Market Summary
If you prefer to trade the good news - the Conference Board reported that with signs growing that the recession has ended, U.S. consumer confidence rebounded in August, especially regarding expectations for the economy six months from now. President Barack Obama nominated Ben Bernanke for another term as the boss of the Federal Reserve. U.S. home prices rose in the second quarter for the first time in three years while logging a second-straight monthly increase in June, according to the S&P Case-Shiller home-price indexes.

But if you want to trade on bad news - Mortgage financing giant Freddie Mac's monthly report showed that whatever improvements there have been in credit markets, the underlying fundamentals are still declining. One analyst commented "July delinquencies showed no improvement whatsoever, and what incremental movement there was, the figures showed accelerating credit weakness." In a mind-boggling forecast, the White House is predicting a 10-year federal deficit of $9 trillion — more than the sum of all previous deficits since America's founding. And it says by the next decade's end the national debt will equal three-quarters of the entire U.S. economy.

SPY Iron Condor
Those who have been following this commentary for the past few months have noticed that thus far we have only traded the 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. We also analyze the other major index exchange-traded funds to evaluate which ETF provides the must optimum risk/reward profile. The other major index related ETF's are the DIA (Dow Jones index, QQQQ (NASDAQ), IWM (Russell 2000), and XLE (Energy).

Each ETF seeks to correspond generally to the price and yield performance, before fees and expenses, of the associated index. Market neutral trading strategies similar to the Iron Condor usually work best in a low volatility trading environment. The advantage of doing an Iron Condor trade with an index ETF compared to individual stocks is that generally ETFs have higher volume, lower volatility, and better credit spreads. For each month's Iron Condor trade setup we perform an analysis to determine which ETF provides the best credit spread compared to the risk incurred. We are again recommending a SPY September option month Iron Condor. Selecting the September option series provides the flexibility of adjusting our positions prior to the September expiration day or rolling out to the September end-of-month quarterly option series.

Trade Setup
Since we decided to initiate a September expiration SPY Iron Condor trade, the next step is to figure out which strike prices will let us collect the most option premium AND minimize the risk of losing money.
SPY closed at $103.16 on Tuesday (24 days to expiration)
SPY is well ABOVE its 200-day simple moving average (see SPY chart)
SPY is trading ABOVE its 50-day simple moving average, 20-day EMA and 20-day Bollinger Band SMA(see SPY chart down below)
Relative Strength Indicator (RSI) is bullish See Spy chart below
Moving Average Convergence/Divergence (MACD) downward momentum has stopped and is starting to turn up See Spy chart below

30 day Historical Volatility is 16.89%. One approach is to use the Implied Volatility instead of Historical. The difference is that Implied Volatility is one of the components used in option pricing, while Historical Volatility measures actual volatility that occurred during the past 30 days. Which number to use is trader preference and generally there is minimal difference in the end result.
Upper range standard deviation is .84162, the lower range is -.84162.
Use the number of days to expiration, volatility number and the standard deviation to calculate the 80% statistical probability for the option price to close within our short strikes at expiration (allowing us to keep all of the money we collected)!

We want the Bear Call spread short strike to exceed defined resistance levels :
$104 calculated based on previous intraday highs and technical resistance levels
$107 equals the upper price level of our 80% statistical probability range
$104 is the upper level of the Bollinger Band – Solid purple line in the SPY chart below

The Bull Put spread short strike price should be below defined support levels :
$98 calculated based on previous intraday lows and technical support levels
$99 equals the lower price level of our 80% statistical probability range
$93.67 is the lower Bollinger Band level – Solid purple line in the SPY chart below

We want the Iron Condor to generate a minimum .50 net credit on each leg AND we prefer 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). The spread in tables below comply with our trading rules for initiating the September option expiration month SPY Iron Condor (based on yesterday's closing prices). The recommendation is to submit a limit order to purchase/sell the option strikes prices below.

Premium Credit $1.09
Total Option Premium Received $2,180 (Excludes commissions and fees)
Maximum Risk $7,820
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)

Risk Analysis
Technically the market clearly is in a short-to-medium term uptrend. The obvious question is whether the SPY will trade range-bound or will the next price breakout go North or South. In the absence of indicators suggesting otherwise the safe bet for us is to presume the uptrend will continue. Our $107 short call strike price will be at risk if the market continues to trend upwards. The SPY has technical overhead resistance at $104 and we will see if this levels holds. If there is a market correction, the most obvious SPY support level should be the 20-day EMA which is approx. $100 (as displayed in the SPY chart above).

Exit Plan
As with initiating the trade, the decision process for exiting our SPY Iron Condor position 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 can 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 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.

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
As discussed in the past, we will reiterate once again that for this particular trading strategy, the primary object is not to get hung up on trying to predict where the market will be in the future. Our primary focus should be to just listen to and understand what the market is 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.