Market Summary
The February 19th Couch Potato mentioned "... It looks likely that stock prices should push higher in the near term, but there is a strong case for some significant pullback within the next few weeks..." Recent Couch Potato articles discussed how when technical stock indicators suggest that prices are overbought, overbought conditions can continue indefinitely before there is a trend reversal. We used the spring of 2011 as an example. Notice in the weekly SPY chart below how the RSI remained extremely overbought from January through March of that year. And this year we can see in the SPY daily chart how stocks have remained overbought for the entire month of February. Many investors are being cautious about the potential for a price correction, but until that happens the smart move is to trade the market that is in front of us.

Traders' perception of the future outlook might be putting a lid on stock prices and limiting upside potential. To the extent that investors factor in projected future economic growth into current stock prices, there are plenty of landmines out there. For example, the Center for New Housing Policy just reported that with rent and housing cost rising and falling income, more households are spending more than half their income on housing. In 2010, 24% of U.S. households spent over half their income on housing, compared to 22% in 2008. In addition, if you consider higher energy cost that are expected to increase during the year, the average American will need to continue pinching pennies and downsizing whenever possible. This concern is reflected in the first quarter 2012 earnings estimates for the S&P 500. According to Factset Research, first quarter earnings growth for the S&P 500 have been revised lower from +3% to ZERO. The Factset report also said that only 63% of S&P 500 companies exceeded fourth quarter revenue estimates, among the lowest beat rates in a decade!

Cheap money from various forms of quantitative easing programs appears to be the primary driving force propping up the market. The Federal Reserve and their European Central Bank counterpart are expected to continue to flood the world with more paper money in an attempt to both stimulate the economy and pay off increasing debt loads. And don't forget the Chinese have recently jumped on the QE bandwagon by recently lowering their bank reserve ratios. The easy money is being used to speculate on riskier assets like stocks and commodities. The central banks appear determined to make sure there is enough easy money floating through the financial markets to keep stocks in bull mode for quite awhile.

SPY Position Update
SPY closed at $136.93 on Friday – the March position is approx. $600 in the black
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 priced ABOVE its 50-day simple moving average (see SPY chart)
SPY is ABOVE its 200-day simple moving average (see SPY chart)
Relative Strength Indicator (RSI) is extremely bullish (See SPY chart)
Moving Average Convergence/Divergence (MACD) is neutral (See SPY chart)

The February 13th Couch Potato published a March expiration SPY bear call spread
The call spread is approx. $300 in the black (see tables below)
$139 strike price short call delta is .2639 (73% probability this position will be profitable)

The February 13th Couch Potato published a March expiration SPY bull put spread
The put spread is approx. $300 in the black (see tables below)
$129 strike price short put delta is -.1125 (89% probability this position will be profitable)

SPY Risk Analysis
Obviously, the near term trend is bullish and unless a correction materializes the continued upward price move could threaten the $139 strike price short call.

DIA Position Update
DIA closed at $129.62 on Friday
DIA is priced ABOVE its current 14-day EMA (see DIA chart down below)
DIA is trading ABOVE its 20-day Bollinger Band SMA (see DIA chart)
DIA is priced ABOVE its 50-day simple moving average (see DIA chart)
DIA is ABOVE its 200-day simple moving average (see DIA chart)
Relative Strength Indicator (RSI) is extremely bullish (See DIA chart)
Moving Average Convergence/Divergence (MACD) is neutral (See DIA chart)

The February 22nd Couch Potato published a March expiration DIA bear call spread (see tables below)

DIA Risk Analysis
We have not had the opportunity to open a DIA put spread, therefore the only risk is price continuing to move up and threatening the $131 strike price short call.

Exit Plan
As with initiating the trade, the decision process for exiting our SPY and DIA spreads:

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.

Exiting this position prior to expiration we will probably “leg out” 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.

Final Comment
The CBOE Volatility Index (VIX) continues to contract and currently sits at 17.31. This is the lowest level since last summer and indicates that traders are not anticipating drastic price movement. If investors remain fearless and volatility remains stable we should be able to expect a supportive environment for trading credit spreads. A slight price pullback would be ideal as this might setup the opportunity to better manage our risks by executing both call and put spreads. The major concern at this point is with the VIX at such a low point and stocks at lofty levels, eventually a correction will happen. The question is when will prices correct and will it be a minor or major correction?

Gregory Clay

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.