To offset our bullish delta bias ahead of the weekend, we’re opening a small hedge position, as follows:
Day limit order
Buy to open 1 SPY Apr 141 put
Sell to open 2 SPY Apr 138 puts
Buy to open 1 SPY Apr 135 put
for a net debit of $0.71 or better.
Note that the 1 contract specified above for the “wings” of this butterfly represents half the number of contracts currently allocated to each strike in the April/May 136/139/143/145 double-diagonal.
Analysis: Since “investors” (to use the term the mainstream business press confuses with the traders and algos that determine much of the intraday action) keep waffling around our risk-management price level, we’re going to have it both ways. This trade gives us some downside protection over the weekend, at very little cost or additional risk, and it can easily be adjusted for a whipsaw reversal next week—or a real, convincing, breakdown in the S&P.
The key numbers: We’re cutting delta, in proportion to total capital at risk, in half, trimming vega (in case the rally resumes), and increasing theta (again, as a percentage of capital at risk) by more than 20%…all with no increase in percentage gamma.
Looking at our new P/L graph below, which shows simulations for one week (red) and two weeks (orange) from now, two things are clear: 1) We’re going to have to add another downside hedge if SPY falls another point or so; and 2) We may want to add a bullish position if the share price rallies as little as $1.50.
Interesting times—but not that unusual for options-trading professionals. No matter what the spam e-mails you’re probably getting every day promise, you can’t make a living trading options if you treat it like a lottery. We target outperforming long-term, risk-adjusted returns and have a very good track record, despite some ups and downs. There’s no free lunch…it takes work to achieve an average annual return of more than 15% over nearly four years. Our objective is to help you do the same.