HiPOS Weekly Update: Give and Take

By Derek Moore

Update on HiPOS Conservative Position

As of the close of trading Thursday April 25th, the S&P 500 Index (SPX) sits about 8.9% above the 4600 leg of our short put spread.

That is the distance out-of-the-money (OTM). Despite the market volatility of late, that is a healthy distance. With 6 trading days left until expiration, the continued rapid decline of time value in the trade will help you and your clients invested in the strategy.

The less time remaining and the higher the distance OTM, the more the value of the open position moves towards zero which is what we want to happen at expiration.

Reviewing The HiPOS Graph

Above we can see visually the distance OTM between the SPX Index price and the 4600 short put leg.

You’ll also notice our purple risk curve which represents areas that if price falls below it, ZEGA’s traders may adopt a more defensive posture to further manage risk. Even with the market correcting over 5%, price thus far has not breached the curved line. As we move closer and closer to expiration, that curve moves down and to the right.

This illustrates the benefits of time decay and probabilities for the position.

As time moves along, the trade has more room to breathe sort of speak with next week being the final home stretch for this rendition of HiPOS Conservative.

What are You Rooting For?

The calendar to keep moving.

Each day that passes means less time to expiration. We referenced time decay but the other factor here is we calculate the probability that an underlying market will reach that short leg and beyond of the spread trade. The less time remaining and the greater the distance between the market and the short strike, the lower the probability that the SPX reaches the 4600 level. HiPOS is called a high probability option trade because when we put the initial position on, it has a high probability of expiring worthless.

As sellers of volatility, going to zero means we would realize a full profit.

You also want the market ideally to go sideways or move higher.

Although, it has room to move lower so long as it doesn’t extend sharply lower over the remaining days to expiration. Price and time are the two biggies right now. I got a question recently asking why we didn’t put on a short call spread to form an Iron Condor position. The simple answer is that side of the trade never qualified under our strict rules for entry.

Often the put side qualifies but not the call side simply because of the inherent skew in option markets.

Our traders do look at it and if we can add the other side under our rules, we will do that.

It wasn’t an option (pun intended?) this time.

With that we’ll call this week’s edition of the HiPOS Update but do reach out to a member of the ZEGA team with any other questions.