Wednesday was a really strange day and it was not kind to us.
We entered the Russell ETF position at the open and that turned out to be the high of the day. The Russell rolled over at 10:30 and went negative long before the other indexes. It was really strange to see the Russell in the red with the Dow up +125 points. It was an exact opposite to the market action on Tuesday when the Russell gained +1.5% and the Dow struggled.
I did some research on the Russell thinking maybe Burlington (BNI) was in the RUT and that was the reason for the big gain on Tuesday. No such luck, BNI is not a RUT-2000 stock. I checked again today and several Russell components suffered serious losses. For instance STEC -9, TRLG -6, SHOO -2, NILE -2, CRR -3, etc. The problem still appears to be earnings. As we get deeper into the earnings cycle the quality of earnings declines along with the patience of investors who hung on to a particular stock in hopes of a positive surprise. Those surprises are turning out to be negative in many cases.
The few Russell components I checked were not enough to drag down the entire index into negative territory while the Dow was in triple digits. This was some coordinated selling by somebody and very unexpected.
I wish I had some good news this morning but the dollar is in rally mode again and the S&P futures are -4 at 2:30. If the overnight trend continues we will probably be stopped out of the ETF position. This is really a bummer since the Fed said exactly what the market wanted to hear. The -100 point Dow decline in the closing minutes was probably a sell program from somebody still cleaning up their October window dressing. They probably hoped there would be a post Fed rally they could sell into and when the Dow hit +140 and failed at 9920 for the second time intraday they decided to pull the exit lever.
Be patient, November is just getting started and we knew there would be volatility this week.
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)