With two major economic events on Wednesday and Friday I am rolling the dice on a potential play.
I mentioned in my market wrap tonight that the Russell 2000 was turning bullish. The Russell dipped to 553 intraday on Monday and that was a valid test of support at 550 in my book. The Russell gained +1.5% on Tuesday while the big cap averages like the Dow lost ground.
I view this as fund managers rotating cash out of the liquid large caps they bought to dress up their end of year statements in October. Now that their fiscal year is over they can sell those positions and move into more risky small caps in hopes of a bigger return in 2010. The Dow only corrected about 5% over the last couple weeks while the Russell corrected more than 10% on end of year portfolio restructuring.
Just because the Russell rebounded strongly from the 553 dip to close at 570 on Tuesday it does not mean the volatility is over. The FOMC announcement at 2:15 on Wednesday is sure to produce some market volatility as will the jobs report on Friday. By making an entry at Wednesday's open I am betting that the Fed will make every effort to paint a rosy economic picture and avoid roiling the markets. A positive Fed statement could provide a boost to the market.
I am going to add a short put position on the Russell ETF in hopes that the support test was successful. We should know the results by Thursday morning.
NO OPEN POSITIONS
IWM $57.06 - Russell iShares ETF
The iShares Russell 2000 Index Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the small capitalization sector of the U.S. equity market as represented by the Russell 2000 Index. The index represents the approximately 2,000 smallest companies in the Russell 3000 Index. Link to Components
The IWM rebounded to $57 on Tuesday and I am expecting it to return to the highs at $62.50 before year-end. However, we only need it to rebound over last week's high of $60 to be very profitable. There is a 10:1 relationship between the Russell and the IWM ETF. A 570 Russell roughly equates to $57 on the IWM.
Sell to Open Nov $60 Put DIW-WH currently $3.45, Stop loss IWM @ $55.75
We do not sell out of the money puts for a few cents and then hope the market does not correct and cost us a fortune to exit. I don't like to risk a dollar to make a quarter.
The concept for Option Writer is to find solid momentum plays with enough volatility to inflate the option premiums. We will sell in the money naked puts ahead of the stock price and let the stock rally to our strike.
Selling in the money puts allows us to capture nearly dollar for dollar the movement in the stock price.
Because we are selling in the money that same dollar for dollar move can go against us as well. For this reason we establish tight stops to take us out of the play for a loss of a few cents rather than let the losers grow and "hope" they rally again. In a typical month we could get stopped out of twice as many plays as we close for a profit but those stops will be minimal and the winners worth the trouble.
If you do not have the ability to sell options you can turn the plays into spreads by buying a lower strike put. This will decrease your margin requirements but it will also decrease your profits.
There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.
Here is the most common margin calculation for naked puts.
100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))
For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)