Thursday Shopping List

Doing the same, but a little different.

It is the first Friday of May, and we wonder where the year has gone. In a few weeks, it will be summer, and the American elections will follow shortly after.

Time flies, and the markets change. That is the only constant of the trading experience.

We noticed on Tuesday that intraday realized volatility was rising, and yesterday's FOMC meeting accentuated that trend. Yet, despite all the recent tribulations, the VIX is stuck at a normal level.

However, keep in mind while there is a correlation between implied volatility and stock movement, it is not causation. A low VIX doesn't mean we can't be in a stock downtrend period, and vice versa. Yet, we tend to favor significant movements in the VIX before looking at things more cautiously: trade the regime you are in, not the one you may eventually be in.

And at VIX 15, the market isn't concerned about the next 30 days despite the recent agitations. Now, can the same be said about the short term? Looking at the 1-DTE straddle prices for SPY, we can see that they are rising and account for the recent short-term moves.

The spread between the 1-DTE prices and the VIX reading is compressed.

We are still far from the crazy swings observed in 2022 when the combination of the rate cycle and the war in Ukraine brought some real uncertainty to the market. However, this is interesting enough to be noted: things have changed since Q1 this year, and we shouldn't expect them to return to March 2023 levels anytime soon, or at least until we have a clear reason to think they did.

This won’t keep us away from the little fun we have on Thursdays. It just means we need to adapt and do things a little differently.

Let's get to it.

The rules

Tomorrow is NFP day, and with the current rise in realized volatility, we will change the execution slightly. Instead of holding the trade throughout most of Friday, we will favor an exit much closer to the open.

Why is that? Well, trading is, first and foremost, about managing risk, and higher intraday realized volatility means more risk in the marketplace. Things are moving, and the longer you stay in the market, the longer you are exposed to last-minute mood changes.

The NFP overnight effect is pronounced enough for us to be rewarded for the risk taken while staying away from the intraday agitation.

Let’s do a quick round-up about the rules.

• Short an ATM straddle in the 1DTE contract 03/05 as close as possible to the close on Thursday night. In all our metrics and charts, we assumed an execution at 3.50 pm, but the entry timing doesn’t matter too much: avoid getting in too early, but getting in too late gets you less premium.

• Exit the position as close as possible to the open on Fridays. Again, we assume an execution at 9:35 p.m.. Still, depending on your risk tolerance and satisfaction with the returns, it can be useful to manage the position a little later—not too long, either. Remember … the longer you are in, the riskier things become.

• One word of caution: leave the trade and eliminate the underlying if you get assigned overnight. If you decide to keep it and “sell premium against it,” it is at your discretion and outside this strategy's scope.

One last thing—we still have a few spots left in our Discord community, where we monitor this strategy, and many others mentioned in this newsletter. Contact us if interested, and we will share the pricing details.