Last weeks' American Association of Individual Investors (AAII) sentiment survey reported that retail investors are 35.85% bullish and 35.22% bearish. Some analyst consider this survey the most important indicator of the public's outlook and it is a contra-indicator meaning that a bullish reading is negative and bearish reading is positive. After the mid-January market peak the market corrected on higher volume down days indicating institutional selling. This week the volume on up days edged up as there signs money managers are buying again. For our Iron Condor positions we prefer that the bulls and bears battle to a stalemate as this improves our chance for continued success.
Regular Couch Potato readers have noted that thus far we have only traded the SPY and/or DIA ETF option contracts. For the March option expiration month we are looking at initiating a MDY Iron Condor. MDY is the ticker symbol for the SPDR S&P MidCap 400 Exchange Traded Fund (ETF). This ETF holds all of the S&P stocks in the MidCap 400 Index and seeks to correspond generally to the price and yield performance, before fees and expenses, of the S&P MidCap 400 Index. Compared to the other major index-related EFTs, depending on the market mood, generally the MDY has relatively lower volume and higher volatility. Selecting the March option series provides the flexibility of adjusting our positions prior to March expiration day or rolling out to the March end-of-month quarterly option series.
MDY ETF Trade Setup
We are opening a March expiration MDY Iron Condor.
MDY closed at $134.26 on Friday (29 days to expiration)
MDY is priced ABOVE its current 14-day EMA (see MDY chart down below)
MDY is trading ABOVE its 20-day Bollinger Band SMA, and 50-day simple moving average (see MDY chart)
MDY is well ABOVE its 200-day simple moving average (see MDY chart)
Relative Strength Indicator (RSI) is bullish (See MDY chart)
Moving Average Convergence/Divergence (MACD) is bullish (See MDY chart)
30 day Historical Volatility is 19%, Implied Volatility is 18.55% - both volatility numbers are relatively low, which is considered bullish
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.
We want the MDY Bear Call spread short strike to exceed defined resistance levels :
$137 calculated based on previous intraday highs and technical resistance levels
$139 equals the upper price level of our 80% statistical probability range
$139 is the upper level of the Bollinger Band â€“ Upper solid purple line in the MDY chart below
The Bull Put spread short strike price should be below defined support levels :
$126 calculated based on previous intraday lows and technical support levels
$129 equals the lower price level of our 80% statistical probability range
$125 is the lower Bollinger Band level â€“ Lower solid purple line in the MDY chart below
We want the Iron Condor to generate a minimum .50 net credit on each leg AND we prefer that the short strikes 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 March option expiration month MDY Iron Condor (based on Friday's closing prices). The recommendation is to submit a limit order to purchase/sell the option strikes prices below.
Premium Credit $1.20
Total Option Premium Received $2,400 (Excludes commissions and fees)
Maximum Risk $7,600
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)
The stock market had the best week of the year and recovered most of the losses since the mid-January peak. The question is whether this recovery has the legs to push prices higher or is this merely a dead-cat bounce? Until the market plays its hand and decides to go up, down, or trade range-bound â€“ you can make a case for either the short call or short put being more at risk. Eventually the market will provide a clear indication of exactly where is our risk exposure.
As with initiating the trade, the decision process for exiting our MDY 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 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 initiating the MDY 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.
As mentioned above, Couch Potato regular readers have probably noticed that we are trading the MDY ETF for the first time. Our bread-and-butter has been the SPY Iron Condor and a few months ago we added the DIA to the mix. Our normal process is to constantly evaluate a series of index ETF's (e.g. SPY, DIA, XLE, IWM, QQQQ, MDY) to determine which ETF provides the most optimum risk/reward profile to trade an Iron Condor.
By definition an Iron Condor trade is a hedged transaction because there are offsetting bullish and bearish positions â€“ this mitigates the need to initiate another trade to protect against losses. Some traders choose to diversify by opening an equity index ETF Iron Condor and also trading a non-equity ETF Condor (e.g. XLE, TLT). As mentioned above we regularly analyze a series of ETF's, and in the Couch Potato we publish what we believe is the optimum trading opportunity.
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.