September and October are behind us. There was no market collapse and those who paid high prices for VIX futures contracts (or options) lost money on their expectation of a substantial increase in market volatility.
The holiday season lies ahead, and that is often a period of reduced market action and volatility. Has complacency arrived? Is now the time for unexpected market moves? Who knows? What I do know is that paying careful attention to position risk continues to be the name of the game. Keep alert. Avoid the large losses and survive. That's goal #1. Find appropriate strategies and prosper – that's goal #2.
Adjusting an adjustment
Let’s say you sold some call credit spreads (either as a standalone trade or as half of an iron condor) before a market rally and that your position became delta short as the market moved higher. Let’s also assume that you bought 5 Nov 350/360 INDX (a fictional broad-based index with Europeans style options) call spreads to offset a portion of your upside liability. The original position is probably 25 to 50-lots if this 5-lot is to be consiered as an early (Stage I) adjustment.
Unfortunately (for you), the market continued to rally and you make another adjustment (or two). The position is still viable, but if INDX moves another 3% higher, your plan is to exit the trade and re-invest your money in a better position.
However, right now that 350/360 spread you bought has done well, and can be sold @ $8. It seems obvious to adopt this thought process: My complete position has upside risk and I need all the protection I can get.
To a point that's true. However, the cost of that protection must be considered. From my perspective, paying $8 for a spread that may, if the market doesn't tumble, be worth $10 when expiration arrives is a poor choice for gaining some upside protection. You, the trader, want to own protection that can earn more than 25% of its cost and which has some positive gamma. There is nothing to be gained by buying more of these $8 spreads.
However, my suggestion is consider selling this call spread. First, it affords little protection. Second, if you sell that 5-lot and collect $4,000, you can accomplish two good things for your portfolio:
- Take out some cash
- Reinvest a portion of the proceeds from the sale and buy different protection
The idea of selling a call spread when you are already short delta seems to be a big gamble. However, I encourage you to look at it this way: These five call spreads offer a maximum gain of $1,000 and that's not nearly enough to make much difference in the future value of your portfolio.
Note: If your original trade is 25 to 50-lots, as suggested above, then you can afford to forgo that last $1,000 from the adjustment. But more than that, you may be able to get better protection.
Original trade: Sell 40 INDX Dec 380/390 spreads when INDX was 320.
Adjustment One: Buy 5 INDX Dec 350/360 spreads when INDX was 340
Adjustment Two: You bought 5 Dec 370/380 spreads when INDX was 360
At this point, the 350/360 spread serves little purpose. Think about 'adjusting the adjustment' by exiting the 350/360 spread, collecting between $8 and $8.50 per spread. Make another adjustment to the main position – if you find something suitable to do. If you find nothing attractive, hold and decide when to exit. This position can become very costly if you don't exit in time. However, the original 5-lot adjustment no longer affords any reasonable upside protection, making it a good idea to sell and look for something better.