Bear market proponents have been predicting a correction for a while and now they may be on to something. Despite basically being overbought for over a month, every time stocks would try to sell off, prices would quickly recover and climb higher â€“ last week this did not happen. Recent company earning pronouncements have been favorable but the deluge of negative headline stories (i.e., the European debt crisis, Goldman Sachs woes, BP Gulf oil spill) has cast a somewhat negative pall over the market. Very soon we should know whether this is the early stages of a correction, or just pause while traders figure the next price direction. For our credit spreads, a market pause is the best-case scenario as this should allow our short strike premiums to erode and minimize our risk.
SPY Position Update
Listed below is the status of our SPY Iron Condor trade as of Friday April 30th. This position has been open for 30 days:
The entire position is approx. at breakeven
SPY closed at $118.81
30-day historical volatility and implied volatility have increased considerably over the past week - especially implied volatility, which is nearing the midpoint of its 52-range, this is a bearish signal
SPY has dropped BELOW its current 14-day EMA (see SPY chart down below)
SPY is trading EVEN with its 20-day Bollinger Band SMA (see SPY chart)
SPY is still priced ABOVE its 50-day simple moving average (see SPY chart)
SPY is still well ABOVE its 200-day simple moving average (see SPY chart)
Relative Strength Indicator (RSI) has dropped to neutral (See SPY chart)
Moving Average Convergence/Divergence (MACD) has turned bearish (See SPY chart)
SPY Bear Call Spread
The April 29th Couch Potato recommended closing out the initial call spread for an approx. $200 loss and following up with a TRADE ADJUSTMENT to roll up the call spread to a higher strike price (see tables below)
The Bear Call adjustment is approx. $380 in the black (see tables below)
Our $124 strike price short call delta is .1356 (86% probability this position will be profitable)
SPY Bull Put Spread
The April 29th Couch Potato recommended closing out the original put spread for an approx. $880 gain and following up with a TRADE ADJUSTMENT to roll up to a higher strike price put spread (see tables below)
The Bull Put adjustment is $830 in the red (see tables below)
Our $117 strike price short call delta is -.3625 (64% probability this position will be profitable)
SPY Risk Analysis
The April 29th Couch Potato SPY Risk Analysis section mentioned "... The recent two-day price recovery presented the opportunity to open another call spread and roll-up the put spread..." Tuesday's price drop may have been a little more than just a hiccup in stocks attempted climb through the next resistance level. We did a trade adjustment on the premise that the path of least resistance is upward. Market sentiment changed almost immediately after the trade adjustment. If the current bearish mood continues our $117 strike short put will be at risk â€“ this is quite a conversion from the past few months where it seems as if we were constantly adjusting short call positions.
DIA Position Update
Listed below is the status of our DIA Iron Condor trade as of Friday April 30th. This position has been open for 15 days:
The entire position is approx. $260 in the black
DIA closed at $110.10
30-day historical volatility and implied volatility have surged higher over the past week - especially implied volatility, which is at the midpoint of its 52-range, this is a bearish signal
DIA is priced a little BELOW its current 14-day EMA (see DIA chart down below)
DIA is trading basically EVEN its 20-day Bollinger Band SMA (see DIA chart)
DIA is ABOVE its 50-day simple moving average (see DIA chart)
DIA is still well ABOVE its 200-day simple moving average (see DIA chart)
Relative Strength Indicator (RSI) has turned neutral (See DIA chart)
Moving Average Convergence/Divergence (MACD) has turned bearish (See DIA chart)
DIA Bear Call Spread
This spread is approx. $520 in the black (see tables below)
$114 strike price short call delta is .1475 (85% probability this position will be profitable)
DIA Bull Put Spread
This spread is approx. $260 in the red (see tables below)
$108 strike price short put delta is -.3324 (67% probability this position will be profitable)
DIA Risk Analysis
After eight consecutive weeks of gains the DIA finally had a down week and has broken below the lower level of its bullish channel. The bulls may no longer have the best hand and if the current bearish technical chart patterns are accurate our $108 strike short pull will be threatened.
The rules for exiting the SPY and DIA credit spreads are:
Anytime the market maker is willing to accept a limit price of less than .06 on one of our short strikes, buy back all the short contracts and sell the long positions on the same spread.
If one of our short strikes is penetrated (closing price above our short call or below the short put) AND after market close, if the delta associated with one of the short strikes is .65 or higher, 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. 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 opened the both the SPY and DIA Iron Condors as a separate orders with four legs each. Exiting these positions prior to expiration we will probably â€œleg outâ€ 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 both Iron Condors is dependent on following our Exit Rules described above.
It may or may not be time to cash in for the folks who have been predicting a price correction for the past month or so. The near-term resistance levels are holding fast and the question is whether prices will continue trading range-bound or is this the beginning of a market correction. Fortunately for us, there is plenty of time left before our May options expire. We have time to step back and see exactly what stocks are going to do â€“ whether the current pullback is a "head fake" or a genuine change in market sentiment. As mentioned previously, our best chance for success is to trade what we see, not what we want and avoid reacting in response to fear of what we perceive might happen.
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.