The morning of Friday, January 21, I was examining my portfolio. I had a RUT FEB/MAR double calendar that was fairly delta neutral, which means that it wasn't going to react too much to a short-range change in price. It was a positive-vega trade, by 107.15 vegas. For those unaccustomed to looking at the Greeks of option pricing, vega refers to how the trade changes with respect to a change in implied volatilities of the options. I had also begun a 15-contract SPX iron condor, but I had been filled on only 8 of the put credit spreads rather than the full 15. Still, that trade was a negative-vega one, at -190.11 vegas. It was a negative-delta trade, then by -13.00 deltas.
I would add up all the Greeks for the various positions to get the portfolio's Greeks. All in all, my portfolio was rather neutral with regard to price-related risks, with a portfolio delta of -5.26, and a portfolio vega of -83.07. I was considering whether to hold my nose and put on the remaining seven SPX put credit spreads wherever I could get them, but I ended up holding off. Why?
Lots of reasons. I'm chicken, and it was a Friday. I worried about the weekend risk. In addition, with the SPX steadying, the market makers had already started rolling volatilities back, as they typically do on quiet Fridays, and I couldn't get decent premium for the additional risk. I typically sell the first put strike that has an absolute value on its delta under 9.00 (or 0.09, depending on the quote source). That would have been the MAR 1130 on that day. I then buy the put 10 points lower, which would have been the MAR 1120. I typically collect about $0.60-0.70 for that credit spread, put on during that time period before expiration at those deltas.
The mark or mid-price for that spread was only $0.45! And this was 56 days until expiration. Not only that, but I wasn't likely to get that much credit, either, as I'd been trying for days to get into put spreads for a credit of about a nickel under the mark. There was a reason I was only in 8 of the put spreads. Market makers weren't interested. I'm not taking on $7,000 in additional downside risk for 56 days for $0.35 or $0.40, or $245 or $280, minus commissions. I'm just not going to do it in this climate in which we get volatile moves. When the VIX had been hovering around reversal levels and the indices had been climbing relentlessly, neither was I going to move up a few strikes so that I could get decent credit.
I'm not a doom-and-gloom person, but I wanted decent value for the risks I would be taking. Moreover, selling those spreads was going to change the Greeks of my portfolio in a way I didn't like. This is really what I wanted to discuss in this article. I wanted to the portfolio to keep an overall negative delta. Adding those spreads would have completely flattened my delta. If the portfolio was delta neutral, the portfolio would not have been helped nor hindered by a price movement over a short price movement. That sounds like a good thing in some circumstances, and it was certainly an okay thing, but it wouldn't have made me sleep any better over that weekend.
Why? Adding those spreads would also have added more negative vegas to the portfolio. That meant that I was going to be hurt by anything that hiked implied volatilities. (Note: In truth, we won't get a global hike in volatilities, typically, but this is the best easy measure we have of how volatility changes will impact our trades.)
Such a hike in volatilities usually occurs when prices dive lower. If my portfolio is going to be hurt by a rise in volatility, usually produced by a dive in prices, I wanted it to be positioned a little negative delta. I wanted to benefit from price movement from that Greek if I was likely going to be hurt by the changes in volatility if prices dropped. Knowing what we know about what happened to the markets just one week later, on Friday, January 28, 2011, I perhaps look prescient, but I roughed out this article a week earlier, and the precepts I'm talking about are ones I always examine. If I'm leaning to the negative side on vegas, I also want to lean a little negative on my deltas, and vice versa.
On January 21, the portfolio was fairly neutral anyway, and I probably would have gone ahead with the rest of the put spreads if I'd been able to collect decent credit for them. However, that low credit was the tipping point in this case. Normally, I have much bigger iron condor positions, at least 25 contracts if not double that, so the portfolio is normally much more negative vega. It's usually more important that I keep a slightly negative delta status for the portfolio, even in an up market, and especially when I fear that the uptrend might be getting a bit overdone. Again, I'm not a gloom-and-doom person, but I do look at probabilities. I do have experience with how quickly downdrafts can take prices lower. With the VIX dropping into a level from which it often reverses and with a long-extended rally, probabilities leaned toward the possibility of a drop sometime before all those options expired.
It may be a good thing to have an overall slightly negative delta bias in your portfolio if the portfolio is also negative vega. This would occur if you're mostly trading iron condors, butterflies or other such strategies. What's a "slightly" negative delta bias? That would depend on the size of one's positions and the underlying. It wouldn't be the same for someone trading 5 contracts of SPY butterflies and someone trading 250 contracts of RUT iron condors.
If prices move up, volatilities typically ease unless the move is an abrupt one, such as a gap higher and violent short-covering rally that takes no prisoners. The negative-delta, negative-vega portfolio typically benefits from the drop in volatility, offsetting some or all of the harm due to the negative delta basis. For example, unless the SPX is moving too close to my sold calls on the call spreads, my iron condors usually benefit from a gentle rally, even if they're leaning negative deltas.
If I were mostly trading debit spreads, calendars, or long calls and puts, I would have a long vega portfolio, so I wouldn't necessarily want to be leaning toward a negative delta. However, that's not the way my portfolio usually leans. This is not an indication that I'm employing a directional bias. I'm not. I'm in fact trying to set up the portfolio in as wise a manner as I can while not employing a bias. I just don't want a downturn to hit my portfolio in two ways rather than one.
Good thing, huh? I don't know what Monday will bring, but my portfolio benefited from Friday's move. Theoretically. We all know that what we see on a profit/loss or analysis chart may not represent executable trade prices, but my hesitancy to move toward a positive delta/negative vega portfolio status and my determination to keep it a negative delta one if it was going to be negative vegas certainly made for a more comfortable day on Friday, January 28.