After the previous closing trade, our IBM portfolio delta bias still exceeds our upper risk-management threshold. I expect today’s bullish reaction to IBM’s investor conference on Tuesday to settle out in coming days, with IBM testing support at $166, and possibly even $164. In light of the whipsaw risk, we’re using a calendar spread (long vega) to hedge the upside this morning:
Day limit order
Buy to open 6 IBM Apr 170 puts
Sell to open 6 IBM Mar 170 puts
for a net debit of $1.78 or better.
Note that the 6 contracts specified above represent 1½ times the number of contracts in our initial, IBM Mar/Apr 165 put calendar. Note, too, that as a Supplemental Trade, this order will not be autotraded.
Analysis: One nice thing about trading long-theta option spreads is that, with unlimited funds, one can just keep piling on positions to hedge the greeks under most conditions and end up with a profit. Unfortunately, few of us have unlimited funds, so we have to make trade-offs.
For example, we could have hung on to Butterfly Hedge #1 and bought an even bigger stake in this position. Or, we had the option of adjusting that hedge into an iron condor like we did last week with BF Hedge #2. But either of these approaches would’ve taken another big commitment of capital, and one of our strategy objectives is to manage risk using a reasonably well-defined capital allocation. So what we’re doing, in a way, is rolling our downside butterfly hedge up to a calendar hedge above the market.
The key here is that, between the two trades, we’re cutting our negative delta bias per dollar at risk (beta-weighted) from nearly 5.3% to about 1.8%. Veteran members know that whipsaws are one of our worst enemies, so we’re adding a little vega at the same time to support our P/L curve in case of a sharp reversal. This is what our Supplemental Trades risk profile looks like after today’s adjustments:
Note that I’ve projected the expiration-week risk curve out to Thursday of next week. Our portfolio now consists of a 165/175 double-calendar (unbalanced though it is) and a March iron condor—both of which will actually lose gamma in the last couple days before expiration, making it reasonable (if IBM settles down, and that’s a big if) to contemplate holding our positions past our normal cut-off date…although it still would be a good idea to pare back risk (at the cost of profit potential) ahead of the weekend. One of the keys to being a successful trader is to limit losses before they get out of control. With the Calendar Options Strategy, that means doing our best not to lose more in one month than we can reasonably anticipate recovering in the next couple cycles, even if that means locking in losses to manage risk.