High theta ahead of central bank announcements

The steep market decline two Fridays ago and the increase in volatility that accompanied it provided an opportunity to aggressively sell premium in the E-mini S&P futures (ES).  The notional value of the ES is the equivalent of 500 shares of SPY.  I like using the ES for a couple of reasons.  The essentially trades 24/5.  It closes between 4:15 pm to 4:30 pm and from 5:00 pm to 6:00 pm (EST).  This allows me to monitor my delta (if necessary) if there is a large after-hours move in the market (eg. Brexit) when the markets are closed.  The size of the ES and the transaction costs are also more favourable.  These attributes along with the extremely high liquidity are why the ES and its options make up a good part of my portfolio.

The ES premium I sold over earlier in the month had expiries of September 23 and September 30.  We are now in the week of the 23^rd and IV is relatively high in these weekly contracts as we await central bank policy announcements from not one, not two, but three central banks.  The Bank of Japan kicks things off tonight, the Fed is scheduled for tomorrow and the European Central Bank closes things off on Thursday (although the ECB won't be addressing policy at its event).  It will be an interesting 48 hours.  As a result of the increasing IV, theta drip has been slow to roll off of my short options and theta has ramped up.  My theta numbers are about double where they were two weeks ago.  The conservative approach would be to reduce some positions and bring down theta/gamma or extend duration which would also reduce theta/gamma.  However, I feel the volatility crush will be significant over the next two and a half days and irrespective of the direction of the market, I’ll be in a good place (barring a 300+ move in the DOW).  I feel the risk to the downside is greater than the risk to the upside so I’m positioning my deltas slightly negative because any upward movement in the market will accentuate the volatility crush. 

June 11 - Postmortem: SPY long calendar spread

Pinning the tail on the donkey.  It's a classic birthday game that I'm sure we've all played (or at least a derivative of the game) .  [Heh heh...did you see what I did there?]

A calendar spread is the options version of the game.  The objective is to guess what the price of the underlying will be at a certain point in time.  A long calendar spread is one of many strategies a trader can employ if a trader believes the underlying stock will remain range-bound for a period of time.  A calendar spread can use either calls or puts.  The position involves a long call (put) position at a given strike and a short call (put) position at the same strike but with an earlier expiry and is generally opened for a net debit.

The objective of the spread is for the underlying stock to settle as close to the strike price as possible when the short option expires.  When the short option expires at-the-money (ATM), the spread between the long option and the short option is maximized.  If the short option expires in-the-money (ITM), the delta of the short option is 1, while the delta of the long option is less than 1.  Therefore, the spread between the options will decrease for every tick the short option is ITM.  On the flip side, if the short option expires out-of-the-money (OTM), the value of the short option is still zero, but the value of the long option will be lower.  Therefore, you can see that the bliss scenario for the calendar spread is for the underlying to pin the strike of the short option at expiry.  This is what happened for me with SPY this week.

On May 25, SPY was trading a little over $209 while I was short a couple of straddles on the SPY with 203 and 206 strikes.  My SPY positions were -delta, meaning my positions would make money if SPY went down, but would lose money if SPY went up.  I wanted to adjust my SPY position to provide myself with some upside risk protection in the event SPY continued its ascent and remained range-bound around $210-212.  I entered into a long calendar spread by:

• buying SPY July (17) 210 puts
• selling SPY June (10) 210 puts

The spread cost me $2.45.  It would more than offset any straddle losses if SPY settled at $210 around expiry, however the hedge would lose its efficacy above $213 or so.  Over the first few days, the spread became profitable.  Calendar spreads are generally very slow moving (ie. they make/lose money very slowly).  However, things accelerate as you get closer to the short expiry.  Both theta and gamma increase.  Theta represents time decay.  A long calendar spread is +theta therefore the spread makes money with the passage of time.  Gamma represents the change in delta as the underlying moves.  A long calendar spread is -gamma and risks losing money if the underlying starts to move rapidly in any direction.  Because of gamma risk, I typically don't hold calendars until expiry of the short option, however in this instance I elected to roll the dice.

