Option Portfolio Theta time decay over weekends

Last Monday, my portfolio exhibited a relatively bigger profit change than what I expected as described in my previous post. It generated my interests in understanding how my portfolio P&L could change over weekends and holidays. After some studying, I'd like to summarize my initial findings here.

• At the portfolio level, the P&L changes with regard to SPX price changes may be larger if the non-SPX positions make bigger changes than normal (Beta), since the portfolio P&L used Beta-weighted Greeks. The Beta is an average calculated over a long time (1 year for TOS?)
• Weekend Theta decay starts around Friday, depending on the market condition at the time and on the market makers.
• Weekend Theta decay on Fridays does not show up in our Theta fields of the trading software, since our SW calculates Theta daily.
• Weekend Theta decay on Friday shows up in our option volatility reducing as the time value decreasing causes option price decreasing. This is the only way (?) we know if market markers have started weekend Theta time decay (if the true market IV does not change much).

To understand how the portfolio Theta changes with volatility, I used the TOS analyzer to see Theta increases as IV decreases as shown below. Beyond the BE zone, the Theta and IV relationship is probably meaningless since the option strikes are too far OTM to have meaningful Greeks.

Since Theta and IV move in the opposite direction, it would make sense for market makers to hold off the Theta time decay over the weekends that major events are expected to happen. In this way, market maker's manipulation of option prices is supported by both the Vega and Theta at the time of high volatility.

Completed May high probability option portfolio

With 50 days to May expiration, I completed selling option premiums for May portfolio today. This time, I sold my last opening RUT trades differently with some adjustments to the current May positions by adding some  positive Deltas. If I had used another RUX iron condor (usually of Delta -6) as I did last month, I would have a portfolio Delta of -24. Since my market outlook is not bearish yet, I'd like to have a smaller negative Delta.

Thus, I sold a May RUT IC with a wing of $10 wide only. The short strikes were selected around Delta -25 and +21 in order to have less negative Delta. Additionally, I also sold 2 bull put spreads ($10 wide) on RUT to get the positive Delta.

After these trades, the May portfolio has its Delta reduced to -19 and I used $1000 more margin than usual. I noticed that the above combination of IC and bull put spreads generated a little less Theta than what I would have received using my regular IC. Since the trades adjusted portfolio Delta as desired, I was OK with the smaller Theta.

The new trades today also raised the lower break even points. I think I can use calendar adjustments if market starts to turn down.

Exited all April high probability positions to open May option inventory

I'd been looking for opportunities to exit April positions last week, as I preferred to use options with about 30 days to expiration for smooth portfolio P & L changes. But the portfolio of Delta -25 & Vega +300 showed some losses (reduced from initial $600+ to $300) last week, as the market was moving sideways.

However, the portfolio P&L changed quickly yesterday AM, as market was pulling down less than 10 points. It was a surprise to me that the P&L switched from -$350 to +$350 when I started reviewing my portfolio around 11:00AM EDT. I had seen SPX dropping 10 points last week, but the portfolio did not act this much.

I was wondering what happened at the time (Monday morning). I guessed the volatility was higher at the moment, which caused my Vega positive portfolio to increase value. Additionally, there were two weedend days of Theta decay which could be $200 as Theta was around 100. I thought market makers started weekend time decay on Thursday PM usually. But it seems that not always true, particularly if market is expecting some important events, such as European issues. Although Delta dropped to -12 from over -25, Gamma also increased to around 2.0+ which meant a 10 point movement of SPX would cause 20 point change in Delta.

Anyway, I'm glad I did close all of my trades which were for April yesterday. It took about one hour to exit all of them. As I was closing trades one by one, the market stopped bleeding and started bouncing up. So I believe I did not get the $350 profit, as I closed the calendars which made good profits for the day first. When I started to close the IC's, their daily profit started to dwindle. In the end, I might be just flat for April. I should know the exact numbers in my quarterly review.

Overall, I felt OK for this month to be flat. The last calendar adjustment worked great and market finally respected statistics in the last week by resting somewhat. Its IV went up since I bought the calendars.

