If in fact we are in an economic recovery, will it follow what economist call a "W" pattern, initial growth followed by a decline, then another recovery? Or, will it be a "U" pattern, a recovery that takes an exceptionally long time to get going? Both of these scenarios contrast with dramatic "V" shaped recoveries that followed past economic downturns, such as the 1990-1991 recession.
Prominent New York University economist Nouriel Roubini, who predicted the global financial crisis and who is dubbed Dr Doom by the New York Times, recently commented "There is potentially light at the end of the tunnel, and advanced as well as emerging economies are showing signs of bottoming out of recession, but there is the risk of a double-dip recession in the second half of next year and into 2011."
Other economists are also anticipating a down-turn next year due to restrictive credit conditions for consumers and businesses compared to the periods following previous recessions. The prevailing economic theme for the moment seems to be "less bad is good". Eventually, we need to move from "not too bad" to truly positive economic results, with net job growth, expanded manufacturing, real wage increases and a truly confident consumer.
Listed below is the status of our SPY Iron Condor trade as of Friday August 7th. This position has been open for 24 days:
The entire position's unrealized loss increased by $840 last week - to $2,460 in the red
SPY closed at $101.20 up 2.3% for the week
30-day historical volatility is going lower â€“ which bullish, though implied volatility is edging higher
SPY is treading ABOVE its 200-day simple moving average (see SPY chart below)
SPY is trading ABOVE its 50-day simple moving average, 20-day EMA and 20-day Bollinger Band SMA(see SPY chart)
Relative Strength Indicator (RSI) is extremely bullish See Spy chart below
Moving Average Convergence/Divergence (MACD) indicator is bullish, but starting to turn down See Spy chart below
Bear Call Spread
Since the middle of July the market has surprised virtually everyone by surging straight up relatively unabated and converting our low-risk opening Bear Call credit spread into an unfavorable position. Two weeks ago we recommended a series of simple adjusting trades to improve the risk profile and potentially recover most of the realized losses (See Tables below). Fast moving markets are the bane of market neutral trading strategies such as the Iron Condor. The flurry of positive economic data released this week injected more fuel into the market, and the SPY bounced up once again. Our open call spread position has soured from breakeven to a $900 unrealized loss, and is threatening our short call strike price!
Bull Put Spread
Several weeks ago the Bull Put spread was closed out for an approx. $1,050 profit shown as shown below (this profit helps offset the loss from the call spread) . There was as general perception that the current market advance was overextended and due for at least a pause, if not a pullback. And with many weeks left until the August option expiration date, it was reasonable to assume there would be an opportunity to do another August put spread trade (to further reduce the overall SPY Condor loss position). But with only two weeks until August expiration this possibility is now very unlikely.
The SPY has gained 14.9% over the last four weeks, and is up 49.4% from a twelve year low in March. Whether one perceives the market to be "overbought" does not matter. The reality is that as long as there are more buyers than sellers, the market will move higher, regardless of whether institutional investors are fully participating. The market moves up (or down) whether we want it to or not, and it is very risky going against a strong trend. Last weeks commentary mentioned the risk that our $102 short call could be threatened; obviously that threat has now become real. If we decide to close the current call spread, at this point, the most probable adjustment might be to roll the position out to next month.
Since we closed the Bull Put spread, the only risk we have to manage is the $102 short strike on the adjusted call spread. The risk associated with the sold call will be evaluated and resolved based on the Exit Plan below.
The rules for exiting the Bear Call spread are:
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.
If the short call strike price is penetrated (closing price above the short call) AND the delta (probability of option expiring in the money) 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 the short strike 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 expire worthless and we keep the entire sold premium for any open contracts where the short strikes are not threatened.
We initiated the SPY Iron Condor as one order with four legs. The Bull Put spread has already been closed. The Bear Call spread will be closed out as a separate order following the Exit Rules described above.
Last week we mentioned the value of following our trading plan and honoring our exit rules! The market is like the spoiled child who does not always do what you want him/her to do and tends to behave badly when you least expect. Even the smartest, most experienced traders suffer occasional losses. But you can be absolutely certain that traders who have been in the game a long time have managed to survive in part due to risk management. For us this means that we have fundamental and technical indicators that signal the trade has become riskier than we prefer and that we should exit the position and set up for a more profitable trade. If one can successfully recognize and manage risk, it is easier to avoid becoming overly frustrated; we can think objectively and get back on track with making profitable trades.
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.