Recent stock market activity appears to be driven by a combination of a possible economic recovery and speculation on increasing profits and earnings. Investors ignoring negative economic data and responding to favorable financial news seems to indicate that people are looking for a reason to participate in the market rally. Earnings reports of many companies that fueled the market rally have been driven by cost-cutting to increase the bottom line. Eventually these companies will need to generate increased revenues because slashing costs can't increase profits indefinitely.
Lower operating expenses should put companies in a good position to profit big-time when the economy does expand and revenues increase. But the obvious questions are will consumers be able to borrow; who will be providing jobs; will excessive taxes, healthcare expenses and energy cost consume disposable income; and will the weak housing market limit growth? Economic data due next week on manufacturing, housing, employment and the service industry may reshape investors' perception about where the economy is headed.
Listed below is the status of our SPY Iron Condor trade as of Friday July 31st. This position has been open for 17 days:
The entire position basically has not changed from last week - $1,620 in the red
SPY closed at $98.81 up .8% for the week
30-day historical volatility is lower â€“ which bullish, though implied volatility is edging higher
SPY is treading ABOVE its 200-day simple moving average (see SPY chart below)
SPY is trading ABOVE its 50-day simple moving average, 20-day EMA and 20-day Bollinger Band SMA(see SPY chart down below)
Relative Strength Indicator (RSI) is bullish See Spy chart below
Moving Average Convergence/Divergence (MACD) indicator is bullish See Spy chart below
Bear Call Spread
The July 26th Couch Potato commentary discussed how the market surge that began in mid-July converted our low-risk opening Bear Call credit spread into a bad trade. We recommended a series of simple adjusting trades to improve the risk profile and minimize potential losses (See Tables below). As mentioned in the POSITION UPDATE section above, the SPY did not move much this week; the profit status is effectively the same as last week.
Bull Put Spread
The Bull Put spread was closed out for an approx. $1,050 profit as shown in the table below (this profit helps offset the loss from the call spread) . Last weeks Couch Potato mentioned the considerable time left until August options expire and the possibility of doing another put spread to further reduce the overall SPY Condor loss position to a negligible amount. With three weeks until August expiration there is still plenty of time for the market to present an opportunity to initiate a put spread that fits our trading profile.
Fundamentally and technically, the market is in a short-to-medium term uptrend. Many analysts are suggesting that the market is overbought and due for a pullback based on momentum indicators (e.g. MACD), oscillators (e.g. RSI), and resistance levels (e.g. SPY $100 November high). And there is the train-of-thought indicating that historically, markets never go straight up or down, there is always a countertrend correction (especially considering July was the best month for the S&P in 12 years)! But recent market behavior has not necessarily been normal. Until there is a pullback we should presume that our $102 short call could potentially be at risk and we might need to consider how to readjust our position. As previously discussed, our Iron Condor strategy is designed to generate a reasonable profit, minimize risk, and preserve capital - not bet on market direction.
As mentioned in the BULL PUT SPREAD section above, if the market corrects as a lot of folks are anticipating, the expectation is that another short put will need to be monitored IF an opportunity that fits our trade profile presents itself. The risk associated with the sold call and/or short put will be evaluated and resolved based on the Exit Plan below.
Our $96 short strike call price was penetrated and we executed the trade adjustment as discussed in the BEAR CALL SPREAD section above. Since we closed the Bull Put spread, the only risk we have to manage is the $102 short strike on the adjusted call spread. The risk associated with the sold call will be evaluated and resolved based on the Exit Plan below.
The rules for exiting the Bear Call spread are:
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 the short call strike price is penetrated (closing price above the short call) AND the delta (probability of option expiring in the money) 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 the short strike has been violated and there is no price reversal, we cut our losses and live to fight another day.
On option expiration day, if rules 1 and 2 above have not been activated, let the Bear Call spread expire worthless and we keep the entire sold premium for any open contracts where the short strikes are not threatened.
We initiated the SPY Iron Condor as one order with four legs. The Bull Put spread has already been closed. The Bear Call spread will be closed out as a separate order following the Exit Rules described above.
Last week we discussed how the timing of the recent market surge transformed the risk profile of our Iron Condor from positive to negative. We can always second-guess ourselves, but the bottom-line is that we properly follow our trading plan, but nobody was anticipating a month of July 7.4% run-up in the SPY! Fortunately, we also honored our exit rules and avoided higher losses. And with three weeks until August option expiration, we may have an opportunity to open another spread to either break even or end August with a small profit.
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.