We’re adding the following position to our portfolio for October expiration:
Day limit order
Buy to open 4 SPY Nov 116 puts
Sell to open 4 SPY Oct 116 puts
for a net debit of $1.44 or better.
Note that 4 contracts per leg is our base position size. Trading whole-number multiples of the base size ensures that adjustments will not result in unbalanced positions. Also note that matching our Model Portfolio risk profile requires a risk-based allocation strategy—i.e., putting an equal dollar amount into each initial position (prior to any adjustments).
Analysis: This is a by-the-book addition to our October trades…well, almost by-the-book. Today’s imminent close above SPY $114 meets nearly all the criteria for a new entry defined by our strategy rules; however, we’re adding more positive delta to our portfolio than we usually target—because we’re compensating a bit for unusual upside technical and event risk.
We’re being a little more aggressive in adjusting our delta bias for two reasons: Today the S&P and the Dow (just barely) confirmed last week’s breakout in NDX. It’s seemed for the past week (or two or three) that all the pundits and analysts have been absolutely certain that the market is stuck in a trading range. Today didn’t prove them wrong, but betting on a reversal here looks like the crowded trade.
More important, the inherent vega risk of a calendar-spread strategy favors keeping delta a little positive, and with an FOMC policy statement scheduled for tomorrow afternoon—as I’ve written more than once in the past week or so—we can’t afford any upside surprises. The +25 base-position delta of this trade shifts the delta per dollar at risk of our Model Portfolio from about –4% to a marginally bullish 0.3%.
The position breakevens shown above give us price-level risk-management thresholds in the vicinity of SPY $113.25 and $118.60, but as our Model Portfolio risk curve below shows, in the bigger picture our watch-points are around $111.25 and $116.70.