The April 1st Couch Potato Market Summary said "... The major indexes did indeed basically trade flat this week as market watchers geared up for the 1st quarter earnings season...the technical momentum indicators and oscillators are flashing overbought signals...Eventually, the trend will change..."
As confirmed in the SPY daily chart down below the major indexes have been trading range-bound since the middle of March as the S&P 500 index ended its worst week of the year. After a spectacular first quarter the question is, are we in for a repeat of what happened in both 2010 and 2011? The yellow vertical lines in the SPY Heikin-Ashi weekly chart below highlight the how strong rallies topped out in the spring of both years and culminated in a dramatic downturn. As the market approaches what is historically the worst performing six months of the year, traders may be getting a little leery. Investment advisors are advising their clients to lock in profits as the low hanging fruit has been picked and stocks are at overbought levels. Remember, stocks started strong in 2011 but reversed course reacting to the end of QE2, high energy prices, the Euro-zone debt drama, and uncertainty about the domestic economy. This year, many of the same issues are in play as the end of the Fed's operation twist is approaching. Energy prices are rising and Spain's severe recession and rising bond yields is the latest episode in the Euro crisis. Dismal job numbers and the Fed announcement that consumer credit expanded slower than expected added to the concern about the U.S. economy.
What has been happing recently is that when stocks pull back to near term support levels, buyers step in to bid prices back up. Most of the major indexes are near their 20-day and 50-day SMA's which are the technical support levels. These support levels should be expected to hold if the bullish trend is to continue before the dreaded month of May. A breakdown below technical support would jeopardize the bullish trend and prices would probably pull back lower and evolve into a range-bound trading trend. Earning results may have a lot to say about whether the bullish leg continues or whether the trend changes. Unless there are major surprises, earnings results are usually imputed into company stock prices. Though most analyst are expecting little first quarter earning growth, 7% second quarter and 5% third quarter returns are expected according to data company FactSet. Investors prefer to trade on economic expectations six to nine months in the future and company pronouncements about future expectations are what traders will probably hone in on. If money managers don't like what they hear about future earning prospects and believe that expected returns are in jeopardy that might be the impetus to push prices lower.
SPY Position Update
SPY closed at $139.79 on Friday â€“ the April is approx. $1,600 in the black
SPY is priced just BELOW its current 14-day EMA (see SPY chart down below)
SPY is trading BELOW 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 neutral (See SPY chart)
Moving Average Convergence/Divergence (MACD) is turning down (See SPY chart)
The March 14th Couch Potato published an April expiration SPY bear call spread
The call spread is approx. $1,000 in the black (see tables below)
$143 strike price short call delta is .1610 (84% probability this position will be profitable)
The March 14th Couch Potato published an April expiration SPY bull put spread
The put spread is approx. $600 in the black (see tables below)
$134 strike price short put delta is -.1238 (88% probability this position will be profitable)
SPY Risk Analysis
The SPY is currently priced basically equidistant between the short call and put strikes. Despite the worst week for the S&P this year, until we get a confirmed change, the trend is still bullish and the most probable risk is prices moving up and threatening the $143 strike price short call
DIA Position Update ---------------------------------------------------------
DIA closed at $130.39 on Friday â€“ the April is approx. $500 in the black
DIA is priced BELOW its current 14-day EMA (see DIA chart down below)
DIA is trading BELOW 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 neutral (See DIA chart)
Moving Average Convergence/Divergence (MACD) is turning down (See DIA chart)
The March 21st Couch Potato published an April expiration DIA bull put spread
The put spread is approx. $500 in the black (see tables below)
$126 strike price short put delta is -.1558 (84% probability this position will be profitable)
DIA Risk Analysis
Couch Potato published several April SPY bear call spread setups, however prices gapped lower the following day(s) and the published trade was not available,. Therefore the only risk is prices continuing to drop and threatening the $126 strike price short put.
As with initiating the trade, the decision process for exiting our SPY and DIA credit spreads 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.
Exiting this position 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.
Regular Couch Potato subscribers are aware that we suggested April DIA call spreads in several recent articles. Unfortunately, prices pulled back in the days following the articles and the published trades were not available. This reflects the fact that the DOW has performed relatively weaker compared to the other major indexes recently. It is not a good strategy to chase trades and if prices move against a trade setup it is best to back off as there will always be another opportunity. It would have been great if we could have initiated the DIA call spread as the trade would be displaying a significant unrealized gain right now. And of course since we already have a DIA put spread in play the call spread did not require additional margin and would provide a hedge for the sold put contracts. But we can't be concerned with what did or didn't happen as we don't control how the market moves; our thing is to manage the risk. With only a few weeks until April options expire our focus is now on managing the trades that we have on the table. We don't want to be playing checkers as it relates to expiration week exit strategies or preparing for trade adjustments, we need to be playing three-dimensional chess. Any further April trades will be closing trades or adjustments to generate realized gains and/or limit loses.
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.