I opened an SPX & RUT iron condor respectively, immediately after the exits yesterday. Today I opened another SPX IC with short Deltas around +25 & -21. The current P&L chart is shown below. I plan to enter the last RUT position tomorrow to complete my opening May portfolio with 50 days to expiration.

Selecting single wing strike price distances for iron condors

When selling option premium with iron condor spreads, it's usually true that the wider the distance of strike prices of either wing (one side of the spread), the lower the return on margin, if the sold option strike is fixed. It's understandable since wider strike distance of a single wind means wider break-even points, or high probability of success.

If we want to use a similar amount of margin for IC spreads, we face a selection of  wider single wing strikes like $20 apart or narrower strikes like $5 for $SPX/$RUT iron condors. With narrower single wing strikes, we need to sell more contracts to reach the same level of margin.

I guess the answer depends, mainly, on whether we need wider break-even points or not. The commission costs and transaction costs are less important in making the decision here usually. If we sell far OTM iron condors with 80% or better probability of success, and our adjustment strategy involves closing (or rolling) the IC once the position has certain degree of damage, we could probably choose narrower single wing strikes ($5) for higher ROM.

On the other hand, if the short strike of the IC is sold less OTM as in the above case, the success probability will be lower. So, we may create a little bit more wiggle room with a wider single wing strike distance ($20). Additionally, if we'd like to hedge against damaging IC positions without closing (some times called rolling) the wings, it would worth having larger BE points with less ROM. This is what I usually do. One of my current SPX April IC has a short $1555 call with a upper BE around $1561. It's damaged modestly as $SPX is at $1557 and hedged by some calendars right now. The damage would be bigger if I used narrower single wing strikes with higher ROM.

Super trader Karen's portfolio margin

Although I don't emulate to trade Karen's strategy at the moment, some reader's comments were interesting. One comment about the Return on Margin (ROM) reminded me of the portfolio margin. Newly available from 2007, the portfolio margin gives traders more flexibility to trade bigger sizes compared with old margin requirements based on "Reg-T". TOS is one of the brokers that support portfolio margin.

For SPX/SPY, the portfolio margin fits into the following category: Large cap broad-based indices are tested with a minimum +6%/-10% price changes. Using this criteria, the Karen strangle shown below would have a portfolio margin of $3838 vs Reg-T margin of $25,283. What a difference! It bumps up the ROM dramatically, even if the minimum price changes are set as 10% to upside and -15% to the downside.

Portfolio margin is available for margin accounts (not IRA) of $125K and above only. A broker can increase its own portfolio margin requirements based on a number of criteria. I believe Karen had complained about a sudden (No advanced Notification) margin requirement change by TOS which resulted her largest loss ever. This margin requirement change she mentioned was very likely to be related to portfolio margin "minimum" stress test I believe.

Without the PM, the naked call determines the margin ($25K) for this type of strangle. The naked put has much less margin requirement ($13.5K).

Hedging adjustments to April high probability option portfolio

SPX finally broke above 1555 level after a couple of tests. Market rise reached top band of Bollinger and Dow Jones Average has advanced for 10 consecutive days. A short term pullback is imminent. But my market neutral portfolio had a delta about -39 and price fell into the right slope of the P&L chart as shown below.

Both the SPX and RUT got into their coresponding adjustment zone. Since $VIX was at  low level of 11.60, I think it's very likely that VIX will not be much lower than that level in the next week of so. Thus, I chose calendars as adjustment strategy to hedge against possible upside movements. After multiple calendar adjustments, the portfolio delta was trimmed by 10 points approximately. The Vega changed from -130 to +285, a big bet on VIX not going down further for the next 2 weeks before I close the April inventory.

All the orders were filled quickly as expected, since the calendars are one or two months away. I could have used bullish spreads to reduce delta if I had more bullish outlook. Time will tell.

The integration of the successful mind set with the high probability trading rules

A few months ago, I planned to review my integration of the successful mind set of high probability traders into my trading rules. Today, I finally got a chance to work on it. The idea is that if this mind set is incorporated into the trading rules, it's most likely the successful mind set is achieved naturally as a byproduct of the trading rules. I'll review the integration of the following actions with my trading rules one by one today and should probably come back to revisit them in the future to make improvements.

