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?

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.

Since this isn’t my typical trade I’m really interested in hearing some feedback from readers.  I already have a little trader’s remorse in how I executed this trade.  I’m fine with the strikes I sold, but since commissions were so hefty with this many contracts traded (80 total: short 20 calls + long 20 calls + short 20 puts + long 20 puts) I think I should’ve done 10 on each side and made the spread $1.00 instead of $0.50.  In other words, it’s the strikes I bought that I’m second guessing.  The price of EEM has changed since I made the trade, but it looks like the total premium intake would’ve been very close, if not better, with the wider spread.  I’ll pay more attention to both spreads next time.

Also, since my initial orders didn’t hit on the puts and I ended up changing and then canceling my original order I will get spanked with another fee from IB for the change.  It won’t be bad in comparison to the $414.20 I brought in, but it’s still another cut into my profit.  If EEM stays within my expected trading range until expiration (if I let it run for that long) I’ll make a 63.50% return (NOT even annualized) based on dividing my potential profit ($414.02) by the money I have at risk (1065.98-414.02).  I can’t lose on both sides, but can “win” on both.  EEM would have to fall 5.32% to make my puts lose money and EEM would have to rise 3.96% for my calls to lose money.  Since I’m working these vertical spreads on both sides, my ratio of potential profit to potential losses is pretty good.  If I repeat this type of trade over and over, I only have to get it right half of the time and I’ll still be ahead of my losses.  I’m putting aside $5,000 (virtually) to try these trades and see if I can work out the kinks.  I’m going to try to use underlying ETFs and stocks that I don’t have current positions on so I don’t get mixed up with my goals for each.  I’m sure my learning curve will be faster with input from some of you, so let me have it – the good and the bad.

I’ll probably write a review of the options book I mentioned above once I finish reading it.  For now, I’ll say it’s nothing Earth shattering.  However, it helped lead me to consider other approaches.  Even though I’m not following his methods I did start down this path of thinking based on how he trades and what I considered too risky with it.

The DJIA hit its 2012 closing high intraday on Friday after nearly three weeks of being in rally mode.  The rally cooled at that point, as is typical when an index or stock reaches its previous high.  This was only a handful of points below the intraday high for 2012 too.  Now it gets tricky.  The large cap index is at the top of its horizontal trading range for the past couple of months after a strong rally, but technical indicators are still saying there’s more upside in this rally.  The 10, 20 and 50 day moving averages (dma) all converged at the end of this past week and the momentum is clearly leaning towards the bulls.  As shorter moving averages overtake longer ones it shows momentum favors higher days still ahead.  This is particularly true with the 10 and 20 dma which cross each other more often.  However, after such a quick pop higher, a short retracement back to the 10 dma can be fairly common.  This will be another buying opportunity (if it even happens) once the moving average shows support again.

Before the moving averages caught up to the change in sentiment, the Williams %R indicator gave a good heads up that this move was coming.  Both the 14 and 28 day periods hit a low of -99.08 and then popped higher as momentum quickly changed.  Now, all three periods (14, 28 and 56 day) are all comfortably in the overbought range.  The rally can last weeks or even months while “overbought”.  Keep watching this indicator to see a change in sentiment marked by a confirmed move below overbought.

I charted the three month view because I consider the moving averages important enough right now and wanted to make sure they were visible.  It’s worth noting that the six month and one year charts show the market is in the middle of its longer ascending trading channel and the bull market doesn’t have stiff resistance at the current levels.  Actually, the Dow is only hitting a small speed bump on the longer charts at a line that was support and has since been occasional resistance.  The top of the longest trend line of higher highs points above Dow 14,000.  Oh, but it’s almost May.  Should we sell and go away or is that too much of what’s expected now and therefore won’t happen?