The reason we look at charts is to try to find a pattern in the past that could reflect the direction to come in the future.  We’ve all read the disclaimers that read, past performance is not indicative of future results, but we keep looking back anyway.  Of course, I believe charts can help predict future results or I wouldn’t be so dependent on charts for my trades.  I also realize that indicators might work the majority of the time, but all fail at some point.  That’s what keeps the “novice investors” at bay.

Many of the indicators in the current chart are bearish.  I didn’t even include the 10 and 20 day moving averages (dma) in this week’s chart, but I can mention they are still showing a bearish signal with the 10 dma below the 20 dma.  The shortest trend line of lower highs from March through mid-May broke support last week too.  That leaves few trend lines to watch until some potential horizontal support comes back into play.  The first of those lines is about 30 SPX points away (2%+) and is just below the 200 dma.  The 200 dma is a major moving average to watch.  If it breaks and doesn’t find support immediately at the horizontal line shown below, the market could quickly drop another 5-8% as computer models initiate sell orders without another level of support close by.  The October and November intraday lows are likely the best areas to expect the computer models to start pumping in new buy orders.  The December low would be an 18% correction from March high.  A retest of the October intraday low would be a correction of almost 25% and have the market in deep bear territory, but close to average bear market correction levels.  Buying in here would be a relatively safe long term investment and buyers should be ready to storm in for above average future returns.

Before those depths can be reached, the SPX has to deal with an anomaly in the Williams %R indicator seen at the end of the week.  I always point out that Williams %R is a great indicator to use after a bottom has been reached, not to pick the actual bottom.  It’s when the indicator moves out of the oversold (0r overbought) area that the next good trade signal is issued.  But is this time different?  In late November the 14 and 28 day indicators ran off the page as both time periods hit -100.  Within two days the market was on to a new rally.  On Thursday the 14, 28 and 56 day periods all hit -100 on the Williams %R indicator.  This is the first time I’ve seen all three periods at that level (I only went back a few years to double check).  In November it helped to trigger such a strong rally that I started watching for it again.  Based on the proximity to the 200 dma, the longer trend line of higher lows and the extreme negative bias in the markets, this could be another signal to buy right now or at least cover shorts.

With the valid reasons for pessimism coming out of Europe, a bounce could be short lived for the S&P 500.  At the same time, stock valuations are going to be hard for value investors to ignore for long.  The rest of the summer is going to be interesting, but don’t be shocked if stocks do not retest their 2011 lows.  Are any investors out there really surprised that Greece’s debt issues are still a concern and will lead to further trouble for the EU?  Isn’t a lot of that built into stocks prices?  Isn’t that part of the reason the SPX’s P/E multiple is so low when compared to historical levels?

That’s one way of looking at it.  Another view is that I’m going to be able to buy into four positions I like for the long term and will be getting in at a discount from where they were trading when I made the trades.  That’s what I’m telling myself at least.  I didn’t roll any of these into months farther out because I’m not sure the strikes I want to use yet.  I think the markets are very close to a bottom based on these three factors.

1. The S&P 500 is down almost 9% from its intraday high.  10% was the low end of my earlier target for a correction.
2. Greece fears are worse than I figured they’d be by now.  (I expected it to be next year.)  Today’s decline is bigger in part due to options expiration volatility, but also because many traders don’t want to be long equities going into the weekend with so much at stake in the euro-zone.  Whenever Greece leaves the euro (don’t we all know it’s not an “if”), it’s probably going to happen on a weekend, so fear mounts late on Fridays during times like this.  Even bonds (as seen through TLT) are somewhat flat today.  There’s not a rush to another investment.  It’s just a rush to cash.  With years of warning about how bad Greece’s debt issues are, I won’t be surprised to see the markets start their recovery once Greece is on their own, out of the euro.
3. The Williams %R indicator is down to -100 again.  This shows it running off the chart, literally, for the 14, 28 and 56 day periods.  The last date this happened on the 14 and 28 day periods was on 11/23/12 – a day before the beginning of the rally that lasted four months.  I noted this in the DJIA chart and the SPX chart at the time.

Ideally I’d like to see a “whoosh” lower on Monday for stocks to knock out the last of the skittish investors.  From there stocks can climb the “wall of worry” all of the way back up.  If not all the way back up, a 50% retracement is certainly in order after such a steep fall.  That might be a better time for me to sell covered calls than at today’s prices.  Of course stocks could just keep falling.  I almost bought a handful of wide SH call spreads, but want to see if my %R theory works out for me first.

