Five financial institutions that owe the federal government billions of dollars have accounted for a substantial amount of stock-market volume the past month. Since the 5th of August, trading in the stocks of American International Group, Citigroup, Fannie Mae, Freddie Mac and Bank of America has averaged about 32% of the New York Stock Exchange's consolidated volume, as reported by the Wall Street Journal. Day traders have bid up the prices of low-quality financial names this summer and helped drive huge gains and trading volume. In the case of mortgage giants Fannie and Freddie, the consensus of Wall Street analyst is that their common equity is practically worthless.
Have traders put the cart before the horse in presuming that we are in a rapid recovery? Most analysts seem to agree that businesses need to generate more growth from increased revenues versus simply cutting cost. Noted economist Nouriel Roubini, one of the few economists who accurately predicted the world's recent financial meltdown, sees a "big risk" of a double-dip recession, according to an article posted on a financial website last week. The most recent economic data suggest that consumers are not yet ready to start purchasing more goods and services. When the effects of government stimulus spending wear off, and if consumers do not return to stores, what will be the market reaction?
Listed below is the status of our SPY Iron Condor trade as of Friday August 28th. This position has been open for 3 days:
The entire position gained $510 last week
SPY closed at $103.38 up .3% for the week
30-day historical volatility is lower â€“ which bullish, implied volatility is also lower
SPY is well ABOVE its 200-day and 50-day simple moving averages (see SPY chart below)
SPY is trading ABOVE its 14-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) upward momentum has stopped and has turned neutral See Spy chart below
Bear Call Spread
This spread is $210 in the black (see tables below)
$107 strike price short call delta is .2215 (78% probability this trade will be profitable)
Bull Put Spread
This spread is $300 in the black (see tables below)
$97 strike price short put delta is -.1514 (85% probability this trade will be profitable)
The market is in a confirmed short-to-medium term uptrend. There is clearly bullish bias from both a technical and fundamental perspective. At this point the path of least resistance is upward and the most probable risk is that the $107 strike price on our sold call might be threatened, and then we would need to decide whether to maintain our position or execute a trade adjustment.
This past week the SPY has been in a tight range trading intraday between approx. $104 and $102. Next week should also be quiet as most professional traders normally take the last week of August for vacation prior to the long Labor Day weekend and the start of the school year for many parts of the country.
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.
We initiated the SPY Condor as one order with four legs. Exiting this position prior to expiration we will probably â€œleg outâ€ of the trade by first unwinding either the bear call spread or the bull put spread; and close out the other side of the spread as a separate order. The timing of closing out each side of the Iron Condor is dependent on following our Exit Rules described above.
We use technical analysis to help increase the odds of a profitable trade by following a set of historical patterns that tend to repeat themselves over and over. This has a proven history of working because the patterns and trends of technical analysis are based on the emotions of fear and greed, and generally does not change much over time. But while the proper use technical analysis should improve our odds of successful trading, it's imperative to understand there are never any guarantees stocks will follow the direction indicated by technical analysis (this is why exit plans are an absolute necessity). Market activity that occurred during the August option month was a perfect example of this concept. Trading is about synchronizing risk and reward, and estimating a probable outcome. We are utilizing a proven trading plan and can expect to have long-tern trading success.
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.