The short side of my spread expired on Friday, June 10.  SPY closed on Thursday at about $212 and gapped down on the Friday open.  SPY meandered around $210 and was pinned to my short strike--the absolute perfect scenario.  I closed the calendar mid-day with a credit of $3.69 for a net profit of $3.69 - $2.45 = $1.24 or about 50% of my initial debit.  A calendar spread home run!  Near market close, the spread actually traded at $4.00, however I was still more than pleased with my 50% profit.  What helped the position even more was the expansion of volatility.  A calendar spread is the only directionless strategy which benefits from volatility expansion, however this is outside the scope of this article.

The calendar spread win more than offset all of my straddle losses for the month (and then some!) which was the objective of this trade.  Many find the strategy boring but for whatever reason I have an affinity to this position.  Since calendar spreads benefit from increasing volatility, it's a strategy that should be considered in low volatility environments like we generally have today.  

Standard June options expire next week so I'll have some more postmortems to share as it'll be a busy week of closing positions.  In particular is my GOOGL call calendar spread and my MCD calendar/diagonal.  The MCD trade has been a grind with a ton of adjustments which I'll recap next weekend.

June 6 - Bunch of rolls

Today was a roll day.

X

X had a nice move up today.  I closed the June 14.5 puts by buying back at $0.28 for a nice profit of $0.71 (initial debit of $0.99).  I rolled up and out by selling July 15 puts for $1.05.  I'm still fairly bullish on X which is in line with my bearish view on the USD.

MCD

Rolled down the short June 130 puts to to 122.  My weighted-average short strikes in June is $122.90.  Even though this number is above the current stock price, my overall delta is still negative (for now).  Delta will flip once we get closer to expiry if we stay here.  I'd just like MCD to meander between $122-123 here on in with a bias to the downside since I essentially have a bunch of diagonals with my long July 130 puts.  MCD has been a disaster the past month or so for me, but if we can stay at this level for the next two weeks, all will be good.

SPY

I had a June(10) short straddle at 203...ouch!  I rolled into an inverted strangle by selling 210 puts while taking off the 203 puts for a cup of coffee (Tim's--not Starbucks).  I'm still -delta on the SPY, but figure this run has to end some time...doesn't it?  Doesn't it? :)  At least my core portfolio is doing well!

GOOGL

Didn't do anything with GOOGL today, but it hasn't looked good the past few trading days.  I'm holding the ripcord and may have to pull tomorrow.

June 4 - Technical analysis and other mumbo jumbo

I'm not a technician by any stretch of the imagination, but I decided to open up some positions based on my technical analysis on some underlyings.  

X - Short put

On May 26, I sold June(17) 14.50 puts on US Steel (X).  IV is fairly high in this underlying which allowed me to credit $0.99 per put with X trading at $14.70.  Not a bad credit for 22 days to expiration (DTE) with the puts slightly out-of-the-money.

The +DI was converging up into the -DI and looks like it will overtake it.  I probably got into this trade a little early and should have waited for confirmation.  However, time is on my side on this trade and I wanted to put this on while IV was still high.  Since the trade, X has moved up about 60 cents while IV has drifted lower.  The puts are now $0.47 and I'll continue to monitor the DIs.  If the DIs continue to oscillate as they did in February or if the +DI continues up, I'll hold on to the position.  If -DI strengthens, I'll have to think about exiting.

GOOGL - Long call spread

In a similar vein, I bought a long July(17) 710/730 call spread in GOOGL for an initial debit of $10.30 on May 23.  It has been a good couple of weeks since (spread is now a little over $15), but the ADX/DI technicals appear to be weakening.  Both strikes are in the money, so theta is now positive so I'll try to be patient to let this trade play out.  But if the DIs reconverge, I'll look to close the position.  