This is how my four contracts expired today:

• DIA May $133 put – Expired about $9.70 in the money.  I still have a DIA June 114/116 put spread.  As with the next two index ETFs, I think the underlying will recover.  The trick is how long does it take.  My current plan is to sell covered calls at the strikes I was assigned, but not until prices recover some, as mentioned above.  I might sell calls earlier at lower strikes if we don’t get the bounce I expect very soon.
• SPY May $143 put – Expired about $13.25 in the money.  I still have a SPY June $137 put which might drive me to using a $137 strike for covered calls.
• IWM May $84 put – Expired about $9.40 in the money.  I still have June $80 and $83 puts.  Yes, I sold these near the top when I got overly ambitious and started selling in the money puts.  I knew better, but can’t fix that mistake now.  I can just manage what I have.
• QCOM May $67.50 put – Expired about $11.50 in the money.  I also have a June $62.50 put.  I expected QCOM to bounce around a lot before I got into it, but this has been more than expected.  The position isn’t an overly sized portion of my account, so I plan to stay long and wait for the recovery that I believe will happen eventually, probably about the time AAPL recovers.

I started playing with TBT (leveraged inverse 20 year treasury ETF) spreads to see what I could come up with to profit from this extreme volatility.  My initial instinct was to buy a call spread to profit from the collapse of bond prices (and matching TBT rally) that should hit within the next month or so.  The issue with that is that if I’m wrong I’d lose twice, once on my TLT calls and then again on the TBT calls.  I ended up doing the reverse, buying puts.  While TBT was trading at $16.50 (and TLT was at $123.75) I bought five TBT June $16 puts for $0.45 and sold five TBT June $14 puts for $0.08.  I paid $191.25 for the $0.37 spread including commissions and have a little more than $800 upside potential including closing commissions.

If the trading gods give me a hand, I’ll be able to take a profit on this trade during June (if not before) and then finish with a profit on my TLT calls in July too.  I don’t think bond prices are going to stay this elevated through July expiration, let alone above $127.  Previous moves in TLT that came near this price area were part of a spike that was short lived.  This could be a black swan moment and if so, I’ll profit on my TBT puts and if I stay wrong long enough I’ll lose on my TLT calls.  Once the turn lower in bonds starts, I plan to buy TBT calls, maybe not with a spread, but just an outright buy.  The only issue with TBT over the longer term is that it is flawed and loses value over extended periods, I assume because of its leveraged set-up.  For that reason I don’t want to go all of the way out to September with my bullish TBT trades.  July options will be available in a few days, so I’ll be able to consider new strikes then.

I might be kicking myself in a week with regret that I didn’t give myself more room to profit in a bond price drop, but I figure my equity positions will be back in rally mode whenever that happens, so I don’t need to add more risk to that side of the trade.  If tomorrow doesn’t give stocks a worthwhile move higher, I’ll probably buy some SH calls or sell SH puts.  That will probably be a signal for all of you to get bullish since I haven’t done well with timing these SH trades in the past.  I also have four puts expiring tomorrow.  All are deep in the money right now, so I have to decide if I want to take the assignments (assuming it doesn’t happen to me before I get to make the decision) or close them for a loss.

The puts had a bid/ask of $0.01 and $0.03.  I thought I could close it at $0.02, but when that order didn’t hit for a while and I saw EEM regaining some of its losses I gave in and changed my order to hit the asking price.  While EEM was trading at $38.98 I bought 20 EEM June $43.50 calls for $0.08 and sold my 20 EEM June $44.00 calls for $0.05.  I paid $98.58 with commissions to close this side.  Originally I took in $247.03 for my call spread, so this gave me a profit of $148.45 for the calls.

Together, my realized loss was $211.60.  While I’m annoyed I took a loss at all, I would’ve taken a bigger loss if I had bought 100 shares of EEM when I made this trade.  I could’ve taken a smaller loss if I let the calls expire worthless, but there’s no guarantee the shares won’t bounce back and I figured I should get out while I could for only three cents and commissions.  I still think EEM will close at June’s option expiration between $39.50 and $43.50, but the risk wasn’t worth the chance, especially with the market misbehaving lately.  I almost closed the iron condor a few days ago and could’ve done it cheaper, but was waiting for support between $39.00 and $39.50.  When we didn’t get a bounce today for more than a few minutes I decided I had to exit with a small loss while it was small.  Letting it run could’ve cost me another $440 and that didn’t seem too appetizing with EEM trading below my long put’s strike.

