Market Summary
This has been an interesting week for the market because it has been relatively muted even though a lot of folks believe that generally, earning reports have been very good. A supercharged rally starting on October 2nd powered the SPY from 102 to the 109 level in less than two weeks. However since the initial burst, the index is struggling to sustain a breakout through the upper bull channel line even as 85% of the S&P stocks have exceeded analyst projections.

If so many companies are reporting excellent earning results, the obvious question is why isn't the market continuing upwards at an accelerated pace? There are probably many reasons the market has stabilized, but one reason is that the rally during the first two weeks of October was based on the expectation of good third-quarter reports. Another valid reason is that the SPY was resting on dual technical support levels – the bull channel support line and the 50-day simple moving average; also most oscillator indicators were at oversold levels. This was an optimum set-up to drive the market higher at the prospect of better economic data (less bad is good). Now the question is what will be the impetus to push the market higher, especially since the quality of these supposedly good third quarter numbers are being called into question?

Position Update
Listed below is the status of our SPY Iron Condor trade as of Friday October 23rd. This position has been open for 4 days:
The entire position is $520 in the black
SPY closed at $108.08
Both 30-day historical volatility and implied volatility numbers are stable both volatility numbers are near 52 week lows, which is bullish
SPY is priced right at the support level of its current 14-day EMA (see SPY chart down below)
SPY is trading ABOVE its 20-day Bollinger Band SMA, and 50-day simple moving average (see SPY chart)
SPY is well ABOVE its 200-day simple moving average (see SPY chart)
Relative Strength Indicator (RSI) has turned neutral (See Spy chart)
Moving Average Convergence/Divergence (MACD) is beginning to turn down (See Spy chart)

Bear Call Spread
This spread is $380 in the black (see tables below)
$114 strike price short call delta is .0960 (90% probability this trade will be profitable)

Bull Put Spread
This spread is $140 in the black (see tables below)
$102 strike price short put delta is -.1798 (82% probability this trade will be profitable)

Risk Analysis
In the Risk Analysis section of the October 18th Couch Potato we stated "Despite the recent pull back, the market is still in a short-to-medium term uptrend. The obvious question is how long the SPY will trade range-bound and will there be follow-through to another bull leg? In the absence of a change in market direction we should presume the uptrend will continue. Our $114 short call strike price might be at risk if the market continues to trend upwards. The 50% Fibonacci retracement level from the March 2009 low to the index all-time high is providing technical overhead resistance at $112 and we will see if this level holds. If there is a market correction, the most obvious SPY support level should be the 50-day SMA ..."

Obviously there has not been a sustentative change in market direction that would impact our SPY Iron Condor; therefore the comment above is still valid. More and more analyst are predicting some sort of market pullback, but the bottom line has not deviated since the beginning of October - the SPY is continuing to trade within upper and lower bull channel trend lines. This situation bodes well for market neutral strategies similar to the iron condor which tend to perform better in a range-bound market environment.

Exit Plan
We will follow the standard exit plan for our Iron Condor:

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 may be able to 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 another short strike price. 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
The plans of the diligent lead to profit as surely as haste leads to poverty - PROVERBS 21:5. We hear a lot of market analyst talk about the restrained volume on market up days compared to down days and how this might be evidence of a pending pullback. From a technical analysis perspective market volume is important, but whatever the volume is, it simply takes more buyers than sellers to move the market up (and more sellers to move the market down). It is true that up or down moves on higher volume might signify investor sentiment. However, there appears to be evidence that the lower volume breakout moves we have been seeing all year are happening because the retail public is "sold out" and has not been investing in the stock market. For our trading strategy, do not be infatuated with volume numbers; average volume has been going down all year, and we already review implied and historical volatility, plus the delta as part of our analysis process.

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.