If it is true the that stock market does not like uncertainty and confusion, then we may have a perfect storm. There are worries about global economic powerhouse China putting the brake to domestic spending. Questions related to the shifting political climate in Washington; Democratic congressional leaders myopic infatuation with healthcare reform; wariness about the President's proposed financial regulations; and suddenly big Ben Bernanke's Senate confirmation is no longer a done deal!
Confusion and uncertainty can lead to market volatility which can wreak havoc on our Iron Condor spreads. The past few months the market has been very good to us with volatility staying near 52-week lows. Of course this situation could not last indefinitely and it was inevitable that higher volatility would return. Over the past few weeks more analysts have been suggesting that a correction is due. Now the question is how deep will be the pullback and is this the start of a market downturn; or is this a normal correction prior to stocks continuing to new highs? The President's State of the Union address is next week and the Fed meeting the week following, plus the Senate needs to confirm Ben Bernake before the end of the month. Maybe this is just a hiccup prior to the market settling down again, but if this is a period of prolonged higher volatility then we will just play what the market gives us.
DIA Position Update
Listed below is the status of our DIA Iron Condor trade as of Friday January 22nd - This position has been open for 5 days:
The entire position is approx $1,280 in the red
DIA closed at $101.63
Volatility numbers have begun to accelerate, especially implied volatility
DIA price has plunged below at its 14-day EMA, 20-day Bollinger Band SMA, and 50-day SMA (see DIA chart down below)
DIA is still priced ABOVE its 200-day simple moving average (see DIA chart)
Relative Strength Indicator (RSI) has turned bearish (See DIA chart)
Moving Average Convergence/Divergence (MACD) is bearish (See DIA chart)
DIA Bear Call Spread
We are immediately closing out the initial call spread for an approx. $810 profit and following up with a TRADE ADJUSTMENT to roll the call spread to lower strike prices (see tables below) - After the trade adjustment the call spread(s) should be approx. $1,840 in the black
DIA Bull Put Spread
We are immediately closing out the initial Bull Put spread for an approx. $2,090 loss and following up with a TRADE ADJUSTMENT to roll the put spread to lower strike prices (see tables below) - After the trade adjustment the put spread(s) should be approx. $500 in the red
DIA Risk Analysis
A few weeks ago Couch Potato Risk Analysis section stated "The DOW Jones Industrial Average pulled back a bit from recent 52-week highs, but this is not considered a correction or confirmation of a downtrend. Until we get a definitive pullback the market direction is still bullish and if this trend continues the most probable risk to our DIA Iron Condor is the price encroaching upon our $109 short call." What a difference a week makes as obviously we have a different situation and the question is whether this is a prolonged downtrend? The violent price correction has obliterated our initial short put strike price and continued bearishness might threaten the adjusted short put.
As mentioned above we will do trade adjustments to roll-down the DIA Iron Condor strike prices. After the trade adjustment(s) we will follow the standard exit strategy:
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 may be able to 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 another short strike price. 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 are closing out the original DIA Iron Condor and opening lower strike spreads. Exiting these positions prior to expiration we will probably â€œleg outâ€ of each 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.
If timing is everything, the bane of market neutral strategies like the iron condor is accelerating volatility and market gaps. Unfortunately for us, immediately after our opening trade, we got the worst 3-day stock plunge in almost a year. Fortunately, there is sufficient time to recover by doing trade adjustments. But, some people may be a little nervous (yours truly included) because it was about this time last year that the market began its final descent to the bear market low! We have been discussing how the past few months have been ideal for market neutral trading strategies, but if we get a repeat of this time last year, generating gains will be more challenging.
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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.