This afternoon’s market implosion has triggered another risk-management alert for our XLE Supplemental Trades portfolio. We’re opening the following hedge position to further offset our delta exposure:
Day limit order
Buy to open 1 XLE May 74 puts
Sell to open 2 XLE May 70 puts
Buy to open 1 XLE May 66 puts
for a net debit of $0.74 or better.
Note, once again, that our target dollar trade size is equivalent to our currently open calendar positions. So in order to match our Model Portfolio risk profile, given an initial calendar-spread allocation of $1000, one would have to trade the number of contracts in this butterfly to equal a $1000 position. Also note that as a Supplemental Trade, this order will not be autotraded.
Analysis: This month’s volatility is presenting us with the most extreme test we’ve faced in years (on the basis of our latest strategy improvements), and yet the premium we’ve sold versus our long cover positions continues to show a reasonable chance of coming out with little or no loss. Make no mistake—trading options can be risky because of the leverage involved, especially if one isn’t sensible to that leverage risk when allocating capital…but that same leverage allows us to outperform the market in more “normal” months. So, back to our current hedge trade…
We’re reducing beta-weighted (to SPY) delta, as a percentage of total capital at risk, from about 2.6% to virtually neutral. Vega is dropping from an already negligible 0.6% of capital at risk to 0.5%, and our probability of breaking even or better—even in one of the most battering months we’ve seen since the inception of the Calendar Options newsletter—is still more than 23%. We certainly can’t let our guard down in this volatile market environment—but we’ve widened our risk-management thresholds beyond the one-month average ATR, which should give us a break from these daily adjustments.
Our new risk-management price thresholds are approximately XLE $72.40 and $76.35, giving us plenty of room for the kind of daily moves we’ve been seeing lately. And, once again, XLE is deeply oversold in every intraday timeframe, so we expect some consolidation over the next few trading days. Nevertheless, we trade according to our risk-management signals, and will continue to take action as appropriate.
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.