WDIS: Back to Cool

Outliers in a Portfolio

| Feb 9, 2015
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    WDIS: Back to Cool

    Outliers in a Portfolio

    Feb 9, 2015

    Looking at Katie's overall portfolio, most of her gains, losses and delta seem to be consistent across each position. Except, however, for RIG. In Katie’s account, they typically like to trade smaller contracts and use consistent buying power (around $1,200 or less per strategy). RIG is only using $800 in buying power, yet the position today is down over $65, which raises a red flag that something should be done to defend the position.

    Before that, the team also looks at UNG. This trade originally began as a Covered Call strategy with additional short Calls to neutralize the delta. Over time, they have been directionally wrong, so they sold a Put to add longer delta to the position. This Put is now In The Money, and they may face assignment soon. This leaves them wanting to roll the Calls to extend duration while simultaneously reducing the amount of short Calls (which will take off some of the risk). This is because they have roughly 200 long shares of stock (due to the deep ITM Put, which emulate 100 Long Delta). Since the stock is still near its lows, they don’t want to short the At The Money Calls in March, because they still have a bullish assumption and like the delta exposure. The further out of the money, the less short delta is added to the position.

    Tony and Katie were initially bullish on RIG, and sold a Naked Put with the hopes that RIG would bounce back with the rest of the Oil market. Over time, RIG continued to drop, so they sold a Call to make an Inverted Strangle. Inverted Strangles occur when the Short Call strike is lower than the Short Put Strike.

    Ultimately, the price of RIG rebounded, leaving them a Strangle that is now trading above both their Call and their Put. With a larger loss in RIG than anywhere else, Tony and Katie aim to hedge the delta in the underlying by selling another Put. They choose to sell another Put rather than roll the trade to extend duration because RIG has earnings soon. Plus, by selling an additional Put, they can pick up some more credit, and cut their short delta by 1/3rd. They still want the price of RIG to fall between their short strikes, which is why they don’t entirely neutralize their delta to be zero. This is called underhedging.

    With these adjustments and a lot of capital on the sideline, Tony wants Katie to get some long delta by selling a Put in IBM, as it has high Implied Volatility Rank and sideways price action. While it takes $2400 in BP, it's not worth it to buy a far OTM Put to define the BP because either enough credit can't be collected or the Put purchase doesn't reduce the BP enough.

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