Delta Adjustment for Monthly Income Portfolio

Market started to roll over in the last week or so. Today market dropped with increased volume again. With about 20 days to expiration, I felt it's time to make the initial adjustment as the price approaching the left edge of smooth profit curve, even if I have not started adjusting this early before.

After the double calendar adjustment, the P&L curve looks skewed to the left side, reflecting my slightly bearish posture. It reduced the portfolio delta by 10 points.

The market drop offerred the portfolio an opportunity to gain more profit after the adjustment, if it works out. The portfolio had reached 10% ROR on an intra-day basis before it dropped to current small profit.

Rolling down of IYR Diagonal Spread

As market weakens, IYR fell quickly. Since general market started rolling down for a few days only, there is some potential for it to go down further. Rolled Oct$66c to Oct$64c(delta=0.56) with a credit of $0.92. The new short delta overall is 0.37. This reflects my short term bearish posture.

---

Created with ProphetCharts®

Profit & Loss Targets of the monthly income portfolio

What are suitable monthly P&L targets for a theta-positive option portfolio that are generally delta neutral? For the smooth option portfolio, the monthly profit target is 10% of maximum risk traded: ROR = 10%, with the average profit of 7.5%. The monthly loss target is limited to 10% to 15% with an average of 10.25%.

The smooth portfolio usually has expiration probability of 25% in either side and potential max ROR of 35% to 40% for its high probability trades. With planned adjustments, the expected win for each year is 9 months and loss is 3 months. So yearly profit on risk is 9x7.5 - 3x10.25 = 36.75%.

Note the annual ROR of 36.75% is based on risks only, not a portfolio return. The portfolio return should be 36.75% times the percentage of risks allocated for each months. If the risk allocated is 30% monthly, then the portfolio annual return rate can be around 11% only.

To have better annual return, the monthly loss target should be reduced and losing months should be reduced as well.

At each month, the market volatility is different. After the initial build-up of the portfolio, the expiration profit may be lower if the IV is lower in an up trending market and potential loss may be higher. The targeted profit (at which the positions should be closed) should then be lower as well. It should be 30% or a little higher of the possible expiration profit. If the expiration potential max ROR is 35%, then the targeted ROR is around 35x30 = 10%. If the potential max ROR is lower than 35% due to lower IV or lack of days to expiration date, then the trade does not meet the expectation any more.

Option Greeks and Stock Prices

The option Greeks indicate current P&L potential of the option portfolio. But identical Greek values may have significantly different impacts on the P&L potentials of portfolios. It depends on the prices of the stocks/indices present in the portfolio. Let's take a look at a SPY and SPX beta-weighted portfolio as an example in part 2 of this series of posts.

Due to the following factors:

• SPX is roughly 10x SPY,
• Delta of one stock is always less than 1 regardless of stock prices
• Gamma is the rate of Delta change per unit price of stock
• Theta is time decay in dollars per day
• Vega is option price change per implied volatility point change

we have the following relationships for SPY/SPX beta-weighted portfolios:

• SPX delta    = SPY delta / 10
• SPX gamma = SPY gamma / 10
• SPX theta    = SPY theta x 10
• SPX vega    = SPY vega x 10

Let's say SPX beta-weighted portfolio has delta of 100, then the equivalent SPY portfolio delta is 1000. If the SPX gamma is 10, the equivalent SPY gamma is 100. If the SPX theta is 40, the equivalent SPY theta is 4 (SPX portfolios offer more theta). If the SPX vega is 150, then the equivalent SPY vega is 15 even if there are similar volatilities between SPX and SPY.

Finally, there is one less trading day for SPX than that of SPY.

Rolling down IYR for diagonal call spread

As delta of IYR Oct$68c dropped to 0.9, it is rolled down to Oct$66c of delta 0.4. The delta of Oct$67 is 0.2.

---

Created with ProphetCharts®

Overview of Option Greeks for Smooth Portfolio

Option greeks are major metrics used to measure potential risk and rewards for smooth option portfolio which is based on high probability trades. What are the proper greek values for this type of portfolio? To answer this question, I'd like to describe the reasoning in a series of posts:

1. Option Greeks vs Stock Prices
2. Portfolio Profit and Loss Targets
3. Application of option portfolio greeks
4. Greek metric and Expiration P&L Curve

October Monthly Income Option Portfolio

After daily built-up in the last 4 days, the monthly portfolio has been established. The top right side of the profit curve is sloping due to today's entry into the RUT double calendar. With the market drop today, the new RUT DC position was selected to be delta negative slightly to neutralized the delta of existing positions. Otherwise, a smoother profit curve could be obtained. Should the market resumes higher, an adjustment on the RUT on the upside may be executed.

Bid/Ask Prices for RUT Butterfly

One day before RUT expires, I closed my RUT Butterfly spread for a break-even trade.

It was added as an adjustment to the smooth portfolio. At the time, I placed a limit order that was $0.05 above mid price and it was filled within 10 minutes, as market was fluctuating a little bit. Today, the bid/ask prices to sell the butterfly was wide. The bid was around -$1.10. Yes, it's a negative sign here. The ask was around $4 and mid was $1.20 to $1.70 for a while. My limit order of $1.65 was filled in about half an hour as RUT dipped temporarily.

FED's QE3 crippled smooth profit curve: $SPX

OOCH, the smooth portfolio was severly damaged by the recent surges in market. SPX jumped 60 points in about a week.

The portfolio had about 10% profit about about 1 week ago and it showed a minor loss after the 9-6 big rise, then the QE3 annoucement day rise crushed the protfolio. This is the life of the smooth profit. Exited all positions with losses except the unbalanced butterfly in RUT.

In the last couple of days, Delta increased from 40 to 130 and Theta decreased from 170 to 30. Vega had major increase as well. The gamma had been suspiciously low at around 1.

Have to restart another trading month.

---

Created with ProphetCharts®

Roll out of IYR for bull call diagonal spread

IYR creeped up to the point where Sept$66c has delta=0.65. Roll out to Oct$67c(D=0.4) and $68c(D=0.22) for a combined Delta of 0.31.

---

Created with ProphetCharts®

Closure of SPY Bull Call Diagonal Spread

After the entry on 7-18, the long call has its delta increased to 0.85 area in about 7 weeks. My past experiences suggested that this is a time (within a couple of weeks) for a potential pull-back. So I closed this position to take the profit.

I plan to have another bull call diagonal spread later in November/December when the market seasonality favors bulls and if market is in an uptrend.

---

Created with ProphetCharts®

Blog Introduciton

As a busy engineer at silicon valley, I use investment and trading strategies that take about 15 minutes during each working day on average. Currently, I use a few investment and trading approaches. I plan to use this blog as a journal to track my progress and to analyze my trades.

The long term investment vehicles are mutual funds and LEAPS options with diagonal spreads on ETF's that are perceived to have a long term uptrend.

• Fidelity New Market Income Fund
• Permanent Fund
• IYR
• GLD

The near term trading vehicles are broad market indices or ETF's. The trading strategies involve smooth profit curve option trades for each month.

Update: After reading and getting inspired by many other great trader blogs, I'd like to share my trading process in this blog with others and invite traders using similar strategies to provide feed-backs as well. I can be contacted at smoothprofitoptions at hotmail dot com.