1.  Pre-define risks of every trades
The risks of my trades are controlled by my trade sizes mainly. I trade a predefined contract size of options persistently. So the portfolio risk is always predefined, although it may increase after certain adjustments. I don't assume MAX losses with my spreads since I plan to make adjustments before that. It's a challenge for me to establish a rule to insure for potential black swan event.

2. Completely accept the risk or take action to eliminate non-tolerant risk

For high probability option selling portfolio, it's crucial to ensure comfort-ability with the risks of the portfolio and corresponding adjustment trades. It's one of my trading rule that if the predefined risk is violated, the extra positions should be closed.

3. Objectively identify trading opportunities

My trading rules specify when to initiate/exit monthly trades, and when to adjust trades. I also trade indexes mainly. As long as these rules are clear, there  is no issue of missing opportunities.

4. Execute trading rules for each opportunity without reservation and hesitation

Since I have detailed rules for opening positions, I can easily open positions without any issue. The challenge is in the adjustment side. As long as my criteria to start adjustment is clear, this should be OK in general.

5. Reward ourselves as market gives a win for us

Need to encourage ourselves for successful establishment and execution of trading rules. I think it helps to nurture winning altitude as well. No plan to take profits away from trading account at this time.

6. Keep monitor trading processes and susceptibility for making errors 

Will work on trading process to establish an enabling trading environment. I have created a trading procedure to validate every trade. Some times, it's easy to make adjustment trade errors. So there is a need to follow the validation rule to minimize trading errors.

April option selling portfolio adjustment

As market turned into bullish again, my April income portfolio showed a Delta of -38. The RUT double calendar position had its price in the right slope area as shown below. So an adjustment is necessary.

I decided to close the DC which contributed no gain or loss except transaction costs, in order to improve portfolio Delta. It also restored the portfolio Vega for bullish market outlook. Additionally, I sold April bull put spreads to maintain a reasonable profit potential. I could have sold IC's for more credits, but they would generate much less Delta that the portfolio needed.

After these adjustments, the new portfolio has a Delta of -19 (a reduction by 20) and Vega of -218 (equivalent to a Delta of +20 approximately). If SPX increases another $15, I might have to do some adjustments again.

Bullish diagonal spread on QQQ

I had exited all bullish trading positions a couple of weeks ago. Since then, the market had a little drop but not to the degree that I was expecting. In the last couple of days, market seemed to start low and close high with lower volumes. Today, the Market appears to shot higher with solidly higher volume. So I think market is back to bullish outlook at the moment.

QQQ meets my bullish entry criteria as it broke out in the morning. So I decided to long QQQ for July$66c/April$70c bullish diagonal spread. This was a laggard in the last market rise. My guess is that it may catch up in the new rise. Other index (i.e. SPY) has MS over 80, which prevents me from long according to my rules.

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Created with ProphetCharts®

A Simple Review of Margin Requirement and Theta of the Karen-Super-Trader Strangle

There were some discussions on Karen (the Super trader)'s strategy about its ROM & Theta decay on average. To answer a reader's question, I spent a little time to analyze a regular strangle on TOS. With 47 days to expiration for April, the strange receives a credit of $5.25 as shown in the chart below. Somehow, the probability of expiration ITM shown in the chart is shown close to 20% on the upside. It contradicts the probability indicated at the trade page on TOS.

The Theta is about 70. I think it's close to the average $80 range as another commentator indicated, considering are many more days for Theta decay. I tried to analyze Theta decay in the analyzer but the analyzer chart showed some weird curves that I don't understand. So I have to ignore it for now.

The margin requirement for a margin paper account was real big. With the 10% probability ITM call and 5% probability ITM put strangle, the margin was a little over $24K I believe. So for a $100K margin account, we can sell 2 such SPX strangles with a margin requirement of about $50K. This is the initial capital used for opening positions. If an adjustment is made by selling another option, the margin will be around $75K, reaching the limit mentioned in the original interview. I think if SPY is used, the contract size will be that of the SPX times 10. Thus, SPY will offer more flexibility for capital usage for a $100K account.

In the IRA paper account, the margin field is illegal + 300 shares. I'm not sure what it means though.