Adjustments

On the other hand, MCD has been struggling and I don't see much upside over the next couple of weeks.  As a result, I rolled down my short some of my MCD June 130 puts to 122.  I have 50 long lots of July 130 puts with short June(17) puts of now 130x15, 125x10 and 122x25.

Other new positions

Long FB diagonal:

• Bought July(15) 115 call
• Sold June(17) 118 call
• $3.28 debit

Long AAPL diagonal:

• Bought July(15) 95 put
• Sold June(17) 92.50 put
• $2.11 debit

Long AAPL calendar:

• Bought July(15) 97.5 call
• Sold June(17) 97.5 call
• $1.16 debit

Long SPY calendar

• Bought July(15) 210 put
• Sold June(10) 210 put
• $2.45 debit

May 19 - rolling MCD, another SPY straddle and diagonal in AAPL

Rolled my May MCD puts into June.  I was happy with the execution even though everything else with this play went the wrong way.  I'm +delta on MCD so unfortunately if the MCD does go up, IV will go down along with it.  The May/June 125 put spread is ~$2.20.  If I can get half of that this time next month with my setup, I'll it'll be quite a recovery.

I sold another SPY straddle with a different expiration.  So right now, I have SPY straddles that expire on June 10 and 17 and a QQQ straddle that expires June 3.  I intend to keep writing these with differing expirations to spread out the risk.

I bought a diagnoal in AAPL today as well (June 92.5P/July 95P).  IV is very low and I'm just looking for a quick downward which will help the vertical part of the diagonal as well as the +vega component of the spread.  All with +theta as well.  So hopefully it'll hit the front-month strike in the next 4 weeks when I can take a profit.

May 18 - Closing SLW straddle and getting deeper into MCD

I made a couple of small trades today.  I closed my SLW 18/19 strangle for $0.39 for a nice 59% gain relative to the initial credit.  SLW moved nicely between the strikes following the release of the FOMC meeting minutes.

Earlier in the day, I added three more short MCD June 125 puts.  I may turn this into a 3x1 ratio spread if things hover between $125 and $130 over the next few days by buying one June 130 put.  I'm memorializing my stubbornness with MCD as I keep adding +delta.  We'll see how this plays out.

May 17 - Is this the return of volatility?

Well that worked out nicely!  GOOGL gapped up quite nicely this morning.  I sold my 4 GOOGL June 715 calls for $28.50 shortly after the marked opened.  This was before the entire market decided to lay an egg.

I'm not sure if volatility will continue its trend up, but it's certainly higher now than it was a week ago.  With the increase in volatility, I decided to sell some SPY and QQQ straddles as well.  I'll always sell straddles on down days.  I'll take profits at 25-30% of initial credit.  On the flip side, I'll get out of dodge if the spread expands to 2.5x (ie. SPY straddle expands to $17).

MCD got caught in the downward momentum of the market.  My target hopes/prayers/best case scenario for MCD for the end of the week (and May options) is between $129-131.  My MCD position is already +delta, but I decided to sell some more short-term puts anyways in the hopes the market's zigzagging will continue tomorrow.

May 16 - Buffett likes AAPL

Busy day for me!  I closed a number of positions.  See my updated P/L.

AAPL

Thanks, Warren for saving my AAPL spread.  AAPL surged 4 percent today and closed at $93.88 after Berkshire's announcement that it has built a $1.1 billion stake in the company.  This move helped my AAPL calendar which had an average front-month strike of $94.25.  I exited this calendar (27% gain on initial debit) and I also bought back my June 90 short puts (46% gain relative to initial credit).

POT

I closed my short POT strangle.  The profits are just enough for three lattes at SBUX.

GOOGL

I closed my short May 720 put for a small profit.  This position was to add some +delta to my GOOGL position.

