We’re hedging our upside delta risk with the following trade:
Day limit order
Buy to open 1 SPY Sep 135 call
Sell to open 2 SPY Sep 128 calls
Buy to open 1 SPY Sep 121 call
for a net debit of $2.54 or better.
Note that the 1 contract specified for the wing strikes represents half the number of contracts allocated to our current September double-diagonal position.
Analysis: We’re taking a conservative approach with this hedge trade, cutting portfolio delta bias, as a percentage of total capital at risk, by only half, from –3.4% to –1.7%. Our standard target for upside adjustments is to bring delta back to neutral, but in this case, 1) the current calendar (double-diagonal) position has half the vega of our typical double-calendar; 2) the S&P has been overbought on the hourly chart since mid-day yesterday, is approaching overbought conditions on a daily basis, and is up against some key technical resistance levels; and 3) the fundamental outlook for the U.S. and global economies hasn’t changed enough to justify the past week’s bullishness.
With regard to volatility risk, we’re maintaining only marginally positive vega (in proportion to dollars at risk) in case the rally does continue—justified or not—and implied volatility drops significantly. If there’s a sell-off, we can roll the long vertical spread down to an out-of-the-money short vertical (with an iron-condor trade), selling premium into the rise in volatility.
As the portfolio P/L graph above shows, our new projected break-evens at expiration are more than $19 apart, and our estimated probability of profit is over 70%. Our next upside risk-management price threshold, at about SPY $123.50, isn’t that far away—but with the current combination of positions and lots of free capital, we have plenty of options for handling pretty much anything the market throws at us. (Except maybe a black swan, up or down, but that’s why we always stress the importance of risking no more than you can afford to lose, on any strategy.)