An hour and a half into the session this morning, there’s been no sign of a major reversal; therefore, in keeping with our strategy rules, we’re adjusting the March/April double-diagonal. This adjustment has two parts—one, we’re buying the complementary diagonal on the call side:
Day limit order
Buy to open 2 SPY Apr 113 calls
Sell to open 2 SPY Mar 118 calls
for a net debit of $2.72* or better.
And two, we’re rolling up the put side to stay well-positioned for a minor correction:
Day limit order
Buy to close 2 SPY Mar 102 puts
Sell to close 2 SPY Apr 97 puts
Buy to open 2 SPY Apr 111 puts
Sell to open 2 SPY Mar 111 puts
for a net debit of $0.95 or better.
Note that 2 contracts per leg represents the number of contracts we’re currently holding in this position. After this adjustment, we’ll have a 111/113/118 put/call/call triple-calendar with an equal number of contracts at each strike.
Analysis: We’re adding a twist to our standard double-diagonal adjustment this time. Instead of closing the out-of-the-money put spread, we’re exchanging it for an additional calendar position at the 111 strike. The first order above turns the bearish 113/118 call diagonal into a bullish double-calendar; the second reclaims the remaining vertical margin and uses the cash to offset the excess delta of the first, leaving us with a net base-position portfolio delta of about –44 (compared to about –23 if we had left out the additional 111 put calendar). This is still a 60% reduction in absolute delta bias—significantly more than we generally look for—but, we’re also reducing the amount of capital at risk, so as a percentage of our dollar allocation, this adjustment cuts our negative bias by only slightly more than half.
One important point to note here is that this trade would not work without the CS#2 position (115 calls) that we opened last Friday. The graph below shows the risk profile for the adjusted double-diagonal position, including the CS#2 hedge trade. Without the latter, the upper breakeven for the adjusted DD alone would be about $113.30. It’s been a while since we’ve talked about the fact that there’s no real difference between an “adjustment” and opening a new position (usually, but not necessarily, after closing another); we just use that term to distinguish the purpose of certain types of trades. So if we include the “new” 115 call calendar as part of our overall DD adjustment, the adjusted position makes sense; otherwise, it just looks like a mess.
At this point, though, what’s more important than the above subset of our portfolio is the aggregate of all our March trades (below). As stated above (and shown in the analysis table), we’ve reduced our upside delta risk by cutting our portfolio bias to about –44. Gamma and theta are essentially unchanged, but our vega has gone up nearly 50% (from about 70 to about 104). This does add risk; however, it’s risk that we would normally have at this point in the cycle if we were trading only calendars and double-calendars. By starting this position out as a double-diagonal, we’ve been able to put off buying most of the position’s volatility until IV has come down more than 35% (about 8 points) from where it was when we first entered the trade.
To wrap up, with our new portfolio breakevens at about $110.30 and $115.12, our current profile has approximately a 46% probability of being profitable at expiration. We’re setting our new upper portfolio-level adjustment threshold about halfway between the adjustment point for CS#1 and our upper breakeven. At the lower end, our expiration risk profile approximates that of a double-calendar, which would put the adjustment point about halfway between our lower strike and breakeven.*The limit originally specified for this order was $2.75, but the market price dropped below $2.70 within minutes of our trade alert going out. For the official record, we’re using the average of the original alert price and our actual fill at $2.69.