I had an order to sell my calendar at the market mid-point for most of the day but never got filled.  I tried legging out of my GOOGL calendar by buying the short side first.  That got filled but I'm left open on the long going into tomorrow.  I'll probably regret this, but it gives me second thoughts about GOOGL spreads in the future.  It's just not liquid enough and the B/A spreads are big enough to drive a truck through.  If GOOGL gaps up tomorrow--great!  If not, chalk it up to a lesson learned on the perils of the lack of liquidity of GOOGL options (or my stubbornness to offer below the middle of the market).

My long call spread is also still open.  All in all, I'm currently very long GOOGL right now.  Go GOOGL!

MCD

I added to my MCD calendar with a debit of $0.80 on the June/July 130 puts which I'm very happy with.  The short side is also made up of some May 129 puts to bring my weighted-average short May strikes to $130.  I'll be happy if MCD stays where it is for the balance of the week.  I really like my MCD setup right now even though it's showing an unrealized P/L.

May 14 - MCD un-contango'd

Earlier in the week, I entered into a time spread with MCD with front-month strikes of 130 (June) and 131 (May) and a back-month (July) strike of $130 with MCD trading around $131 and change.  The debit on the June/July 130 spread was $0.88.  Fast forward a few days and the trade worked perfectly--the underlying dropped a few dollars and IV increased.  The position should show a small profit, right?

Except for one thing--the options got un-contango'd.  The IV of the June options increased more than the IV of the July options.  The positive horizontal skew disappeared.

MCD implied volatility (1 month and 1 week)

This caused the spread (June/July 130) to shrink to $0.73!

Closing option quotes (last, change, bid ask)

Positive horizontal skew or increasing IV with longer dated options is typical with no pending major announcement such as earnings.  As you can see in the first chart above, MCD exhibited negative horizontal skew leading into earnings.  Skew flipped to positive once earnings were released.

Once I'm in the position, I generally don't care about the IV of the front-month options.  I typically hold them until 4-7 days until expiration, so the IVs don't really have a large influence on the value of the option (relative to the back-month).  But in this case, I'm tempted to add to my position given the un-contango'd (loss of skew) nature of the options.  One positive takeaway is that I've spread my short options between May and June expiry.  Hopefully, the June options will maintain their high IV until I roll the May shorts into June which I'll do some time next week.

May 12 - Some short puts and what's wrong with AAPL?

A couple of more trades over the past two days:

• Sold GOOGL May 720 puts @ $3.40 x 1
• Sold AAPL Jun 90 puts @ $2.21 x 2

Rationale for selling the GOOGL put was to add some +delta to the 715 calendar.  AAPL sold off early this morning, so I wanted to sell some premium with the bump up in IV.  AAPL cracked below $90 this morning.  It's not in a happy place.  My AAPL calendar needs some help.  I think AAPL is a good candidate to open up an iron condor or butterfly next week.

I'm mulling over a long-term SPY diagonal 205/210 (January back month, perhaps June/July front month).  I'll roll the front at the 210 strike until SPY hits 210 in which case I'll roll $5 higher.  I'll keep doing this for the balance of the year.  Downward trending IVs generally aren't good for my regular calendars, but am hoping by adding +delta with the diagonal will mitigate some of the low vol risk.

May 10 - Repairing GOOGL calendar

Markets are up 1% and GOOGL is up to $738 halfway through the trading day.  I should have made an adjustment earlier, but lesson learned.

I bought a May 730/740 call spread for $5.80 (x1).  This will give me some upside protection up to $740.  However, I'd rather see sub $730 prices this time next week.

• Bought May 730 call @ $13.15 x 1
• Sold May 740 call @ $7.35 x 1

If we get a few consecutive down days, my current setup should work well.

-------------------

At the end of the day, Dow +222 and S&P 500 +26.  Great day for my core portfolio--not so great with the options portfolio.  However, still showing a positive unrealized P/L with the options.  I'm hoping for some down days the rest of the week.