My TLT call spread has doubled in value, but I’m letting it run longer since it’s still $5.70 out of the money which is more than 4.5% from the current price.  Some analysts say the long term yield will fall below last year’s low (i.e., bond prices will go higher than last year).  I’m not sure that’ll happen and have a $2.00 cushion above last year’s TLT intraday high and nearly $4.00 from the closing high last year before my short call comes into play.  I have more than an 8% cushion on my DIA put spread.  So, I’m not worried about it yet either.

I thought about opening a QQQ put spread 10% out of the money today and decided to hold off a few more days to see if the market turns higher first.  I’m glad I waited.  QQQ has fallen about $0.80 since I was eyeing that trade.  I’ll be back to it, but don’t have to rush to it yet.  I might look back and say today would’ve been a good day to buy more on the dip, but I have enough in the money puts to appease me if we get a rally.

I went back six months on this chart so I could point out where the DJIA had its 50/100 day moving average (dma) bullish crossover at the beginning of December.  I pointed out this majorly bullish technical indicator on the S&P 500 on the December 2nd chart.  Following that call, the Dow and SPX had nearly four months of bullish trading.  The reverse crossover has not happened yet, but the Dow chart has traded below its 50 dma for more than a week and has dipped below its 100 day a few times recently, including Friday’s close that was slightly below it.  These are all warning signals, but aren’t necessarily sell signals yet.  The true sell signal will come when the crossover actually happens.

The sell signal that I missed (but am not stressed about yet) was from the Williams %R indicator.  When it broke below the overbought range I didn’t react right away because I think it tends to give false positives sometimes and needs one or two confirmation days before I generally trade on it.  In this case it broke and by the time it got the confirmation days it found support.  I might be playing with fire by not adhering to the indicator’s signal, but the 100 dma will be important to watch for real support.  In addition, the trend line of slightly lower lows that started in February is still holding support.  I’m in the mindset that we’re in a trading range right now and this past week’s intraday lows are just testing the bottom of the trading channel.  I’d like to say this is a good buying opportunity, but want to see more than just support.  I want to see a bounce before I get bullish too much.

The 10/20 dma crossover (not shown) favored the bulls just a couple of weeks ago, but that ended up being one of those devilish false positives.  Now the tables have turned and the 10 and 20 dma are close to having another crossover, but in favor of the bears.  If the bears truly gain control for more than half a session, the Dow could fall all of the way down to its 200 dma, around 12,150 now, but edging higher every day.  That would be close to a 9% decline from the intraday high seen recently.  Unless Europe falls apart quicker and more severely than expected, falling more than a 10% correction is unlikely in the near-term.

The DJIA went through a period like this last summer and fall where my favorite indicators toyed with me.  What I learned was that when stuck in a trading channel these shorter-term indicators don’t work as well.  Of course the trick is knowing when it’s a trading channel and when it’s an actual change in longer term sentiment.  For now, I’m banking on it being a trading channel that will hold support, but I do have a finger on the sell button, just in case the trend line at the bottom fails.

Happy Mothers’ Day!

When I closed the May put, I also sold one MDY September $182 naked put for $12.50 and received $1,249.70 after commissions.  My net premium intake was $648.67 for this calendar spread.  I did this for a couple of reasons.  I am getting close to being on margin due to most of my options that are on the way to being assigned and wanted to make sure I kept some cash handy, even if it’s spoken for later in the year.  By going out a few more months than usual I also was able to bring in a lot more in premiums so my cost per share is reduced even more if the option is assigned at or before expiration.  I didn’t want to sell out of the money because I think we still have higher days ahead, although it might not be right away.

By rolling this option I was able to keep cash available, maintain exposure to mid-caps and left a lot of upside potential if stocks rally again.  I thought about selling a June contract, but wanted a better cushion if stocks don’t recover as soon as I think they will.  This September contract gives me 3.86% downside protection and 7.37% upside possible (19.9% annualized).  Having the potential of making more than 7% in just over four months works for my plans.  I’m expecting this summer to be full of tension out of Europe which will keep stocks range bound.  By the end of the summer or early fall stocks will be finished with this consolidation phase and start moving higher.  My September contract will expire then and I’ll be able to adjust accordingly.

I chose this strike because I wanted to go close to 10% out of the money.  The $116 strike gives me 9.67% cushion and I figured that was close enough to my target with only five and a half weeks left before expiration.  Although it could happen, it’s extremely rare that the Dow falls 10% in less than two months, let alone five and a half weeks.  Also, DIA is already 3.6% off of its intraday high from less than two weeks ago.  Including that extra cushion I think this is a very low risk trade.  The call spreads I looked at didn’t offer close to the same returns, so I backed off from trading an iron condor again and left the trade with puts only.

