Another week is nearly gone, and SPY is pretty close to where it was last Wednesday. Generally, that’s great for a market-neutral option-selling strategy like Calendar Options, but the side-effect is that our risk-management rules have kept us from putting more capital to work. So, newer members might be asking, why are we 75% in cash when conditions have been unbelievably favorable? The answer is, because we don’t know when conditions might change.
In the four years I’ve spent fine-tuning the Calendar Options strategy, always with risk-management taking top priority (c.f. Warren Buffet’s Rule #1), one of my key take-aways has been not to pile up negative gamma around one strike range. Calm markets are tempting to option-sellers, but complacency ultimately results in losses…occasionally, big losses. That’s why we enter a new position, if we already have at least one position open, only when the underlying price has moved far enough that the new position is centered a certain distance (details are proprietary, but one can figure it out pretty easily by studying the trade history) from the current delta-neutral point—and the resulting portfolio risk profile conforms to our targets for net portfolio delta, vega and theta (again, proprietary, but discernible from past trades and analysis, which are available only to subscribers).
- We don’t get clobbered if the market suddenly jumps;
- See #1.
- We aren’t over-leveraged…oh, wait—that’s actually a pro;
- Our monthly Model Portfolio return is limited to about 6%…oh, wait again—that’s a great return for just one month, risking only 25% of portfolio capital.
To the Point
Okay—this is a status update, so here it is: Just after the bell this afternoon, our unrealized return on capital at risk was about 13.5%, and we were showing a Model Portfolio return in excess of 3.3%. Delta was about as close to neutral as one could possibly imagine, and vega, as a percentage of capital at risk, was a very tame 3.2%.
While our probability of showing a profit at expiration, based on current implied volatility, is approaching 55%, increasing gamma has narrowed our projected risk-management price thresholds to approximately SPY $139.70 and $142.45. As hinted above, just one macroeconomic “surprise” could be all it takes to reach either trigger level—but we’re well-armed with strategies for hedging against such a move.
On the other hand, in the absence of any dramatic event, we remain on the lookout for an opportunity to sell more premium, as conditions permit (e.g., a slow rise into the holiday weekend). For now, though, this is what our P/L model looks like: