SPY: 50 day MA continues to act as resistance, low volume, lots of data coming out this week.
Keep an eye on the following - US Steel (X) & Occidental Petroleum (OXY)
Monday, March 31, 2008
SPY, X, OXY
Friday, March 28, 2008
Credit Spreads: shop around
Major indexes continue to be temporarily directionless. Of course that’s good if you’ve been long theta (profit from time decay, i.e. you sold options).
Economic data continues to be negative; however, none of it is shocking and the market has priced most of this into current prices. It will take another major event to drive this market into the ground, which these days always seem around the corner.
I still feel confident in recommending OTM credit spreads on one of the major index ETFs (SPY, IWM, DIA, QQQQ, etc). Keep in mind that currently you will get better pricing on the downside - due to market bias and volatility skew. If you’re looking for a good probability play, look to sell options with a delta of .07 (although with only 21 DTE (days to expiration) that will be tough). This correlates roughly to options that are 1.5 standard deviations away from the current stock price. You are looking for a 10% return per month with this strategy as well.
In order to get a respectable premium, with only 21 days until April expiration, you might have to sell options with a slightly higher delta. Then buy an equal number of puts x strikes below depending on your risk profile.
For the following example, let’s use options that are 3 points apart. Also, and this is in regards to a previous post, I want to point out the difference in premium between similar index ETFs, when they should seemingly have the same risk/reward profile. Hopefully the following example will make this easier to understand.
Suppose you think that SPY has found support around 125. You could sell SPY puts at 122 and buy SPY puts at 119. The short puts have a delta of .09 and the long puts have a delta of .04. Check out the trade calculator.
OR you could do the same for DIA - sell the 114 puts, buy the 111 puts. The short puts have a delta of .09 (same as SPY) and the long puts have a delta of .04 (same as SPY). Check out the trade calculator.
In my opinion, you’re better off going with SPY, on this day, at this time, all else equal. I know that's a lot of qualifiers but these things aren't static and may be opposite tomorrow. Here's why I think SPY is a better play.
SPY will yield a credit of $290
DIA will yield a credit of $280
First the obvious, SPY yields a credit of $10 more. But there's more: SPY would require a 7.1% move down to hit your short strike, whereas DIA only needs a 6.6% move down to hit your short strike. Granted, SPY and DIA are not the same and do not move identical to one another but I think you'll find them extremely comparable. Keep this tip in mind the next time you are 'shopping' for the best credit spread.
Wednesday, March 26, 2008
GOLD
First chart - update on GLD. I'm not recommending anything here, just a follow up to yesterday's post.
Next up, SPY. We got our expected pullback which was nice. There is likely to be a little more pullback as more negative news should come out tomorrow (GDP, jobless claims, etc.). Just keep in mind that most of this "news" is already expected.
Overbought conditions in SPY, IWM, and DIA have all subsided but not so much in QQQQ which has been known to 'lead' the market. Based on that, after hours trading (which is meaningless), and current futures prices (almost meaningless), QQQQ may further the pullback. Let's call SPY 132ish a short-term target.
Tuesday, March 25, 2008
I thought this was worth looking at. Even though the points where GLD touch the lower trendline are awfully far apart, yielding them less predictive, I wanted to share this one-year chart since so many people have only been focusing on the extreme short-term plummet from 1000+ to 920.
SPY still seems poised for a pullback as it remains a little overbought - as do all major indexes. Plus, the S&P alone is up something like 6% over last several trading sessions so some pullback would be expected.
The market in general; however, has been doing an amazing job of brushing off extremely negative news - which is bullish at least for the short-term. Once we get that pullback, I would strongly consider rolling-up or exiting any short positions that are in reach of the underlying. The market has shifted and is presenting more upside risk in the short-term.
To further that thought, I think it is okay, again hopefully on a pullback, to sell some April Put Credit Spreads below 125 (sell at 130 if you're feeling lucky). Remember to use a trade calculator to see which index gives you the best premium. You may find that for the same delta, same standard deviation, same dollars risked, etc. that a much larger premium can be had for selling IWM over SPY, or DIA, for example. Finally, the last few weeks have forced us to set common sense and rationale aside - so just try to go with the market - even when you know you're right.
Monday, March 24, 2008
I would like to point out a couple of charts today and then offer a suggestion for a possible trade adjustment. First, I found it interesting where the market closed today - see the 30 day chart on the left. Clearly broke through 135 but was met with a lot of selling pressure as soon as it saw levels not seen since Feb.
Also, check out this site for this weeks upcoming announcements which may have an impact on your trading. http://biz.yahoo.com/c/e.html
One final thought: there is nothing that says that the Fed, nor the market need act rationally. If the market is in fact making a turn around, if even temporary, don't fight it - you won't win. Be flexible, admit if you were wrong and fix it. That said, I continue to recommend probability trades. Trading the news, which is what the markets are trading on right now, is almost impossible. So, let's look at some iron condors and credit spreads that will allow you to profit from a such a volatile market.
Let's say that you took my previous advice (March 8th post) of selling 140 calls and buying 143 calls for a net credit of $350. My current recommendation is to do nothing. I think the market will pull back some in the near future, plus it has a lot of resistance to overcome before it gets to 140. Of course, we would want to roll up before it gets too close. This would be a slightly riskier play.
If you want to play it super safe do the following: on the next pullback, buy back the 140 calls that you sold and sell the 143s. Now, (or wait a day, it's up to you) sell the 143s and buy the 146s. See below.
Breakdown (right now we're just focusing on the call credit spread portion of the IC):
Cost Basis (what our original position was)
Sell 140 Calls @ 0.70 --> $700
Buy 143 Calls @ 0.35 --> $(350)
Price (current)
Buy back the 140 Calls @ 1.15 --> $(1,150)
Sell the 143 Calls @ 0.43 --> $430
So where does this leave us? We have 'locked' in a $370 loss....but we're not done.
Note: you could cut your losses here - that is perfectly okay. Remember that a trade adjustment is a new trade. If you're completely befuddled as to how the position moved against you, just cut your losses and live to fight another day.
Sell 143 Calls @ 0.43
Buy 146 Calls @ 0.12
This results in a net credit of $310, for a total loss of only $60. While a loss isn't ideal, it sure beats losing the $2,690 at risk. By the nature of this strategy, you should expect to break-even / incur small losses for 2-3 months out of 12. That's why this is a probability play. And you're not completely out of the woods - as the price could always continue upward. With each adjustment, you decrease your credit and increase your risk.
At this point we could stop tinkering, since commission fees DO exist. Or we could go one step further. Remember the put spread we sold for a net credit of $320, we can roll it up for additional profit.
Breakdown (now we're just focusing on the put credit spread portion of the IC):
Cost Basis (what our original position was)
Sell 116 Puts @ 1.03 --> $1030
Buy 113 Puts @ 0.71 --> $(710)
Price (current)
Buy back the 116 Puts @ 0.24 --> $(240)
Sell the 113 Puts @ 0.14 --> $140
So where does this leave us? We have 'locked' in a $220 gain. You could stop here,or.....
Sell 125 Puts @ 0.90 --> $900
Buy 122 Puts @ 0.57 --> $(570)
This gives us an additional gain of $330.
In conclusion, we started with an iron condor that yielded a $670 credit. If you felt like you were getting pinched you could have executed the above strategy for a new total credit of $160 (220-60) + $330 = $490. Not as good as a credit of $670 but good capital preservation none the less (actually capital preservation + $490 + invaluable experience in trade adjustments). Previously, I eluded to commissions which can become costly if you do too many adjustments. That's why ideally, positions are put on deep OTM (for example, with a delta of 0.07). More than anything this has merely been an example of a trade adjustment. Personally, I think it's too early to panic, with regards to upside risk; however, hopefully this example will better prepare you should the position at any point exceed your risk tolerance. One final note, due to the effects of gamma close to expiration, it is always recommended to close out your position prior to expiration (i.e. 7-10 days) unless it is astronomically OTM, then just let it expire (to avoid commissions)
Here's the other chart I promised:
Friday, March 21, 2008
Double Bottom?
The million dollar question seems to be whether this market has formed a double-bottom. This chart would suggest that maybe it has - if even for the short-term. SPY is once again range bound between 130 and 135 though not likely to be bound for long. The resistance in the 135-137 area is significance. Similarly, there doesn't seem to be a lack of buying interest when the market tests it's recent lows. All breakouts lately seem to be to the downside but are always met with large up days. Volume is slightly more significant during down days for what's it's worth.
Ultimately, there are more reasons for this market to go down than up - from the value of the dollar, to jobless claims, to record foreclosures and falling home prices. And of course the Fed lowering rates to a level that got us into some of this mess to begin with - although banks and lenders are acting a little more responsible this time around. It may take another piece of bad news as a catalyst to send the market lower - or at least, no more Fed announcements that artificially drive the market upward.
For the bullish case, the market may have found some support (maybe temporary, maybe permanent). Much of the fear surrounding the financial sector has been relieved and the veil of uncertainty has been lifted - in other words, the still ugly conditions involving write downs, horrendous YOY earnings, etc. have likely come to the surface and been priced into current prices.
