Considering Our Options – Short and Neutral to Long: $XRT, $CSCO

by CC August 27, 2015 1:35 pm • Commentary

We have a couple of in-the-money butterflies that moved out of their established range on this bout of selling. I wanted to go over them and see what the plan is for them now. The first trade to go over is the Retail ETF XRT. Here was the original trade and the rationale:

XRT ($97.18) Buy Sept 100 / 95 / 90 Put Fly for 1.75

Rationale: XRT is showing signs of waning momentum with $95 an obvious level to return to if it can’t break the downtrend. This trade targets that area while beginning in the money and therefore not susceptible to decay. If the index does indeed break above its downtrend on a broader market rally, we’ll look to take the trade off defensively.

The index did indeed break but like most trading this week it was impossible to do anything defensively. The trade quickly turned from an in the money bearish position to an out of the money bullish one (the same thing happened in GOOGL but we were able to get out for a small profit on a bounce back). And the rally in the broader markets past 2 days gives us a chance to be even more patient on this one.  Now with the ETF back to 93.75 it’s just 1.25 from our sweet spot. Currently it’s worth about 1.85. The reason it’s not worth more is because implied vol spike so much:

[caption id="attachment_56465" align="aligncenter" width="679"]Screen Shot 2015-08-27 at 11.12.26 AM XRT 6 month IV30 from LiveVol Pro[/caption]

But vol is coming in a bit and this trade is currently worth 3.75 intrinsically (at 93.75) so that means there’s some wiggle room for us to be patient. But as we’ve seen, things can go south quickly and our patience on this will only last until the next turn red in the markets as we never intended this trade to be long deltas and bearish. (it’s currently long about 15 deltas).

The next trade to look at is CSCO. This is one that got away from us when the market tanked and in hindsight we should have closed it for a small loss when we had the chance. Here was the trade and rationale:

Trade – CSCO ($29) Buy the September 31/29/27 put fly for .85

Rationale – CSCO stock hasn’t shown any indication of being able to breakout to new highs and it seems to have found buyers on better than expected earnings which makes it unlikely that any significant breakdown happens without a broader market correction. This trade plays for continued sideways action with a breakeven on the upside near recent highs and one on the downside near recent lows. The trade is short vega with vol at about 20 in September. 20 is typically where implied vol is right after earnings but it also tends to go down a few more points in the days after with lows closer to 16. If that happened again that would be positive for the trade. On the defensive management side of this trade we’d likely close it for a loss if the stock made moves outside of that range.

The key point in that rationale was “without a broader market correction”. And again, we said we’d be sell it defensively if it got out of the range. We had a chance when it threatened the bottom of the range to get out for a smaller loss but then the big swoosh came and then it turned into a bit of a lottery ticket. What this has basically become is a synthetic 27 call. Let me explain.

The 29 and 31 lines are 100 deltas, the long 31 put and 1 of the short 29 puts cancel each other out. That leaves 1 short 29 put at 100 deltas (which is a synthetic short stock position) vs 1 long 27 put (which is 75 deltas or so) That short stock vs a long put equals a synthetic long 27 call at around 25 deltas. (Technically it’s an ITM short put spread with a max gain at 29 which ain’t gonna happen, so essentially it’s a long call on the 27 line)

So we need this back above 27 to be able to get out for anything close to even. If it does make a run at 27 we’ll be quick to pull the plug for what we can get.