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Saturday, September 15, 2012

Weekend Portfolio Analysis (09-15-2012)

The S&P500 grew 27.85 points this week. That is 1.94% in positive territory and there was plenty of activity in the portfolio including the first two trades of the October cycle.

The firs trade of the week was an SPY 149/151 Bear Call spread. The position was played on Wednesday before the QE3 announcement by the Federal Reserve and while SPY was still hovering around 144.50. Like I said in that article, I was aware that this position could get some hit because the market was not at an extreme level yet, and because there were important releases both on Thursday and Friday. But I decided to enter as I didn't want to miss the opportunity in case of a pull back. Well, I was wrong, and this position is showing a loss right now, although SPY hasn't hit my adjustment point.

(Click on image to enlarge)

Temporary loss $544 probability of success 65.36%.

Then Thursday came with its bloody announcement, and the last position of the September cycle the RUT 860/865 took some hit and resulted in a sizable loss. I closed the position for a loss of $1110. I obviously misplayed this position, that was showing a nice $250 profit a couple of weeks ago. Well, who would have guessed it. Back then it seemed like a very safe position. At least I followed my plan and closed it with RUT at 858. I would have normally rolled over to October right on the spot. But the VIX was just getting crushed and options' implied volatility going down resulting in unattractive prices to sell Out of the Money options. At the time, selling the October RUT 900/905 Bear Call Spread was only yielding a 0.65 credit which was just too small, for a 40 point distance for RUT. So, I decided to just give up on the position and not to adjust/roll at that moment.

With that trade, the September expiration cycle resulted in the first losing month of the track record: a -7.80% performance after commissions. Ouch! The track record is now showing 24 winners, 5 losers and a +29.77% performance after commissions in ten months of trading activity. The loss this month was obviously bad, but things didn't get out of control. A -7.80% for the month is definitely something to expect given the aggressiveness of this strategy. Obviously, I couldn't be simply getting 4% - 6% returns per month forever so easily, and the market eventually catches you and humbles you.

Then on Friday the market kept going on, and entered very overbought levels, suddenly there was a more attractive position on RUT, selling the 910/915 October Bear Call, for 0.70 credit, which was what I did. That is 10 points farther than the previous proposal, and a greater credit received. So, I guess the decision of not doing the roll over the day before was correct. That position is now showing some profit and looks fine:

(Click on image to enlarge)

Temporary profit of +$60 and probability of success 82.67%.

Lessons learned

As much as I hate losing, it is definitely the best way to learn.

I believe now after 10 months of credit spread trading activity that the worst environment for a credit spread seller is a slowly up trending market like the one we have had for the most part this year. And here's why. I think we all agree that a trending environment in general is bad for credit spread sellers and neutral traders. We usually need for the market not to move or if it does, well, let it do it in the direction that is opposite to our positions. But there's no guarantee that if it is trending it will always do it in the opposite direction. We need to assume that some of those trends will bite our break even thresholds and loss areas at some point over a statistically significant number of trades. And on a trending market, some strong trend will eventually reach your break even points and will result in a loss typically greater than your average winner. So, as a credit spread seller, trends are definitely not our friends.

Now the second part. What is worse, an up trending or a down trending market? This is a very interesting question because it is true that the market falls hard and usually goes up at a slower pace. However, look at past runs on the daily chart of SPY and tell me you wouldn't have been scared selling calls during some massive and unstoppable rallies in the past century? And here's the other part of the equation and perhaps the greater problem. When the market is slowly up trending for too long, the VIX gets crushed, options premiums decay and then you find yourself in a situation where in order to get a decent credit for your position you have to sell options that are not far enough. I would have loved to sell RUT 920/930 or even higher than that but the credit received for doing so was just too miserable, as a result, I get closer to price action which over time is obviously more dangerous. I might get away with it, once, twice, three times, but eventually and over a significant number of trades, playing closer will eventually backfire. With a down trending market on the other hand, premiums are juicy and you can position yourself farther out for a decent credit. This leads me to believe that trading credit spreads all the time doesn't necessarily make sense, and in an environment like this I could/should have used something like a Put Calendar spread, expecting VIX to increase sometime soon, while also playing a much more favorable profit picture, let's take for example an 810 PUT Calendar spread:

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That's a nice profit picture, with only one contract per leg! Or something like a broken wing butterfly. This is the profit curve of a 850/855/865 Call Broken wing butterfly:

(Click on image to enlarge)

Again very nice proposal with only one contract per leg. Much less commission cost.
Ok enough with the rant. Just a good lesson learned, and growth as a trader for the future.

Plan for the week

So, there are two Bear Call positions in the October portfolio right now. Obviously I don't like that. That's twice the risk on the upside, and no downside exposure. The risk is not balanced.

I would like to sell some Puts this week, after a small pullback materializes. That would somehow mitigate the double upside exposure. At the same time, I will close the SPY 149/151 spread as soon as the current loss is recovered. I definitely won't hold that position till expiration. If SPY rallies to 148.80 I'll adjust further up this week, using October options, probably selling the 151 or 152 strike price.

As for the RUT 910/915 I don't anticipate any activity on it this week.

Market conditions right now

The SPX index continued its medium term (3 months) uptrend. This week with the break out above the uptrend channel the market spiked to very overbought levels: 83.32% of stocks above their 20 SMA, Stochastics overbought, McClellan Oscillator overbought at 190.

(Click on image to enlarge)

I believe this is the time for some digestion. I expect some sideways action or small pullback this week. I think chances of another breakout similar to the one we had this week are low. The week will be very light in terms of news releases. So, the pull back if any, will probably be shallow.

Possible high impact news this week:

Tuesday - Building permits and Housing starts at 8:30am.
Thursday - Initial Claims at 8:30am. Then Philadelphia Fed Survey at 10:00am.

Good luck this week.

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