With XLE down more than 6% since Monday morning, we’re opening a downside hedge position, as follows:
Day limit order
Buy to open 1 XLE May 79 put
Sell to open 2 XLE May 75 puts
Buy to open 1 XLE May 71 put
for a net debit of $1.49 or better.
Note that 1contract represents our base position for this hedge trade. In order to come as close as possible to matching our Model Portfolio risk profile, it’s important to allocate risk equally across each initial opening trade in a cycle–so this position would be sized to match the dollar amount risked in each of the previous May XLE trades. Also note that as a Supplemental Trade, this order will not be autotraded.
Analysis: This week’s mini-crash in energy has been damaging to our Supplemental Trades portfolio…but these things happen, and that’s why we have risk-management controls that keep any potential losses below our target gains. Our current unrealized loss is 16.2% of capital at risk (less than 14% in Model Portfolio terms), and with this hedge position, we still have a 25% probability of profit. Yes, that’s small—but if that’s the worst we do under the most challenging conditions, we can continue to outperform the market over the long-term.
We’re retaining a slight directional bias here, under the assumption that energy is grossly oversold and will rebound in the next week or so. That isn’t our usual approach—a risk-managed market-neutral stance is our core strategy—but Supplemental Trades give us the opportunity to take on higher risk with the promise of higher reward (or, in this case, a smaller loss).
As the P/L curve below shows, we’re very close to the next adjustment trigger…however, our directional thesis puts us in the bullish camp, expecting a retracement to at least XLE $77.25.
NOTE: Supplemental Trades are optional and primarily intended for more experienced/risk-tolerant subscribers. They are not autotraded, and have no bearing on our core newsletter portfolio; however, we 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 if they wish to match our risk-management profile.