So the question becomes, HAS the market already priced all bad news into current market price? I think there should be some more downside but it doesn't matter what I think. If enough people think the worst is over and start 'value' investing then this market could go up - slowly - as no one can admit that the outlook and future growth of most companies look great.
One last point. A lot of people thought they were 'value' investing when BSC, for example, was down to 101...and again at 70...then at 30...and somehow at 2. Very few people have been successful at picking market bottoms but that doesn't stop them from trying (albeit BSC is an unusual example). Fear drives these investors - fear that they will miss out on the next big rally. So, if you're a short-term investor please be careful if you have recently changed your tune from bearish to bullish.
Wednesday, March 19, 2008
Saturday, March 15, 2008
zoom out
I wanted to take a step back and take a look at this 10 year chart - just as a reminder of where we've been and what can happen. No, I don't think we're headed back to 767 any time soon (or ever).
Note: the Fed doesn't often bail out individual companies as it did with BSC on Friday.
In the case of LTCM (http://en.wikipedia.org/wiki/Long-Term_Capital_Management), for example, I can see the downside of allowing the world to go bankrupt but I don't think it's the Fed's job to make sure that a presumably much smaller company gets bailed out from exhibiting, albeit in hindsight, poor risk management.
Is it really a better policy to artificially bolster the market at the expense of inflation and devaluing my currency? Apparently.There is certainly more downside risk than upside but please be careful. Tuesday showed us how violent these bear market rallies can be and it's real easy to to whipsawed. The worst part about this downward bias, from an option selling standpoint, is that it is difficult to get the credit you'd expect from selling OTM calls - this of course is due to the volatility skew. It means you either have to sell on the put side at a seemingly safe level (delta of .06 - .07) and except the downside risk, OR sell OTM calls with a delta closer to .20 to get a decent premium.
This has been a hectic week for the market so I have hesitated putting on any new trade recommendations - although it seems my original trade recommendation (below) would still be working out quite well for you.
There is no need for any trade adjustments at this point.
Shameless Plug: Speaking of trade adjustments in general, here is a free spreadsheet to help you out.
http://www.strategicmodeling.com/Products.htm
Scroll down and click on the icon 'Option Adjust' and the download will start automatically. Depending on your internet browser settings it will either open itself when it's done downloading or it will prompt you on where to save it.
Basically, enter your current position (using drop-down menus), what the market has done since you entered said position, and your short-term outlook on the market. The spreadsheet will then provide you with several suggestions on ways to adjust your position to either lock in profits, cut losses, or generate additional cash flow. Oh, and did I mention, it's free.
In the near future, I will post some more trade opportunities with screenshots of their respective trade calculators.
Wednesday, March 12, 2008
Due to the way the market finished today and IF you're feeling like taking on a little risk - I recommend a bearish strategy, knowing that there is some significant resistance in the upper 130s on SPY. Specifically, I would look at selling some call credit spreads above levels of said resistance.
If you're feeling risk averse then wait until after the Fed cuts, although it will likely cost you some premium.
I will usually try to spare you my brilliant market commentary - for that I strongly recommend you check out the links on the right side of this page.
I will post some meaningful graphs today/tomorrow.
Tuesday, March 11, 2008
Even though the markets finished up today, 1option has a great analysis on the action by the Fed.
http://www.1option.com/index.php/global/comments/option_traders_scale_into_short_positions_on_a_failed_rally/
Here are a few suggestion to the trade recommendation from the weekend. Use the strength in the market to your advantage. For example, the same call credit spread that we would have received $350 for(assume 10 contracts) on Friday, would now net you $580. Just something to keep in mind. If you're feeling less aggressive consider selling something around 144/141. I see no reason to sell the put credit spread quite yet - let's wait to see what the market does this week.
Saturday, March 8, 2008
Current IC recommendation for an index:
SPY APR 143/140 - 116/113
Reward: $670
Risk: $2,330
Short call delta: 0.2
Short put delta: 0.077
Ideally, we would want the delta on the short call to be closer to 0.07 (SPY @ 148) instead of 0.2; however, due to the volatility skew and current downward bias of the market, we would only receive a credit of about $8 for each call spread that far OTM. That said, there is plenty of resistance at 139 so it's not a huge concern.
I don't recommend putting on this trade on until after Monday or Tuesday, as the beginning of the week might have some more downside.
{See the following}
http://www.1option.com
http://adamsoptions.blogspot.com
It might even prove to be a good idea to enter the put credit spread on Tuesday and wait till later in the week to put on the call spread.