Many analysts are anticipating a continuation of the current market action with stocks trading back and forth in a relatively narrow trading range. Institutional investors want to secure year-end bonus and will do whatever is necessary to keep stock prices from falling very much. The big boys will probably try to sustain the market at least through the end of the year, unless something serious changes the dynamics completely, and that means the selling pressure will probably be offset by bullish traders. A serious event would be a 180-degree reversal in QE2 in an all-out currency war, including tariffs and trade restrictions imposed by China.
If the expected scenario plays out it bodes well for market neutral positions. Take a gander at the charts below and note how after stock prices rose unabated from August lows, the major indexes have traded range-bound since hitting 52-week highs in early November. Don't forget that institutional traders are sitting on boat-load of cash, propping up the market should not be a problem. The current range-bound trading is the ideal scenario for our trading plan. As this past week demonstrated it is easier to get into put spreads at the support level and exit near resistance. Conversely, we can open a call spread at resistance and exit when prices pull back to support. The million-dollar question is what will traders do next year after they cash their bonus checks?
SPY Position Update
We are closing out the December expiration month Bull Put spread and opening a December Quarterly expiration Bear Call spread
SPY closed $122.89 on Friday â€“ 15 days to December expiration
SPY is priced ABOVE its current 14-day EMA (see SPY chart down below)
SPY is trading ABOVE its 20-day Bollinger Band SMA (see SPY chart)
SPY is ABOVE its 50-day simple moving average (see SPY chart)
SPY is also ABOVE its 200-day simple moving average (see SPY chart)
Relative Strength Indicator (RSI) is bullish (See SPY chart)
Moving Average Convergence/Divergence (MACD) is bullish (See SPY chart)
SPY Call Spread Trade Setup
30 day Historical Volatility is 14.27%, Implied Volatility is 15.46% both numbers are near the bottom of their 52-week range â€“ which is considered a bullish sign
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 SPY Bear Call short strike to be above defined resistance levels :
$123 calculated based on previous intraday highs and technical resistance levels
$126 equals the upper price level of our 80% statistical probability range
$124 is the upper level Bollinger Band â€“ upper solid purple line in the SPY chart above
We want the SPY call spread to generate a minimum .50 net credit 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 a December Quarterly expiration option series Bear Call Spread (based on Friday's closing prices). The recommendation is to submit an order to purchase/sell the option strikes prices below. Please confirm the correct option symbols with your broker.
Premium Credit $.53
Total Option Premium Received $525 (Excludes commissions and fees)
Maximum Risk $3,915
Margin Requirement $5,000
10 contracts traded (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)
SPY Bull Put Spread
The November 28th Couch Potato recommended a December expiration month put spread
We are immediately closing out the entire SPY put spread for an approx. $500 profit (see tables below)
IWM Position Update ----------------------------------------------
IWM closed at $75.67 on Friday â€“ the December position is approx. $250 in the red
IWM is priced ABOVE its current 14-day EMA (see IWM chart down below)
IWM is trading ABOVE its 20-day Bollinger Band SMA (see IWM chart)
IWM is ABOVE its 50-day simple moving average (see IWM chart)
IWM is also priced ABOVE its 200-day simple moving average (see IWM chart)
Relative Strength Indicator (RSI) is bullish (See IWM chart)
Moving Average Convergence/Divergence (MACD) is bullish (See IWM chart)
IWM Bear Call Spread
The November 28th Couch Potato recommended a December expiration month call spread
This spread is approx. $250 in the red (see tables below)
$76 strike price short call delta is .4635 (54% probability this position will be profitable)
IWM Risk Analysis
The IWM index represents small-cap stocks that are ahead of their big-cap brethren in leading the market higher during the recent rally. This index is currently at its 52-week high and getting close to our $76 short strike.
As mentioned above we plan on immediately closing the SPY bull put spread â€“ if stock prices gap down on Monday we will delay the trade until prices recover.
The rules for exiting the SPY and IWM call spreads 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 may be able to hold out for a .05 bid.
If one of our short strikes is penetrated (closing price above our short call) AND after market close, if the delta associated with one of the short strikes is .65 or higher, we will look to close out this spread (buy the short contracts, sell the long) and roll it out to another short strike price.
The November 28the Couch Potato Final Comment mentioned "...In addition to taking another shot at doing the SPY put spread we will attempt an IWM call spread. One or both of these trades should be available on Monday. If stock prices gap up the IWM call spread will be in play, the premium credit that we take in will be higher and/or you can do higher strike prices to maintain the same risk level. Conversely if prices gap down, then the trade will be the SPY put spread, with possibly more premium and/or lower strikes..." On Monday the SPY trade was the move as the price was at the low level of the recent trading range. A few days later IWM was the play as its price gapped up to recent highs. As mentioned above the recent price surge is presenting an opportunity to extract a nice gain from the SPY bull put spread after only a week.
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.