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Saturday, October 12, 2013

Weekend Portfolio Analysis (October 12, 2013)

We had probably the most exciting week of the year in terms of significant moves in both directions. We had  a VIX that went up and down like crazy. We had opportunities to sell premium, we had positions threatened, we had it all! It was fun! In the end SPX went from 1687.15 to 1703.20 for a +0.95% gain.

Market conditions
The market was extremely oversold short term on Wednesday, and I talked about it that day. And because it was so oversold, the laws of demand and supply increase the probabilities for a rebound. I'm not a market guru, I'm not a genius. I have just realized over time that when the market goes to an extreme condition, that is when balance between supply and demand goes to an extreme, the probability of a move in the other direction increases in the short term. I have seen it over and over again for 3 years now and it's my bread and butter. When the market is not at an extreme level, then I don't dare, and simply can't place my bets.

Why all this bla bla bla?

Well, because it really pisses me off when the big financial media (Marketwatch, Bloomberg, CNBC etc) tries to justify the move with an irrelevant news. They all said on Thursday that the markets were up because Republicans and Democrats were making progress on negotiations behind closed doors. Yes, negotiations whose details nobody had any idea about, precisely because they were closed door meetings. I call BS!!! The market rebound didn't start on Thursday, in fact it started on Wednesday afternoon! When the whole world is short there comes a point when there is nobody else to short, and then buyers attracted by lower prices start to support the markets. At some point some Bears take profits, other Bears panic, and the rebound starts to materialize. Simple law of supply and demand when the market is at an extreme. I think some news DO MOVE the markets, just not all of them.

Every single day that there is a rebound the media will find something, some positive news and will use it as the justification. There are 7 billion people on this planet and there is always some good things and bad things happening. So, there will always be a news to justify any market move. You can check it out, it happened on February 26, April 19, June25, September 3. What a coincidence! Every single one of those days a rebound started because it was just meant to be, yet the media found a reason to account for it. Something going on in the world caused it!

If you believe the meeting without results behind closed doors really created this rally, and that it started on Thursday and not before, well I can respect that. I can respect your opinion. But please, don't become paralyzed as a trader and stop trading due to news or events, because in the end they will always exist. Events in the world won't cease to exist, and politicians in the world will always be arguing and disagreeing on something. Don't get paralyzed, learn to live with the news around you, and realize they are noise most of the time. Back in December 20, 2011 I wrote a piece that took me a lot of effort called The Media and Markets' noise precisely about this. Things haven't changed, and they never will.

(Click on image to enlarge)
The rebound was beautiful, by the books, right at the base of the trend-line.
Stochastics: 70 (neutral)
McClellan: +38 (neutral)
65% of stocks are above their 20 SMA (neutral)
69% of stocks are above their 50 SMA (neutral)

No man's land folks. There is plenty of room now in both directions and anything can happen. We are obviously closer to overbought territory than to oversold, but we are not quite there yet. A +1% move this week, let's say SPX 1720 and RUT 1100 would put us there. Don't worry, if the market falls at that point, CNBC will find an event, a reason for it, and will let you know.

October positions
SPX 1595/1600/1780/1785 Iron Condor the put side was entered this week as an adjustment to the old 1615/1620. I didn't roll the calls down to make up for the little loss, as I was afraid of a rally. I saw the 1710 strike had a 10% probability of being in the money at expiration. Normally I would have sold that and now I would be sweating cold. The Iron Condor looks very comfortable as it is right now and will expire worthless (98% probability of success) for full profit this week (+$520).

RUT 970/975/1120/1125 Iron Condor. The 970/975 side was entered on Wednesday this week, betting on a market rebound from oversold conditions. With RUT at 1084 the position is showing a 90% probability of success. Looks like a winner. The 1120 strike is close, but for one week left is not bad. It is +3.32% above current prices, and at this level I think chances are, we won't see such a rally in just one week. We'll see.

November positions
SPX 1565/1570/1800/1805 Iron Condor With SPX at 1703, this position is looking beautiful. 82% probability of success and I'm not worried at all.

SPX 1520/1525 Bull Put Spread  Virtually a winner with 99% probability of success.

Action plan for the week
If RUT hits 1100 or near that level, I will sell RUT November Calls above 1150 without hesitation.
Other than that I have no other plan. I think I will be pretty quiet. If the market goes down, I won't do anything as I have two Credit Put spreads in November already and don't want to add to that.

