We’re opening the following hedge position to adjust portfolio delta for this week’s rally:
Day limit order
Buy to open 1 SPY Feb 133 call
Sell to open 2 SPY Feb 137 calls
Buy to open 1 SPY Mar 141 call
for a net debit of $1.95 or better.
Note that the 1 contract specified above for the “wings” (long legs) represents half the number of contracts allocated to each leg of our prior February trades.
Analysis: As this afternoon’s strategy post suggested, we’re adding a new type of hedge trade to our bag of tricks, to allow even more flexibility for managing portfolio risk in multiple dimensions. In this case, we want to bring portfolio delta back to neutral with a minimal increase in capital at risk and without increasing volatility risk or gamma (in proportion to total dollars at risk). This calendar butterfly does exactly that.
The strikes were chosen both to achieve the desired portfolio risk profile, and to set up a position that we can adjust, up or down, with less margin than we still have available in our Model Portfolio allocation. This trade brings delta back to virtually neutral, from a negative bias exceeding 3.5% of capital at risk. Gamma is unchanged, and vega drops slightly, from about 6.8% to approximately 6.0%.
But as the P/L graph below shows, even a sophisticated, painstakingly honed calendar strategy like Calendar Options can’t just sail through a strong 10-week rally, with implied volatility dropping at the fastest rate we’ve seen in 3½ years, without taking on some water. If IV doesn’t bounce back, the odds of seeing a gain this month are now only about 30%…nevertheless, there’s still a small, but real, chance that we could hit our target average return.
Making February pay off, though, will take diligent risk-management and disciplined adherence to our strategy rules. From this point on, we’ll be managing risk by adjusting or closing current positions. Our new projected risk-management price thresholds are approximately SPY $132.90 and $135.35.