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Saturday, January 25, 2014

Weekend Portfolio Analysis (January 25, 2014)

Folks, yesterday was a very exiting day in the markets. We had a scary bearish candle that is mostly body and no wicks, with the market closing at the low of the day. A -36 SPX points candle. Needles to say, a bar like that one is not frequent. Suddenly, all CNBC analysts are saying that it was "clear" we were going to correct and that this is not the end. Folks, your electricity and your cable bill. You don't need market media for your trading. Doesn't provide you with actionable ideas, but it's really fun to turn it on in a day like yesterday for entertainment purposes.

SPX opened at 1841.05 on Monday and closed at 1790.29 yesterday for a -2.76% decline. We hadn't seen that number for a week in a while. The VIX spiked up to 18.14, the exact day after I opened my RUT Iron Condor. I was patient for 27 days without opening a new position and premiums come to inflate right the day after. Should have waited one more day, but who the hell knows anything!?!?! I'm not a retrospective trader, I'm not a left side of the chart Guru, announcing how easy it was to make a killing here or there! No!!! I'm doing this in the present! Trying to gamble on future outcomes just like you are.

Market conditions
(Click on image to enlarge)
Stochastics: 40 (neutral)
McClellan: -98 (neutral)
36% of stocks are above their 20 Simple Day Moving Average (neutral)

We're in no man's land and there is plenty of room for the markets to move in either direction. I avoid selling close to at the money options at this point, but due to the high VIX it is a good time for selling well out of the money Puts. Notice, in spite of the Friday sell off, we are still in a long term uptrend. It's no time to panic yet. There's horizontal support in the 1775 area and then along the lower boundary of the uptrend channel.

February positions
RUT 1040/1045 Bull Put Spread 94% probability of success 27 days to expiration. This position is comfortably 100 points bellow current RUT price and there's no need to do anything here.

March positions
RUT 1040/1050/1250/1260 Iron Condor
RUT's currently trading at 1144, right around the middle of the Iron Condor, which is good. The position is showing a 72% probability of success. The decline is due to the increase in volatility. I'm not concerned with this position in spite of the significant sell off and volatility spike of Friday.

Action Plan for the week
The two greater risks for Iron Condor positions are:
  1. When the market slowly grinds higher non stop day after day.
  2. During quick sell offs.
The first scenario is the most challenging one. Once the Call side of the Iron Condor is being tested, volatility has gone down, making Out of the Money Call spreads very cheap which difficult your adjustments. You can't adjust much further up, which is what you need, as the credits obtained suck and you end up adjusting just a little further up and not as far as you would like to. You could go very far out yes, but if you do the credit received will be much lower and your position could be a loser even if it all expires worthless after the adjusment.

The second scenario is challenging as well. You entered an Iron Condor, which is a Vega negative trade, and volatility is now much higher than when you initiated the position. But unlike the first scenario, the fact that volatility expands means option premiums are rich and you can make adjustments with Put options that are comfortably Out of the Money and still obtain decent credits for them.

The March 1040/1050/1250/1260 RUT Iron Condor may face the second scenario. I will adjust the 1040/1050 Put side down to lower strike prices if/when the 1050 Put reaches a 30% probability of finishing in the money by expiration. That value right now is 19%. In theory, the 30% probability for the 1050 Put is reached if RUT goes down to 1100 - 1105 this week. If that happens, the 1040/1050 Put spread would be worth something around 2.00 dollars. And because I received 0.60 credit for them, it would mean a temporary loss of 1.40. At that point, the 950 Put (or even strike prices lower than that) would show a 10% probability of being in the money and I could use the 940/950 Put spread as my new position for 0.60 credit. Which means my real loss on the Put side of the Iron Condor would be 2.00 - 0.60 - 0.60  = 0.80. That 0.80 loss is covered with the credit received on the 1250/1260 Call side resulting in a wash for the whole Iron Condor. It's very unlikely for RUT to be trading at 950 by March expiration. A 20% market correction in 2 months. There's a lot of "ifs" in this analysis and a lot of theoretical pricing models built into the hypothetical scenarios. But the math is sound. RUT's unlikely to go down to 1100 - 1105 this week as that represents a 4% fall in just a week. If RUT does end up correcting that much it won't be this week, and by the time it happens, due to the magic of time decay, the 1050 Put option won't hit the 30%probability of being in the money. At that point RUT would have to go even lower. All I'm saying with this analysis is, the RUT Iron Condor is safe. And even in very bad situations, it won't harm the portfolio as you would think. I won't touch this Iron Condor this week, unless the 1050 Put reaches the 30% probability of being in the money, and as I mentioned, that's unlikely.

If the markets reach an oversold extreme this week, I might add a Bull Put spread to the portfolio using SPX. I'm not sure whether I'll use Feb. or March expiration. With February expiration I will sell the 1645/1650 Put spread, if I decide to go with March I can sell lower than 1600, maybe 1590/1595 or something like that. If the market rebounds and doesn't reach overbought conditions, I won't do anything.

Economic Calendar
Monday: US New Home Sales
Tuesday: Durable Goods and Consumer Confidence
Wednesday: FOMC and Chinese PMI
Thursday: GDP, Consumer spending
Friday: Chicago PMI

Good luck this week folks!