This could be another exciting week, with the same theme: Politicians in Washington negotiating budgets and debt ceiling matters. Appart from that we have:

Sunday: Chinese PPI and CPI
Tuesday: German Zew Economic sentiment, US Trade balance, NY Empire State Manufacturing index
Wednesday: US CPI
Thursday: Initial and continuing jobless claims, Building Permits, Housing starts, Philadelphia Fed Index and Chinese GDP

I'm out. Good luck this week folks!

Check Out 2013 Track Record

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  1. Good morning LT,

    After the two BIG rallies the market is still neutral? I have a question. When you're closing a vertical spread position, do you enter a debit spread order or do you enter a sell order to your long and another order to buy back your short? Thanks.


  2. Hi L,

    Make no mistake, when I say "Neutral" what I men by that is that the market is not oversold nor overbought. To me Neutral doesnt mean it will go up or down. I cant make those predictions. It simply means it is not oversold not overbought and as such it has room to move in either direction.

    As for your question, I closed the whole spread at one. Dong it independently might give you a fill on one side and not on the other leaving you with time decay exposure or undesired directional exposure.

    Thanks for dropping by!

  3. Henrick,

    This was one of the most brilliant articles you wrote about the market. I have researched this oversold and overbought condition in the stock market going back since 1988. 80% of the time, when the market is oversold or overbought, you can expect it to snap back in the opposite direction.

    If RUT hits 1100, I am there with you selling the November bear call spread. Everybody is expecting the market to go to new highs once the debt deal is done. Well, markets are not that predictable. So instead of listening to the news or other people, I like to trade price action. The price action will tell me everything I need to know. When market is overbought, sell bear call spreads. When market is oversold, sell bull put spreads. You will be right 80% of the time.

  4. Thanks for dropping by once again pal!
    I would add to your statement the following: Sell out of the money, far as possible, and preferably above previous support /resistance levels. Talking about overbought/oversold conditions, I think the McClellan Oscillator in particular has been very accurate for a long time (measures how many stocks are going up vs how many are going down) Above +200, or below -200 signals a reversals almost unequivocally, the problem is if you wait for that level, you would only make 3 trades per year. The % of stocks above their 20SMA is a pretty good indication as well. The problem is that this trading style takes some balls. You end up entering trades afraid of going against the herd, but in the end that's what works. As always, good to have your feedback, and have a good week!

  5. Yes you are right. It is always hard to do the opposite of the heard. But if investing was so easy, most investors would be rich. I don't think I can take only 3 trades per year. That would be too less.

    I use a simple strategy to time my trades. When RUT falls around 4% from its recent 10-day high, I want to sell OTM bull put spreads giving me at least .40 credit on a 5-wide spread. On SPX, I let it fall 3% from its recent 10-day high to initiate a new bull put spread. If markets continue to fall, I will continue to sell for every 4% (on RUT) and 3% (on SPX) drop. Assuming we drop 15% on SPX one of these days, that means I will sell 4 or 5 times during the correction. If SPX does correct 15% or more, there is a good chance that I would need to roll some of the existing positions down and out too. So my strategy is not sell only once and adjust. I usually sell a little at a time so that I don't commit all my money at once. This leaves me with a few positions at different strikes or what I call strike diversity.

  6. Thanks Jonathan,

    Your idea about layering different positions at different strikes makes perfect sense. I will definitely be giving it some thought as I believe it to be pretty clever. Have you been using it for a long time? Did you find thee ideas somewhere else? I would like to look at some past studies and results before I start crunching numbers myself for endless hours.

    Thanks for your comments

  7. Henrick,

    I been doing it for about a year now. I read about this idea from a couple iron condor traders. The philosophy of this strategy is that no one can consistently time the market bottom or top. So instead of committing all your money into one position, why not spread it with strike and time diversity.

    There are a couple variations to this. One guy does it by having positions at different strike prices. For example: he might start out at 980/970 on RUT. He will look to get fill for .50 to .90 credit. He will sell some contracts when the position meets the pre-determined credit of .50 to .90. If it starts to fill for more than .90 credit, he will click down to 960/950 or lower depending on how much RUT has fallen. He wants to stay within that range of .50 to .90 credit. He will continue to collect premium during the life of the trade until it no longer meets his minimum premium. He might end up with a few positions at different strikes going into expiration.