U.S. stocks rallied more than 2 percent yesterday spurred on by favorable comments related to financial sector stocks. Light volumes made it easier for stocks to react to positive news. The Dow industrials and the S&P 500, which had their best gains since June 1, rebounded sharply after registering weekly percentage drops for four straight weeks.
SPY Iron Condor
We are looking at doing a SPY Iron Condor. SPY is the ticker symbol for the SPDR Trust. SPDR is an exchange-traded fund (ETF) that holds all of the S&P 500 Index stocks. This ETF seeks to correspond generally to the price and yield performance, before fees and expenses, of the S&P 500 Index. Compared to the other major index-related ETFs, depending on the market mood, generally the SPY has relatively high volume, low volatility, and good credit spreads.
Our short term trading time frame is 30 to 45 days. Options that expire on the August expiration date comply with our investing time frame. Selecting the August option series provides the flexibility of adjusting our positions prior to the August expiration day or rolling out to the September option series.
Since we decided to initiate an August expiration SPY Iron Condor trade, the next step is to figure out which strike prices will let us collect the most option premium AND minimize the risk of losing money.
SPY closed at $90.10 on Monday (39 days to expiration)
Relative Strength Indicator (RSI) is neutral See Spy chart
Moving Average Convergence/Divergence (MACD) indicator is bearish See Spy chart below
30 day Historical Volatility is 23.28%. One approach is to use the Implied Volatility instead of Historical. The difference is that Implied Volatility is one of the components used in option pricing, while Historical Volatility measures actual volatility that occurred during the past 30 days. Which number to use is trader preference and generally there is minimal difference in the end result.
Upper range standard deviation is .84162, the lower range is -.84162.
Use the number of days to expiration, volatility number and the standard deviation to calculate the 80% statistical probability for the option price to close within our short strikes at expiration (allowing us to keep all of the money we collected)!
We want the Bear Call spread short strike to exceed defined resistance levels :
$95 calculated based on previous closing highs and technical resistance levels
$95 is the upper price level of our 80% statistical probability range
$96.55 is the upper level of the Bollinger Band â€“ Solid purple line in the SPY chart below
The Bull Put spread short strike price should be below defined support levels :
$87 calculated based on previous closing lows and technical support levels
$80 is the lower price level of our 80% statistical probability range
$87.27 is the lower Bollinger Band level â€“ Solid purple line in the SPY chart below
We want the Iron Condor to generate a minimum .55 net credit on each leg AND we prefer the short strikes to fit our statistical probability profile (80% chance all the options will expire worthless and we get to keep most of the sold premium). The spread in tables below comply with our trading rules for initiating the August expiration SPY Iron Condor (based on yesterday's closing prices). The recommendation is to submit a limit order to purchase/sell the option strikes prices below.
Premium Credit $1.13
Total Option Premium Received $2,250 (Excludes commissions and fees)
Maximum Risk $7,750
Margin Requirement $10,000
20 contracts traded on each leg (number of contracts can be increased or decreased based on risk tolerance and/or funds available to trade; this will impact Total Premium Received, Maximum Risk amount, and Margin Required)
We are in a confirmed short-to-medium term downtrend. There is clearly bearish bias from both a technical and fundamental perspective. Recently some traders have been prognosticating about the possible impact of a head and shoulders pattern that has formed on the SPY chart and is considered a bear market indicator. And folks have probably been hearing discussion related to Fibonacci retracement levels associated with the major indices' gains from their March lows to June highs. None of these technical indicators is a panacea but many traders use these tools to identify potential support and resistance areas. The point is that whatever is one's opinion of the effectiveness of these tools it is useful to be aware of where other traders might view market support and resistance.
As with initiating the trade, the decision process for exiting our SPY Iron Condor position will be simple:
Anytime the market maker is willing to accept a limit price of less than .11 on one of our short strikes, buy back all the short contracts and sell the long positions on the same spread. However, if it is a few days prior to the expiration date, we can hold out for a .05 bid.
If one of our short strikes is penetrated (closing price above our short call or below the short put) AND the delta rises to .65 we will look to close out this spread (buy the short contracts, sell the long) and roll it out to the next month. Unless this is option expiration week, do not panic and rush to close the trade, many times the market will reverse itself and remove the sense of urgency. If one of our short strikes has been violated and there is no price reversal, we cut our losses and live to fight another day.
Let us not get too hung up on trying to predict where the market will be in the future. We will continue to listen to and understand what the market is telling us and manage our risk accordingly. Whichever direction the market goes we have a ready exit and are planning our next move!
Couch Potato Trader Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices (though many often do) or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what. It isn't the fault of the strategies.