Check out 2014 Track Record

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  1. This is probably the best piece of weekend analysis I have read from you in a while. I agree with most of what you have said.

    You said, "I was patient for 27 days without opening a new position and premiums come to inflate right the day after."

    Why do you feel you need to have an iron condor or credit spread position every month? Why not just wait until your signal shows it is overbought or oversold? Yes, you will miss out when markets are in no man's land for a prolonged amount of time. But I believe you will will still be able to make many high probability trades if you wait for the overbought or oversold condition. Just something to think about.

    You said, "We're in no man's land and there is plenty of room for the markets to move in either direction. I avoid selling close to at the money options at this point, but due to the high VIX it is a good time for selling well out of the money Puts."

    I think we are almost oversold now. I did test the waters and sold the March SPY 162/160 for .12 credit. I waited until the last hour of the day to do this trade so it was close to the bottom of the day's range. I am still waiting for RUT to do down another 10 to 15 points or more before I consider it oversold. I am shooting for the March 1000/990 or lower on RUT if it continues to go down next week. I complete agree with you that selling when VIX is high is the ideal time for us credit spread traders since we can get much farther away from the market and still receive decent premium.

    You said, "The first scenario is the most challenging one."

    I completely agreed. 2012 and 2013 had some challenging times for selling bear call spreads for sure. Perhaps, we will see less of that this year with Fed reducing QE. You forgot to mention that when VIX is very low and it all of a sudden shoots up, you are still looking at a loss on the iron condor due to increase in premium assuming you sold the spread when VIX was extremely low.

    I much rather deal with the second scenario than the first. As we know, markets crash fast and hard. Then it rebounds hard sometimes and slowly grinds higher and higher. If we mainly sell credit put spreads, we can hedge a bit by buying OTM put options when they are cheap. I know you don't hedge using straight options debit spreads but this is something to consider when you don't have an iron condor position.

    If I had the March RUT 1050/1040 and it had a 30% probability of ITM, I would adjust down 50 points to 990/980. I think 950/940 is too far.

    A 20% correction in 2 months can and will happen. We had it most recently in 2011. The market can do anything at anytime. It does not remember what happen last year. It does not follow normal human patterns. That is why most forecasters are wrong and can't consistently forecast what is going to happen with the market. They are trying to predict something that is random. All we know is that when we get the extreme overbought and oversold, it tends to reverse. When we are in no man's land, it is all noise.

    I would go with March since you can go further out. If you are nimble and aggressive, February can work for you too. I am nervous as I sold some credit put spreads this month when markets were calm and VIX low. While they are still safely out of the money, if we get panic selling next week, I will be force to adjust down and out for a big debit.

  2. You have touched several points here. Let me see if I can answer them all.

    Yes, waiting for an oversold or overbought extreme is ideal. That's the reason why I waited so long before entering a new position. I would like to play under those circumstances only, ideally. You could wait for those extremes 5 - 8 times a year and be an ultra sniper. But I feel I can increase my returns using some other strategies such as Iron Condors for times when those extreme conditions are not present. Without abusing them, and playing as safe as possible,widening out the strikes at levels where chances are good for the market not to go.

    Yes, I did say no man's land. But remember that is based on the few indicators I follow. Overbought/oversold conditions may be defined differently by different traders. To me we're not oversold yet. Now you're right that we're closer to oversold territory. With a -1% decline,we will be there according , once again, to the usual stuff that I follow.

    I have considered hedging strategies, using simple long Calls or Puts, or like you mention, debit spreads. In the end I believe it limits my returns and to me it complicates the picture. So I have decided to keep one single position,to which I make adjustments, rolling up or down and eventually out to the next month,decreasing number of contracts here, increasing it there. Not saying it is a superior approach. I havent conducted a serious statistical analysis. It is just the approach that makes me feel more comfortable.

    "If I had the March RUT 1050/1040 and it had a 30% probability of ITM, I would adjust down 50 points to 990/980. I think 950/940 is too far."

    Well, you think 950 is too far, but later on you said that a 20% correction in 2 months is possible and that anything can happen in the markets. I say anything can happen! That's why I prefer to play it safe going down to 950. This is obviously a matter of risk tolerance and you my friend are a wilder cow boy that I am. There's no perfect approach here. You take more risks, you can potentially be rewarded with better returns. You take less risks, you live with a little more peace of mind at the expense of lower returns.

    "All we know is that when we get the extreme overbought and oversold, it tends to reverse. When we are in no man's land, it is all noise. "

    I do agree 100% with that. Old regression to the mean. Bread & Butter of credit spread traders.

    Finally, we will see if I go with Feb or March. But thanks for the advice. Good luck with your one position that may be threatened, yes, probably MARCH will give you better credits due to the higher extrinsic value in those options.


  3. Thanks Henrick for your detailed response.

  4. Great post LT. BTW wondering what happen to the put spread only seller? I lost his web site address...

  5. Google him. Try thebullogic. Although we wont see his trades until closed as we're not subscribers. But ot should be interesting to follow him from time to time.


  6. great work LT. I am starting in premium selling. I have an amateur questions. How do you calculate the 36% of stocks being above their 20 SMA? Is there any tool?

  7. Hi Manuel,

    Welcome to the journey of premium selling mate!
    Yes, there's a website for that, here is the link