GOOGL - $739.38 (+10.25)
AAPL - $93.42 (+0.63)
MCD - $131.60 (+0.77)
POT - $16.15 (+0.54)
SLW - $18.41 (+0.21)

May 9 - For the love of calendars

It was the summer of 1998--the summer before my first year of university.  I entered into my first options position.  It was a calendar spread on Dell Computers.  I think DELL was trading at around $116.  Earnings were scheduled to be announced after-the-bell on the Thursday of the week of the expiry of the short leg.  I remember the September 120 call was $7 and change and the August 120 call was $4.30.  I opened the spread with 16 DTE on the August contract.

DELL headed straight downhill.  I was bleeding money despite the volatility spike (I paid little attention to IV anyways at the time).  I think DELL flirted with $100.  My position was way out-of-the-money.  I remember watching the Nightly Business Report on PBS and the blowout earnings report.  The next day, DELL spiked to $119 or so.  Perfect--I could close out my spread for a nice gain.  But I didn't.  I held on to the following week.  The next Monday, DELL opened at around $123.  The short August contract expired and I sold the long September contract for $7 and a bit.  With four contracts, I ended up making $1600 on the trade.  As an options-virgin no more, I was on cloud nine.  I had no idea what I was doing.  Reminds me of other things that year...

Low IV environment

Maybe it's that first experience, but I've always had an affinity for calendar spreads.  With the low IVs we're seeing these days, there's no better opportunity to open a position in one of my favorite strategies.

GOOGL

Last Thursday, I legged into a GOOGL calendar (May/June 715 call) for a net debit of $7.10 x 4 contracts.

• Bought June 715 calls @ $19.40 x 4
• Sold May 715 calls @ $12.30 x 4

IV is 20% with a six-month range of 17-40%.  I chose calls simply due to improved liquidity versus puts.  However, if volumes are equal, I prefer the put side to avoid any headaches with early assignment.

GOOGL closed today at $729.  I'll get out if it goes much higher, otherwise I'll hold on until early-mid next week when the May contracts expire.

AAPL

In a similar vein, today I legged into an AAPL calendar/diagonal.

• Bought June 95 calls @ $2.07 x 20
• Sold May 95 calls @ $0.88 x 5
• Sold May 94 calls @ $1.30 x 15

Low IVs are the theme.   AAPL closed today just under $93.

MCD

• Bought July 130 puts @ $3.30 x 25
• Sold May 131 puts @ $1.29 x 10
• Sold June 130 puts @ $2.42 x 15

MCD closed today at $130.80.

Strangles for fun

I shorted a couple of short-term strangles to get my feet accustomed to undefined risks.

• POT: Sold May 15/16 strangle for $0.43 x 3
• SLW: Sold May 18/19 strangle for $0.95 x 3

IVs for both in around the middle of their six-month range.

The start of my journey

As a fourteen-year-old teenager, I remember meandering the Coles Bookstore at the Seaway Mall in Welland, Ontario.  I remember picking up this thin, blue book published by an affiliate of the Globe and Mail.  The book was titled, "Exploring Options".  I had an interest in personal finance at the time and wondered what this book was all about.  Ten minutes into my reading I was hooked.  I've had an insatiable hunger to learn more about options ever since.

Fast forward a little over twenty years.  I'm now in a unique situation to comfortably allocate $100,000 to 'speculate' in options.  Like my days in front of a fume hood during my misguided pursuit of an undergraduate degree in chemistry, I now wonder how the pilot project of mine will fare.  Sure, I've traded options over the years, but never with a purpose.  I now have a purpose--to generate consistent annual returns in excess of 15 percent and to double the value of the portfolio at least every 5 years.

As with any journey, half the fun is getting there.  I intend to memorialize every trade, thought and rationale to be able to objectively reflect on my decisions.  I hope the critical thoughts of others will provide alternative views to my own so that this journey will enrich all who take the time to read and participate in this discussion.