A Trading Strategy to Fight Time Decay Dear Savio, I think we can all agree that this year is quite different than any other year, especially when it comes to volatility. On Wall Street, we measure volatility with an instrument called the CBOE S&P 500 Volatility Index (VIX). It is a real-time market index representing the market’s expectations for volatility over the next 30 days. Some traders will even trade a variety of options and exchange-traded products like the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX). These can be dangerous products to trade but worth watching when it comes to trading options because options are based on volatility. When the market or a specific stock is expecting a large move, like earnings or a correction is coming, volatility will increase, increasing option prices. When the market is not expecting anything big, or earnings are over, we will see a volatility crush. Take a look at this weekly chart of the VIX and you will see that 2019 was a very flat normal baseline year, but in 2020 we had a huge spike in volatility followed by a huge volatility crush. 
When the entire market has a volatility crush for eight straight months, option prices decay rapidly. This is the first pandemic that I have ever traded through, and I will honestly admit, it has been extremely challenging. I was able to help my followers capitalize on the initial market crash, but the volatility crush that has followed it has made it difficult to capture the profits that we normally see on a month to month basis. Dark Pool Trader was specifically designed to capture unusual gains on directional option plays by spotting massive Dark Pool activity on stocks and entering out of the money options. The goal was to gain tremendous momentum on these options when the delta increases due to the stock's rapid price movement. The highest return on investment (ROI) happens when your out-of-the-money (OTM) options become at-the-money (ATM) options. This strategy performed very well last year when the VIX was baselining and not expecting any big movements. This year has been more challenging due to the overall volatility crush that has happened after the initial spike. While we have had some great gains, many of our options have not gained at the speed that we would have liked. The downward movement of the VIX has been putting downward pressure on all of our option prices. Another obstacle that we have been facing is theta decay. Sometimes referred to as an option’s “time decay,” it is the measure of the rate of decline in the value of an option due to the passage of time. If everything is held constant, the option loses value as it gets closer to its expiration date. This is happening to a few of our option trades. Dealing with Theta Decay Let’s take a look at the chart of the Consumer Staples Select Sector SPDR (XLP). If you recall we sold half of our position off when our option prices moved up over 100%, but stocks usually do not go straight up, they zig-zag quite a bit as you can see from the chart below. 
Even though XLP will most likely hit our $70 target, it has taken longer than expected. There is an options strategy that can really help us with our theta decay. This is why I would love to introduce you to it. It is called a debit call spread or bull call spread. As you know, we bought the XLP November 20 $70 Calls. If we put on one more trade, selling the XLP November 20 $71 Calls for the same expiration, we could have turned this into a vertical options trade, a strategy that mitigates theta decay immensely. But for these trades to work, you need to put them on and off simultaneously. In other words, we can’t sell the XLP November 20 $71 Calls now and expect them to help us limit our time decay on the XLP November 20 $70 Calls. To use this strategy, you need to start by buying and selling both options from the beginning of the trade. Before attempting to put these trades on, you need to make sure you have approval from your broker. Here is an example from the Charles Schwab option trading approval levels. You will need level 2 approval to do these trades if you have a Schwab account. 
For those of you have never done spread trades, please paper trade first, however I know many of you may already be familiar with these spread trades. If we are bearish on a particular stock, we could put on what is called a debit put spread. For example, on Friday I put on a recommendation to buy the Wells Fargo & Co. (WFC) December 4 $22 Puts after it fell below a massive Dark Pool level. We could have easily turned this into a debit put spread by adding an extra leg to this trade and selling the WFC December 4 $21 Puts. Take a look at this picture below from my TastyWorks trading platform. This spread trade is only a $0.12 risk for a maximum profit of $0.88 a contract. 
By selling the WFC December 4 $21 puts and buying the WFC December 4 $22 puts at the same time, it gives us more time for this trade to work out without having the full theta decay effect. These will still decay, but at a much slower pace than long option trade. When we have rapid movements on stocks, it makes sense to go with directional calls and puts, but in tough markets where the VIX is moving lower and the market is choppy, it helps tremendously to put on these vertical spreads. Expiring Trades This week, the following options will most likely expire worthless: Nike (NKE) November 20 $155 Calls, Yamana Gold Inc. (AUY) November 20 $7 Calls, and iShares Silver Trust (SLV) November 20 $30 Calls. The remaining portion of our XLP calls will also expire worthless on Friday. Unfortunately, even though we had massive Dark Pool prints on gold and silver, there has been no agreement on a stimulus package. This did not help our option trades. The presidential election is still up for debate and has not been officially announced. This is an unusual year that will always be remembered. We were able to take some profits on our strangle on Citigroup (C) last Monday after the market gave us a huge opening rally. The bearish half of that strangle will expire on Friday, but we got over a 100% profit on our C November 20 $50 Calls, so this was an incredibly successful trade. Congratulations! This week, I may be recommending a bullish vertical debit spread on SPDR Gold Trust (GLD) going into January. We should have some kind of stimulus package by that time, and using a spread will help our theta decay tremendously. I will be giving you directional and vertical spread trades from now on, but only take the trades that you feel most comfortable with. I also want you to keep an eye on the $350 level for the SPDR S&P 500 ETF (SPY). We had the biggest Dark Pool levels at that price point. Bullish if we stay above, very bearish if we go below. Until next time… Happy trading!
Stefanie Kammerman,
Editor, Dark Pool Trader
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