SPY Calenderized Straddle Strategy

- Now that we were back at Volatility levels last seen in September 2018, I can take advantage of cheap optionality through calls and puts.

In my last option strategy which I set up with my dear friend Seraphim Czecker, we were talking about buying deep out of the money Call options and taking advantage of the cheap optionality through calls. In this report I´d like to present the SPY Calenderized Straddle Strategy, which is a bit more advanced.

Before we begin, I´d like to emphasis that the inspiration for applying Calenderized Straddles came from Patrick Ceresna´s webinar where he was talking about it. I´m a very big fan of Patrick´s podcasts at Macrovoices and Market Huddle where he is doing a great job talking about recent topics in macroeconomics and trading strategies. Definitely worth checking out both of these podcasts and regardless of your trading style to improve your trading and getting ideas.

Also thank you to Seraphim Czecker who contributed to this article again. Make sure to check out his blog as well (https://macrom8.wordpress.com/).

1. The Strategy

Most importantly, what I´m trying to achieve with this strategy is to do one of the hardest things in trading, catching the top of the market. Hence I know this is a very risky idea, I had to come up with an idea on how to be hedged in case the market goes up, while betting on a breakdown.

So why am I using a Calenderized Straddle and what exactly do I mean by that?

The reason why I use calendarized Straddles is simply because the optionality of gamma and vega at different expiration dates.

Recall: Gamma is the second derivative of an option's price with respect to the underlying's price. When the option being measured is deep in or out of the money, gamma is small. When the option is near or at the money, gamma is at its largest.

The first leg of my straddle is being long a short dated call option. By being long a short dated call I´m long delta, gamma, vega and rho but bleed constantly because of theta. The most important ingredient in this scenario is Gamma. As you can see in Figure 1, thanks to gamma I can nearly offset the amount of money I lose because of time decay.

Figure 1

The second leg of my calenderized straddle is being long a longer dated put (currently 19th July Expiry). I´m doing this because I´m not that much exposed to Gamma and Theta by using a longer dated option as you can see again in Figure 1.

Most importantly, if the breakdown that I´m waiting for would occur, I would profit mostly thanks to implied volatility spiking up and therefore my long dated put would increase in value thanks to vega (Figure 2). As you can see from Figure 3, there is an inverse relationship between the S&P 500 and the VIX because if the market crashes down, hedge funds and other institutions have to hedge their exposure to the downside by buying puts.

Figure 2

Figure 3

2. Trade Management

Because you have two different expiry dates, you have to roll both legs constantly. Currently I´m are holding a April 29th 2019 Call and a July 19th 2019 put with a strike price at 286. If the market moves 1 weekly STD (currently around 5 SPY points) which I calculate by using an implied volatility calculator model recommended by Patrick Ceresna, I roll both option-legs to a new strike price and new expiration dates. If the breakdown that I´m are waiting for finally occurs, I would let the call expire worthless and hold on to the put.

Trade History

First trade: I executed the first trade on the 3rd of April and had to readjust our position with taking minor losses on the 12th of April because SPY was trading in a range and I suffered losses due to Theta.

Second Trade: On the same day I sold my 286 Spy position and rolled it forward to the 290 strikes.

After 2 weeks in the position I had to take minor losses again due to a ranging market and lower implied Volatility.

Third Trade: Again on the same day I rolled our position forward to the 294 strikes and was finally lucky with spiking volatility and collapsing SPY.

At the end I had nearly staggering 35% profit on our last trade!

Fourth Trade: I was out of the trade now for over 1 month because we saw new highs in the SPY and low IV overall.

In the middle of July I set up a new Calendar Straddle as more economic uncertainties emerged and I wanted to hedge myself for the downside again.

After 3 weeks of holding the position and having a negative PnL on the trade of -5%, we finally saw our expected market correction again and I was able to make 81% profit on the 5th of August.

Here a snapshot of yesterdays PnL

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.