Launched in early 2023, Pure Theta was one of Sonic’s first systematic strategies. These accounts focus on hyper-aggressive income generation utilizing liquid equity and futures options, similar to traditional covered call and covered put strategies.
However, unlike traditional covered positions, the investments in this portfolio utilize long-term, deep in-the-money options to mimic the outright long and short exposure that would otherwise be needed to sell the short leg of what is known as a diagonal spread.
This type of spread has two legs – a long and a short leg – but can be structured to generate regular income while taking on some directional risk in specific stocks, ETFs, or commodity contracts. Because options have finite expiration dates, their extrinsic value is subject to depreciation due to the passage of time in what is know as theta decay, the namesake of this strategy.
There is no secret in spread trading, but it is difficult for retail investors to dedicate the time to rolling their positions and researching which underlying assets are optimal for their portfolio. Sonic Capital utilizes a variety of analytical research to establish a directional bias in the underlyings, and uses additional volatility analysis to optimize which options are bought in sold in each transaction.
To neutralize market risk, at least to the highest extent possible, the portfolio is weighted approximately evenly between long and short exposure. Half of the positions in the portfolio use call spreads and the other half put spreads. Due to the hyper-aggressive nature of the strategy, a substantial portion of the portfolio will be kept in cash or money market securities to dampen the volatility of the overall fund. Inevitably, and because of the built in leverage that comes with options trading, some positions will be wiped out entirely in short periods due to idiosyncratic market moves. This exemplifies the need for diversification. Sonic’s proprietary models seek out the lowest correlation assets that best complement the existing portfolio.
Even with diversification comes market risk, which cannot be diversified away. The fund is structured in a way in which a Black Swan may eliminate the long side of the portfolio – in the case of a market crash – but the short side would be expected to remain intact, along with the money market allocation intended to soften the hit of any market selloff or major rally.
Clients should not be tempted to allocate a substantial amount of their net worth to a strategy operating at a level this speculative. This fund is intended for sophisticated investors as a way to complement their other investment portfolios or trading strategies. All investors should be familiar with the Risks and Characteristics of Standardized Options.