Wal-Mart has taken a pounding this week, but August implied volatility is only about a point above our target range for new trades. It’s a bit of a stretch, in terms of volatility risk, but we’re going to add a new position this afternoon to offset our Supplemental Trades portfolio delta:
Day limit order
Buy to open 2 WMT Aug 50 calls
Sell to open 2 WMT Jul 50 calls
Buy to open 2 WMT Aug 47.5 puts
Sell to open 2 WMT Jul 47.5 puts
for a net debit of $1.37 or better.
NOTE: As a Supplemental Trade, this trade is optional and is primarily intended for more experienced/risk-tolerant subscribers. It will not be autotraded, and it has no bearing on our core newsletter portfolio; however, we will follow up by posting any additional entry or adjustment trades that the Calendar Options risk-management approach may call for. Also note that it’s important for anyone who chooses to participate in Supplemental Trades for a given cycle to follow all Supplemental Trades in that cycle, in order to match our risk-management profile.
As usual, two contracts is our base position for double-calendars. Trading whole-number multiples of the base size ensures that adjustments will not result in unbalanced positions.
Analysis: We’ve given this trade a bullish bias in order to take some of the heat off our WMT Jul-Sep 50/52.5 double-calendar, which is now deep in adjustment-watch territory. As explained in yesterday’s Adjustment Watch post, an adjustment is triggered only on next-day confirmation of a closing price, unless the position is trading at our maximum stop-loss level—and even though the underlying price has fallen below our expiration breakeven as well as our price-level adjustment threshold, we’re showing “only” about a 10.5% loss.
Nevertheless, since back-month implied volatility is below our normal entry range, and pretty close to the range we look for when volatility is on the high side, we’re playing it safe and opening this position as a buffer against the downtrend. The position has a 48% probability of being profitable at July expiration, as shown in the risk graph below:
But what’s more important is that we’re shaving about 8.3% off of our base-position delta and cutting our portfolio delta per dollar at risk by more than 60% (assuming equal capital allocated to each trade). Our new Supplemental Trades portfolio risk profile is roughly equivalent to that of a center-weighted triple-calendar (which is among our standard adjustment strategies), as shown below:
This picture doesn’t show very good odds of ending up with a net profit, but we hope to change that as we adjust or add to our position to manage risk and increase profit potential. For example, an adjustment to the Jul-Sep 50/52.50 position is still on the table for next week. With today’s hedge in place, we’ll be looking for WMT to fall below $48.50 (or rally back to about $50.75) before making our next move.
[A footnote regarding the initial trade alert: I had price-discovery orders in for both the July/August and the July/September spreads, and the latter happened to get filled first—which is what led to the pricing error in the alert. The July/August trade, for which I'd prepared the alert text because it carries a little less vega risk, was filled shortly thereafter…but for any members who may have looked at the price and decided that the mistake was in the back month and not the price, and placed an order accordingly, the risk profile of that trade isn't very different from what's shown above. (I, myself, am the tentative owner of an orphan four-lot in the Jul/Sep position.) Once again, my apologies for the confusion.]