With $211.00 in potential profit and $3789.00 at risk, I can make up to 5.57% on this trade.  That comes out to a monthly return of 4.5%, assuming I let it go all of the way to expiration and the puts expire worthless.  Instead of looking at annualized returns on these spreads I’m watching what my return could be on a monthly basis.  I’m thinking a little farther down the line, when I’ll need to use some profits for income next year, and want to get an idea of how much I can start to plan on, reliably. My goal is to average around 2.5 – 3.0% per month on these trades, but not make spreads a majority allocation for my account until I’ve been trading them for a couple of years.

Since using spreads hasn’t been a regular trade for me over the past decade I don’t know how much I’ll use them from now on.  I like the idea of using 90-95% of my account for slightly out of the money naked puts (and soon to be covered calls too), and another 20-30% with far out of the money put and call spreads.  Those ratios should push me close to a steady 15-18% return annually with less volatility than using more at the money and in the money options. Right now I have about 103% allocated to naked puts and less than 7% allocated to spreads.

Around the time all of that was brewing, when TLT was trading at $119.10 I sold 10 TLT vertical call spreads for a net $0.16 credit and received $145.50 after commissions.  I sold the $127 strike calls for $0.44 each and bought the $129 strike calls for $0.28 each.  Thanks to some advice I’ve received via email since my EEM iron condor trade on Friday I moved farther out of the money with this trade to decrease the probability of the short call moving in the money.  I also had to push the expiration to July instead of June to bring in a net premium worth trading.  Originally I priced spreads that had much lower strikes and would’ve given me much better returns, if they didn’t go against me.  I decided the risk wasn’t worth the possible gain.

I’m risking $1,854.50 with this trade which makes my potential return 7.85% in less than 11 weeks.  I doubt I’ll let it run until expiration unless TLT tanks within the next month and the chance of assignment drops even farther.  My plan is for TLT to not gain much more, if any, over the next four to six weeks.  By then, the far out of the money contracts’ value will have dropped significantly and I should be able to close the spread early and move on to something new.  TLT topped out at $125.01 in October last year.  I don’t think it’ll get back up there before July expiration.  I don’t even think it’ll get above $122, but for a 7.85% gain, I saw no reason to push the limits.  I’m still fully invested with my other option positions and most of those are in the money.

What I’m learning about trading these spreads that is different than my usual naked put trades is low probability of assignment can be more important than raking in big premiums to start with.  As I mentioned in my EEM post, I figured that I could come out ahead if I lost on half of my trades.  That’s really not a good way to approach options.  By going farther out of the money with my short strikes I take in less, but should lose money very rarely.  That means that my total income in the end should be steadier and each position should call for fewer adjustments.  I’d like to keep my naked puts as more regular income and use put and call vertical spreads and iron condors to add a little extra earnings along the way.

The technical indicators are not giving as clear of a picture as they often do in foreshadowing what is to come in the near term.  This tends to happen when an index or stock is in a consolidation phase and is range bound.  Indicators, such as the moving averages and Williams %R can give false readings or roll over before the next trigger comes into play.

The 10 day moving average (dma) moved above the 20 dma early in this past week.  This crossover is bullish and typically indicates more positive days are ahead for the bulls.  However, within a couple of days, the 20 dma moved below the 50 dma.  This is often indicative of the end of a rally and can lead to weeks lower for stocks.  The direction for stocks lacks certainty without these three moving averages in agreement.

Williams %R showed a fall below the overbought range in the 14 day indicator by Thursday.  This is another bearish signal, but the 28 and 56 day periods had not made it back to the overbought range before stocks rolled over again.  This means any dip should be short lived.  Large bear markets rarely start without extreme optimism seen within longer time periods.

The lack of clarity from the moving averages and Williams %R leaves the trend lines to tell traders the story.  The area of resistance to watch comes from the trend line of lower highs and the horizontal line that is close to multiple intraday highs.  Both of these are above 1,410 and give the SPX plenty of room to move higher from Friday’s closing level.  The downside is closer to being tested sooner.  The large cap index closed within a few points of the trend line of higher lows.  Friday’s intraday low is very close to multiple points of support and resistance over the past three months and could mark another turning point.  If Friday’s low doesn’t remain as near term support, the next area to watch is close to 1,350, about 20 points or less than 1.4% below Friday’s close.  Another 1.5% lower will shake out more of the nervous traders and will bring the S&P 500 to a point where value investors can start picking up stocks that have been dragged down with the masses.  This will stop the exodus from stocks and move the index back towards the middle of its trading range where it could stay for another month or longer before breaking to the upside unless a new catalyst surfaces to warrant more selling.