Life is filled with uncertainty - it's for this reason that the ability to adjust to unforeseen circumstances is such a key life skill.
Financial markets are also ever changing, which is a reason that traders have to be especially nimble of mind. The recent referendum in Britain is a great example of this job requirement.
Prior to the referendum, early polling suggested that the majority of Brits would vote to "remain" in the European Union. Markets were therefore "surprised" on June 24th when they voted to walk.
For those net short premium, this was likely a difficult day. However, if you were net short deltas against your portfolio, you may have been slightly insulated from the pain. Staying short deltas against a portfolio of short premium is a structure we've highlighted in the past on the tastytrade blog.
While any moves made in the wake of “Brexit” will of course be dependent on the specific strategy you employ, it's entirely possible that the downturn in the markets (and associated spike in volatility) may have offered a chance to sell additional premium.
No matter how you responded to the "Brexit" news, a recent episode of Best Practices called "The Art of Adjusting" may be right up your alley. Knowing when and how to adjust one's portfolio is partially an art form, but there’s certainly aspects of the skill that can be learned and improved.
After the Brexit results were announced, the VIX spiked over 20% on the first day of trading. But since that time, the VIX dropped 7% on Day 2 and 21% on Day 3. It now sits just below 19, which is right around its historical average.
While the world is facing a lot of uncertainty going forward, we do know that referendum results (at least out of Britain) won’t be released again any time soon. The event has passed. And in terms of uncertainty, that’s not exactly anything new.
It’s for this reason that volatility traders typically rely on statistics to govern their trading approach, as opposed to emotion. And historical analysis tells us that short premium trades have a higher probability of success over the long run.
On the Best Practices referenced earlier, hosts Tom Sosnoff and Tony Battista outline some ways that traders can manage positions when volatility gets elevated. Because "defined risk" trades have a known maximum loss, the guys focus more on "undefined risk" positions.
Four main strategies are discussed on the show that can be utilized when facing adverse market conditions in one or more positions:
Extending duration (rolling into a new expiration month) for trades that are tested, especially if the underlying assumption of the position remains the same
Adjusting the strike(s) of a position by rolling closer to at-the-money (ATM) in the same expiration month
Hedging the position's delta if the underlying has pushed your net risk too far in one direction
Closing the position outright
For the best possible understanding of the approaches outlined above we suggest you watch the entire episode devoted to this topic.
There’s no official rulebook on the management of positions. This skill is refined over time through experience and effort. While the Brexit may have produced some uncomfortable moments, it may also have imparted some valuable lessons. Knowledge that could translate to real dollars during the next instance of increased volatility.
We’ll be following up with a more comprehensive piece on portfolio management in the near future.
In the meantime, if you have any questions related to “the art of adjusting” we hope you'll follow up at email@example.com.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.