If I could summarize the overall theme of this blog in one sentence it would be this: spend most of your time figuring out how you’re going to reduce portfolio risk! I think most traders put on a trade and then stick with it until it either goes bust or the pain of holding it is so great that they exit it (often just before it turns) just to stop that pain. That is not a strategy that will lead to success. When I initiate a trade based on a chart setup, I have a stop plan in place allowing for a relatively small drawdown or I initiate a low probability (relatively cheap) trade where the entry cost is effectively my stop. In other words, the cost of the trade is the exact amount that I’m willing to lose. That is one of the prime benefits of trading cheap spreads! I also have a plan in place to reduce risk by exiting or rolling the position early. I typically don’t wait for a trade to approach expiration to make those adjustments. Reduce risk when you can instead of when the trade forces you to!
The risk profile below shows a SPX short Call Diagonal that was bought on 12/24 and adjusted 3 days later even though there was 14 DTE (days to expiration) remaining.
Below are the fills for buying the 100-lot of Jan10/13 SPX 6090/6100 (10-point wide) short Call Diagonals generating a $1.00 ($10,000) credit and adding a $100,000 margin req.
These are the fills for selling 60 of the 100-lot for a $.30 ($1,800) debit.
That left me with the risk profile that was shown above. Here it is again down below. 👇 Short 40 Deltas and the margin requirement has dropped to $40,000. My open profit is around $6,200 and the maximum profit to the downside is $8,200 so I can only make $2,000 more if SPX continues lower whereas I could lose close to $40,000 if SPX were to explode higher by 4-5% early next week. If you’ve followed markets for awhile you’ll realize the risk of that happening is exceedingly small with no positive catalyst (Fed rate cut, extremely bullish economic news) likely next week. However, a 1-2% move higher is always possible and that could potentially push the open profit into a loss next week. What to do?
My trades are never based on probability and are always based on price action and my chart analysis. Below is the current SPX daily chart. When yesterday’s price approached the 5915-5941 Fib support zone of the rally from the 5832 low to the 6049 high, that was good location to reduce short Deltas by either exiting or reducing a short Delta (bearish) trade or by adding a new long Delta (bullish) trade.
I decided to add 2 long Delta trades. I added 2 new 20-lot Call Calendars to my SPX position. Both were cheap because both are OTM (out-of-the-money). Why not add even cheaper short Diagonals? Short Call Diagonals are initially a short Delta (bearish) position which turn into a bullish position with the passage of time IF SPX doesn’t rally too fast. If I’m expecting price to find support and likely rally from an important Fib support zone now, why would I want to add a short Delta trade there? The answer is I wouldn’t! I typically add an OTM Call Calendar which can later be rolled-up into a short Diagonal for a credit or can be rolled-up into a further OTM Calendar for a credit. Either adjustment trade would generate a credit and reduce my initial cost in the position. Now scroll back up and re-read the first sentence summarizing the most important message in this entire blog. Go ahead…I’ll wait.
Below are the fills for the 2 bullish Call Calendars.
Now see the current risk profile after making those adjustments. The net position is now long Deltas which brought the position into alignment with the chart analysis I discussed above. Adding OTM Call Calendars has now tipped the risk profile up so a rally next week will increase my open profit. In fact, because the Calendars were bought at good location for a long Delta trade (Fib support zone) they have already added another $1,400 to the position’s open profit taking it up to around $7,600. Since I didn’t spend the entire credit from the Short Diagonal I can’t lose all of my open profit even if SPX moves sharply lower next week.
Now, in addition to those Call spreads I’ve started adding Mar21 OTM Put Vertical debit spreads for what I consider to be a huge opportunity trade for a potentially strong move down in the first quarter of 2025. I do not intend on DH’ing (Delta Hedging) those trades and, in fact, I’ll be adding to them over the next few weeks and using Call spreads such as I’ve shown above to hedge those March Put spreads. But this is all I have time for now, I’ll try to update this post later this weekend.
Again…none of this is trading advice! This entire blog is for educational purposes with a goal of causing traders to think outside of the box that most of them are trapped in!
Leave me a comment or question down below.
Thanks for a nice post! Why did you place PUT vertical instead of OTM calendar?
My primary bias on SPX is lower into Mar mopex so an OTM Put Vertical debit spread is the most efficient (cheapest) way to trade that bias. Over the shorter term, I will likely have many trades, both bullish and bearish, that will either hedge or enhance that primary position.