It’s been tough going these past three or four months, largely as a result of increasing market volatility similar to the July 2007 through April 2008 period that preceded the fall 2008 crash. But another factor has become an equally strong headwind of late: a pattern of front-month implied volatility rising more rapidly than back-month throughout the weeks preceding our target expiration. No matter how low IV is when we enter positions or how much front-month vol exceeds back-month, our unrealized P/L curve is steadily pushed down week by week, forcing us to:
- Make adjustments because we’ve hit our maximum allowable loss, even though we don’t have a delta-driven risk-management trade signal, and
- Keep most of our positions open right up to the final few days before expiration.
We’re already seeing this pattern emerging again this month, only two days into our first trade of the cycle. I’ll come back to this topic when I review the status of our open position, after a look at the latest period’s results…
In an Extreme Market, Success = Capital Preservation
Despite the challenges—which were perhaps the most difficult we’ve faced in the three-year history of the Calendar Options newsletter (we stayed in cash through the October 2008 expiration cycle)—we managed to close the August cycle with a 2.66% Model Portfolio return. It took a big (temporary) infusion of additional capital and an unusual amount of trading,…but even after accounting for reasonable commission costs, our results beat the benchmarks we use for comparison. The S&P 500 Index lost 14.63% between July and August expiration, and the CBOE Volatility Arbitrage Index was down 15%.
Here’s the updated performance graph (not including commissions and fees):
Stand In the Place Where You Are
As noted at the outset of this update, volatility skew is once again weighing on our current unrealized P/L:
Ignoring, for the moment, the paper loss of 7.7% on total capital at risk, we’re in a nearly ideal position with respect to risk-management. At yesterday’s close, portfolio delta was a mere –0.5% of capital at risk, and vega was just 1%. Projected probability of profit at expiration has actually risen a tad, to 58%. Our projected risk-management price thresholds, factoring in the strategy’s maximum loss limit as well as delta relative to volatility risk, remain at approximately SPY $106.90 and $121.60. That gives us a tolerance range of more than ±6%. Even in this volatile market environment, that’s a pretty robust position.
Nevertheless, should SPY approach either adjustment trigger, I’ll post an adjustment-watch update and, if necessary, a trade notice, prior to any measure we might take to hedge our risk. And next time we’ll consider waiting until a week or two before expiration before opening any new positions (just kidding, of course).