Theta > Delta

Below are my 4 SPX trade fills from today’s trading. I was bearish and expecting price to move lower but price is already very oversold so I didn’t want to take a large amount of Delta (directional) risk. Look at the fills and then keep reading to see what the risk profiles looked like and why it’s better to convert Deltas into Theta when the market offers that opportunity!

Below is the risk profile of the 40-lot May27/31 SPX 3910/3900 Put Diagonal spread. That’s a reasonably large size position with $22,000 of upside risk. However, if you’ve read anything else that I’ve written in the blog you’ll know that I’ll likely find ways to reduce that risk and probably in a short period of time. It’s important to note that even though the upside dollar risk is substantial the Delta risk is less than -60 Deltas. That’s not a lot for a position of this size and the trade is starting off with a large potential amount of Theta.

In fact, as the /ES (SPX futures) chart was looking more bearish as the morning trading progressed I decided I actually wanted more short SPX Deltas to be able to profit from a drop in price. Here was my tweet making that very point.

Below is the risk profile after I bought a 5-lot of the May31 SPX 3910 Puts for $67.50. That took my Delta risk to around -200. That would increase my profit if SPX moved lower. This was a temporary position! I would not carry it overnight without hedging it. This trade was based on what I anticipated (based on the hourly chart) would be an immediate (within the next hour or so) move lower. If that move lower didn’t materialize then I would sell those Puts. If SPX did drop prior to today’s close I would sell a 5-lot of the May27 SPX 3900 Puts, hopefully at a price greater than the $67.50 that I paid for the 3910 Puts.

SPX did move lower and so I was able to sell a 5-lot the May27 SPX 3900 Puts for $70.50 or $3.00 more than I purchased the May31 SPX 3910 Puts for. That means I own a 5-lot May31/May27 SPX 3910/3900 Put Diagonal spread for a $3.00 ($1,500) Credit. The 45-lot of Put Diagonals now has a lower cost basis than the 40-lot did. I’m moving in the right direction!

Below is the risk profile showing today’s trades. I’ve reduced my upside risk by about 10% and increased the potential Theta substantially. I’ve also reduced the position’s Delta risk by almost 70% and when I want to further reduce my portfolio’s Delta risk (I have other positions than this one) I’ll simply use longer dated SPX Calls to flatten the Deltas even more or even turn the portfolio long Deltas.

One final note: the reason I selected the 3900 short strike is because of the daily chart below. See if you can figure out the significance of SPX 3900 before reading the note on the chart. It’s important to understand that doesn’t mean it’ll be a quick move down if SPX moves down at all. Price could easily retest last year’s 4235 HB again or much higher of course. Price does what it does! That’s is why I selected May27 as the expiry on the Diagonals. Price can flop around all month for all I care as long as it makes it way lower over that time! In the meantime I’m ready to hedge my Deltas whenever the chart warrants a bullish bias.