Market Summary
Last weeks commentary reflected on the dire unemployment statistics in the U.S. and questioned whether consumers could drive economic growth given the massive job losses since the beginning of 2008? It was reported that Federal Reserve Governor Kevin Warsh offered a similar assessment. Mr. Warsh warned that growth could disappoint for several quarters with excessively high unemployment and the "trauma" of consumers and businesses "should not be underestimated". Further evidence of consumer belt tightening is reflected in last weeks reported 4.5% drop in national chain store sales comparing the first two weeks of June to the previous month.

The labor department reported that the number of unemployment insurance recipients had the largest drop in more than seven years and is a sign the jobs picture might be improving. But several economists suggested that it is highly unlikely there is substantial improvement in new hires. The question is when or if we should expect businesses to start hiring, leading to net job growth?

SPY Iron Condor
In last weeks commentary we discussed looking at doing a SPY Iron Condor. SPY is the ticker symbol for the SPDR Trust. SPDR is an exchange-traded fund (ETF) that holds all of the S&P 500 Index stocks. This ETF seeks to correspond generally to the price and yield performance, before fees and expenses, of the S&P 500 Index. Compared to the other major index-related ETFs, depending on the market mood, generally the SPY has relatively high volume, low volatility, and good credit spreads.

Our short term trading time frame is 30 to 45 days. The July option expiration date is within our investing time frame. Selecting the July option series provides the flexibility of adjusting our positions prior to the July expiration day or rolling out to the August option series.

Trade Setup
We initiated the SPY Iron Condor on June 15th, the technical indicators we evaluated to set up the trade were:
SPY opened at $93.96 (32 days to expiration)
24.82% 30 day Historical Volatility
$90 support level
$100 resistance level
Relative Strength Indicator (RSI) was neutral
Moving Average Convergence/Divergence (MACD) indicator was flat

We successfully fulfilled our trade criterion, which was to generate a minimum .55 net credit on each leg of the Iron Condor. The legs are the bear call spread (short lower strike, long higher strike), and bull put spread (short higher strike, long lower strike). AND we needed the short strikes to fit our statistical probability profile (80% chance all the options will expire worthless and we get to keep most of the sold premium)! Our order was filled at the prices described below:

Bear Call Spread
Sold 20 $100 strike price call contracts at .74 for a $1,480 credit
Bought 20 $105 strike price call contracts at .13 for a $260 debit
Credit (Cash) Received at .61 per share is $1,220

Bull Put Spread
Sold 20 $86 strike price put contracts at .915 for a $1,830 credit
Bought 20 $81 strike price put contracts at .365 for a $730 debit
Credit (Cash) Received at .55 per share is $1,100

Premium Credit $1.16
Total Option Premium Received $2,320 (Excludes commissions and fees)
Maximum Risk $7,860
Margin Requirement $10,000.
20 contracts traded on each leg (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)

Position Update
Listed below is status of our SPY Iron Condor trade as of Friday June 19th.
SPY ended the week at $92.04
The $100 short call has a delta of .0690 (93% probability this trade will be profitable)
The $86 short put delta is -.1948 (20% probability this trade will be profitable)
Our overall position is $1,090 in the black
At this point, market activity since initiating this trade has not given us any reason to reevaluate our decision process or think about doing an adjustment.

Risk Analysis
When we initiated the Iron Condor trade there was a short-to-intermediate term up trending market environment. Technically, this situation still exists, BUT it is beginning to change. A few weeks ago bull market proponents vociferously opined about the beginning of an enduring market upturn, while the bear market camp remained relatively silent. The bear market folks are starting to awaken from hibernation and are eyeing recent market activity as a sign that it is their turn to croon! But the question on the minds of some people is whether the market is simply catching its breath and going through a basic correction after the historic breakout from the March lows? Is the market forming a base for the next leg of a Bull Run or will the bears reassert themselves?

The SPY failed to sustain a breakout above 95. This level is important because it represents the January 2009 high and the market plunged shortly after. Trading continues in a relatively tight range, typically the price breakout from a tight trading range (whether to the upside or downside) is very aggressive! Daily trading volume has been relatively light compared to the 280,020,000 three month average daily volume. Volume remains below both its 50- and 200- day moving averages. Since the beginning of April, volume has been below average every single day. Also, several analysts have reported that money managers are holding higher than normal cash levels and are waiting on a pullback that will give them a buying opportunity. For us the benefit of this long sideways move is the premium is eroding from our sold options (money we hope to be able to keep)!

The SPY Put/Call ratio is 1.35 (considered bullish). But volatility indices have gapped up and that is a bearish sign. Relative Strength Indicator (RSI) and Moving Average Convergence/Divergence (MACD) are neutral. SPY is treading above its 200-day and 50-day moving averages. Also SPY is trading right at the 20-day EMA and 20-day Bollinger Band SMA. These have been the support levels for the month of June, and the obvious question is will support hold, or will there be a further breakdown? Another concern is that SPY had several bearish distribution days this week (losses on higher volume days).

Technically, the most probable risk is the $86 strike price on our sold put might be threatened. However, evaluating the situation from a fundamental perspective the risk might not be as clear. Despite the SPY’s first weekly loss since early May, we are still in a short-to-medium term up trending market, and thus far price has held above support zones. We can easily make the argument that based on the current market direction the higher risk is the $100 strike price on our sold call might be penetrated and we would need to decide whether to maintain our position or execute a trade adjustment. As of today, our SPY Iron Condor is almost perfectly positioned and if we exited the position today we’d do very well. But the real deal is there is a month to go until July options expire and the market can become volatile in hurry. Whichever risk scenario comes into play we must be prepared react accordingly!

Exit Plan
When we initiated our SPY Iron Condor trade we decided the rules for exiting the position would be:

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 can hold out for a .05 bid. (Note that our $100 strike price short call ended the week at .15 and the $105 long call is .03 – if we bought back our short call and sold the long call, the .12 we would pay is close enough to our defined exit price to consider closing out this position. Next week if we can pay .12 to exit the bear call spread we will close out this position take the $1,000 profit off the table!

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 the next month. 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.

On option expiration day, if rules 1 and 2 above have not been activated, let the Bear Call spread and/or the Bull Put spread expire worthless and we keep the entire sold premium for any open contracts where the short strikes are not threatened.

We initiated the SPY Condor as one order with four legs. Exiting this position prior to expiration we will probably “leg out” of the 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 market has been very cooperative after our opening trade. We are showing a $1,925 paper profit and both short strikes are within our 80% probability of success profile. However the reality is that we still have 29 days until the July option expiration date and as stated before the situation can change rapidly. Also, the Federal Reserve Board meets next week and oftentimes volatility increases prior to and after the board meeting.

It is critically important for us to manage the risk associated with our Iron Condor position. This type of trade is not a bet on whether the market will rise or falls, some of my colleagues have written about option strategies that depend on a market move to be successful. Insurance companies accept our premium dollars to insure a risk and if we start filing claims or the circumstances change to increase their risk, insurers ask for more premiums or cancel the policy. The concept is similar with Iron Condors in that we accepted premium, and if the risks become unacceptable (e.g. excessive volatility, short strikes penetrated) we cancel the position before suffering a catastrophic loss.

The point is that in initiating the Iron Condor trade we have to evaluate market fundamentals, perform technical analysis, and calculate entry and exit points. But it is not important to spend time trying to predict where the market is headed because nobody really knows. We need to listen to and understand what the market telling us right now, and manage our risk accordingly. Whichever direction the market goes we have a ready exit and are planning our next move!

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.