Thursday, December 27, 2012

Selling more premiums for Feb high probability portfolio

Market dropped in the last couple of days with higher volumes and the current intermediate uptrend is in danger. With volatility shooting up, I sold more premiums via February RUT and SPX iron condors with about 50 days to expiration.

Since market can drop rapidly and usually rise at a slower pace, I selected short strike prices in the following way: the short put strike had a delta around -20 as analyzed before and the short call strike had a delta around +24. This slight change in my strike selection rule is partially inspired by Karen's interview, and partially intended to reduce the effect of Vega of the high probability portfolio.

Using the above rule, I sold a RUT iron condor yesterday as shown in the graph below. IC's always have negative Vega, which favors reduction of volatility (market to rise). So the small negative delta of the position can neutralize the effect of Vega somewhat, making the position more market neutral.
Today, I also sold another SPX iron condor. My current portfolio has a Beta-weighted delta of -7, accommodating some down side market movements. The graph below recorded my current positions on RUT & SPX. I plan to complete my Feb portfolio tomorrow by adding another RUT time-decaying position.
To calculate how much Delta is needed to offset the Vega to obtain a market neutral portfolio, I used ATR to correlate Delta and Vega of SPX in the following way. Currently, SPX has ATR(30) of 14.3 and VIX has ATR(30) of 1.2. If the weighted SPX Delta x ATR is in the same range of VIX ATR x Vega, then the portfolio is about neutral. Thus, the Vega should be around 10 times of Delta to maintain the neutrality.

As an example, my Feb RUT IC has Vega of -47 and Delta of -5.3 is in the above range, making it perfectly market neutral. My 1st Feb SPX did not opened in this way while the 2nd SPX IC did. In the future, I will follow this rule when I intend to build market neutral portfolio in sideways market.

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