begins to work against us and we move towards the zero (yellow) line.
So, do we get greedy and hold the position, hoping that price decreases to give us a $10,000 profit or do we take the current $3,000 “paper” profit by closing the position out?
What I will do in a position like this is watch the Theta value of the trade. Provided Theta is positive I will continue to hold the position, but if Theta goes negative I will close the position out. [An alternative might be to compromise and roll the vertical put spread up a few strikes – this would widen the profit range at the expense of reducing maximum profit]. This may give back a little profit if price rises but should still provide a small profit. This really isn’t too bad, since it means that SPX would probably be trading at least where it was when the hedge was placed – and our portfolio assets have performed better than the SPX. The (hedged) portfolio position is currently as shown below (the yellow line shows profit/loss at expiration):
Update at close 01/26/2015
Note position (negative Delta) has lost $1,250 due to today’s increase in price of SPX. However Theta (time decay) has increased to $127.23/day so the position will be held as described above. The value of the assets held in the portfolio has increased to compensate for the loss in value of the hedge.
Update at close 01/27/2015
With today’s drop in the value of the SPX our hedge gained $3,600 due to the negative Delta (directional movement) and Positive Theta (Time decay). As pointed out in the original Post Theta expands rapidly in the last week of expiration and is now at $304.79/day.
The portfolio value and profit/loss of current assets (including the hedge) is as shown below:
If only this was Friday this would be perfect since we are at the optimal position. However, with 3 days left and a very volatile market the chances of closing here aren’t great – we’ll have to wait to see where we go from here. However, with a positive Theta we stick to the plan and hold the position for another day.
Update at Close 01/28/2015
A slightly different look at the hedge position at today’s Close. The market was down significantly today (following the Fed announcement) and the position is now showing a profit (if closed) of ~$9,000. At this point I am tempted to close the position out and avoid the possibility of losing the current “paper” profits.
Theta (time decay) still remains high at $694/day, but there is only an additional ~$1,000 to squeeze out of this position with ~$9,000 to give back on a strong bounce. It is often better to take 80% profits and to re-position than to hold out for the last 20%. I will be watching carefully from here and am prepared to close the position out and look for a new hedge for the next few weeks if it looks like there may be a significant bounce.