Thursday Shopping List

Boring is good.

As we were writing on Sunday, this week's realized volatility is being crushed, and things are awfully quiet. The premium has disappeared from the juiciest corners of the marketplace, and boredom is back in full force among (retail) participants based on tweets and Reddit posts.

We've said it many times, but allow us to insist—boring, unlike greed, is good. Stocks are slowly drifting up, making variance risk premium strategies more likely to work, as implied volatility, despite being low, is still overstating what happens in the underlying.

But boring doesn't mean no risk at all. At Sharpe Two, we do not delta hedge. It is expensive and operationally prone to costly mistakes, to the point that what was initially a good trade can quickly become a nightmare from which we can't wake up. Instead, we keep positions for a fixed period (generally two weeks for the Signal du Jour) or get out when we are close to an average win observed in the recent past.

The downside is that sometimes, we will suffer painful losses when the market decides to enter a trend, leaving no prisoners behind. When you accept that variance is your main source of income, you must also accept being hurt by the variance. Having an edge doesn't mean winning 100% of the time. But who would want that anyway? Wouldn't it become... boring?

Yes, we give you that: we write like a degen gambler would this morning, but it's Thursday, so it is... kind of allowed. Today is the little fun trade of the week, where we bet on the terminal distribution of 1 DTE. The premise is really simple—options tend to be much more overpriced on their last day before expiration than what happens in their respective underlying. Why? Because it is much harder to predict the short term than the long term. We've written a few articles on the topic here and here.

Now, let's get serious again. This trade will not make you rich. But if you don't take it for what it is—a little fun bet we take on Thursdays—it can make you lose some serious coins like any other market position. Therefore, managing risk, particularly your sizing, is as critical as any other trade.

We had a good reminder last week when, despite the natural tendency for the options market to overstate prices on NFP day, the rally after the number was so pronounced that it only resulted in painful losses, alleviated by the long volatility we took in the bonds.

You can't control this thing. However, you can control the human entering the order before it hits the market.

Think about it.

The rules

Before we start, let’s do a quick round-up about the rules.

• Short an ATM straddle in the 1DTE contract 10/05 as close as possible to Thursday night's close. In all our metrics and charts, we assumed an execution at 3.50 p.m., 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 Friday's expiration. Again, we assume an execution at 3:50 p.m., but depending on your risk tolerance and satisfaction with the returns, it can be useful to manage the position earlier.

• One word of caution: if you get assigned, leave the trade altogether and eliminate the underlying. If you decide to keep it and “sell premium against it,” it is at your discretion and outside this strategy's scope. It’s okay to keep the other leg expiring out of the money; there is no reason to pay an extra dime to your broker. Ensure it is far enough from any post-market move — the settlement happens at 4.15 pm, not 4 pm.

One last thing—our Discord community is now burgeoning. You can find a few industry professionals, professional retail traders, and absolute beginners.

Yesterday, an ex-long/short institutional trader who went on to create his fund talked to us about the life of a fund manager. It was very enlightening. What is the link with volatility trading? Fund managers are the happy dogs wagging their tails. Options traders? The tail and nothing else.

We monitor the Thursday Shopping List, the Signal Du Jour, and many others mentioned in this newsletter. It is a great place to hold yourself accountable to key mandatory principles for success. Contact us if interested, and we will share the pricing details.

The list

Let's start by reviewing some of the results from last week.

As we mentioned earlier, we've had better NFP days, and if it wasn't for the slight change in modus operandi, where we decided to go long on bonds and short on equity, it could have been much worse.