When to Hold, Fold, and Roll 'Em

Checkpoints for overlay, VRP, and directional options strategies

Created with DALL-E

Setting the Table:

• I’ve been scared about both legs of my short condors this week. The markets have gyrated up and down, only to land within 25bps of where we started.  It’s not uncommon to have that little net movement, but it certainly juxtaposes the feeling anyone felt looking at the brokerage statements Wednesday or Thursday evening.

  

• Short term vol (10 day) in SPY popped about 2 points across the board after the sell-off, and then fell right back down. However at 30 days, the bump persisted. We’re 50 bps higher than we were at the start of the week, which makes sense given the uncertainty in CPI and PPI readings.

  

• A lack of movement has definitely performed well for VRP collections strategies, as premiums all week at the 30 day level registered over 2%, fully 50bps above the long term average.

  

  • As the chart demonstrates though, VRP can be fickle, and like any risk premium must be harvested consistently. Check out yesterday’s edition of The Till for more thoughts there.

Identify:

• Every options trade is a volatility trade. Because there’s time on the clock, trading a call or a put is making a bet on how much it will move in the remaining time. Time and volatility are two sides of the same coin. No matter what the implied level is, if you restrict the time an option can only have so much value, and conversely even the lowest vol, out of the money option can have value if given enough time. 

• The expiration date “feature” of options means that greek exposures are constantly changing. In a simple covered example, if today you sell the 30 day out call in MSFT, you’re going to get about 1.4% of the stock price, collecting ~$5.80 at 30 delta.  

  

  • When you sell this call initially, your delta exposure would be considered roughly long 70 - short 30 from the call and long 100 shares. However as time passes, if stock doesn’t move, your delta will increase. You have some “charm”, or you get long deltas naturally as time passes from options decay. You also have some short gamma, because you’re going to get longer deltas on the downside and shorter on the upside. 

• We know stocks are going to move - that’s why the options have implied volatility. But how should investors react to these changes in prices and position? 

• Below we’ll dig into some rules for knowing when to hold ‘em, and when to close ‘em. And sometimes roll ‘em. These can be based on time passing, underlying movement, or options price change. It depends on what your objectives are, and what the realized path has been.