Since I started to build my portfolio hedge position using SPY Options we have seen quite bit of price movement. When I started to build this position SPY was trading at ~$340 and it moved up to the $350 level in the first week – where I added some new “legs” to the position. In the past week, SPY continued to climb and got close to $360 on Wednesday. At this point I was worried about the proximity of the $365 strike Calls (expiring in October) that I had sold. I considered two possible adjustments. The first was to simply buy back the short $365 strike Option. This would have left me with an extra long Call Option that would have provided for possible profits on a continued bullish trend (that may well still occur) – and this is probably what I would have done had the objective of the “position” been to generate a profit either to the upside or to the downside. However, since the “position” is intended to provide a hedge against existing long portfolios I am not too concerned about upside profits if I can establish a “free” (no cost) downside hedge. Buying back the Call Option would have cost me more than the net credit that I was holding from the other leg trades.
Rather than just buying the Short $365 Call, I therefore decided to buy back the 365/370 “Vertical” Call Spread (Buy $365 Call, Sell $370 Call). I could do this for less than the credit that I was holding on the “position” – and it reduced my upside risk by $500.
Then came Thursday and the ~3.5% sell-off back to the $345 range. At this point I was more concerned about the downside again and wanted to get back to a position with a little more negative Delta. Buying back the short 365/370 vertical spread, while getting me out of troubles to the upside, had also reduced my negative Delta, since long Call verticals have positive Delta. I therefore decided to replace the short 365/370 Call spread that I had bought back the previous day. This, of course, was a little aggravating since it was a “whipsaw” trade that cost me a few dollars. However, the sale did give me back a reasonable portion of my “position” credit – so, I decided to use this to buy back the closest “Vertical” Put Spread at the 325/320 strikes in the October expiration. Normally, I would only have done this as SPY approached the $330 strike – but, having got “whipsawed” on the 365/370 Call Spread, I chose to buy the Put Spread where it would be cheaper to do so that when price (at ~ $330) was closer to the $325 strike. Since the purchase of the 325/320 Put Spread was closing an existing long spread position this would result in a profit on that ‘spread” trade.
This second adjustment was placed as a single order in a configuration often referred to as a “Risk Reversal:
and was placed for a small credit. It has negative Delta and ~zero Theta – although theta is at an inflection point where it can go positive (if price declines) or negative (if price increases).
Currently, looking at my current “position” in the Excel spread sheet we see this:
That is not all that different from last week – except that it is missing 2 legs in the 325/320 Puts.
Checking on the graphics we see the following:
where we see the price chart in the top left and the PnL Risk Graph in the top right. We also see how the Implied Volatility has risen over the past 2 weeks (bottom left) and the impact this has on PnL (Bottom right). As I mentioned in my last post, since we have a “position” with negative Vega, this increase in volatility will hurt us a little. However, let’s move on to a tabular look at the new “position” and the other “greeks”:
Here, we see that we are holding a $27 position credit (down a little from last week due to the adjustments) with a current (unrealized) loss of $83 (slightly less than last week’s $95) and ~$1,970 maximum risk. What we don’t see here, but is more important to me, is that downside risk is now less than $1,500 since I have taken off one of the Put “Verticals”.
Looking at the “greeks”, Delta is ~ negative 13 – not quite as strong as last week (-15), but this is offset by a maximum potential profit (in 14 days) of $639 – up from $422 last week. Theta, at ~$13 per day, is up from ~$5 per day last week – and this will accelerate as we approach expirations.
So, despite the frustrations/aggravation of the whipsaw, I am comfortable with the current position.
I probably should have mentioned that I am comfortable building a position with up to $5,000 maximum risk – but, obviously, if I can keep it below this level I will be happier.
If, as I expect, we see volatility rise over the next 60 days (leading up to the election) I will be looking to sell more premium.
A pdf copy of this post is available at https://www.dropbox.com/s/boxx50cmrjdj5gv/Options%20Corner_200829_1.pdf?dl=0
Update: 11 September 2020
No adjustments were necessary last week and the “position” currently looks like this:
With the short September 320 strike Option leg expiry next Friday (18 Sep) we should pick up a little time decay in the next few days (Theta = ~$16 per day).