Sunday, December 9, 2012

How portfolio Greek changes within last 2 weeks of expiration

After a series of adjustments to my December high probability option trade portfolio, its P&L chart does not look really smooth anymore. The red expiration curve shows more profits if price goes higher by 10 or more SPX points while the portfolio delta is -26 which indicates more profits if price goes lower.  So I studied its Greeks verse time and prices using the ThinkOrSwim Analyzer.

First, let's take a look at how Delta changes as days get closer to expiration and prices fluctuates . After analyzing the delta changes in time, I found my delta would continue to go more negative in the next few days and it would start to increase only in the last 7 days to expiration as shown in the image below. The daily delta changes would be smaller if price increases to 1423 vicinity. I think it is most likely caused by the butterfly spreads that the portfolio has.
Secondly, let's review the daily changes of portfolio Theta. It's likely to change $10 to $20 each day next week at the current price range. However, if price goes a little over $10 which correlates to the top spot of the portfolio P&L curve, the Theta decay will be maximal for this portfolio. Theta decay will be smaller outside the indicated range in the following image.
Thirdly, the portfolio Vega is small (16) right now and it will double or triple in the next week even if price does not change. This is because the volatility will make up most of the time value in the last few days of expiration while Theta diminishes. The Vega will also shot up if price drop by 15 points.
Forth and lastly, let's see how profit and loss changes in the next 2 weeks. The following P&L chart shows profit will double 8 days later if price remain the same. If SPX price drops a bit, the profit will also increase. I believe the profit curve will have its top shifting to the 1430 area in the last 4 to 1 days of expiration to match the original expiration curve.
There are probably a number of conclusions that can be drawn from this type of Greek analysis and be incorporated in option trading rules. At the moment, I'm particularly interested in the daily Theta decay and Vega enrichment in the last 2 weeks before expiration. These two components are the time value of OTM options. For a market neutral portfolio comprising of many iron condors, the decrease of time values in the last 2 weeks will not be as dramatic as one would typically expect as long as the short strikes are still out-of-money.  It's an evidence supporting early IC exit (about 2+ weeks before expiration).  There is probably no significant loss of time decay if one starts IC 2 month ahead. Further study will be done to check it out.

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