Weekend Portfolio Analysis (September 19, 2015)

Market Conditions

The FOMC policy statement has come and gone and volatility is here to stay – at least until the next Fed meeting. The FOMC acknowledged positive labor market conditions in the U.S., but indicated that concerns related to an economic slowdown in China have outweighed the domestic positives. Janet Yellen stressed that these developments have weighed on the inflation outlook, contributing to the decision to maintain the current rates. However, the Fed has not ruled out the possibility of raising rates later this year (possibly as early as October). Initially the markets reacted positively after the Fed announcement with the S&P 500 Index rallying to 2,020. However, within minutes, traders rejected the Fed’s decision as markets began a decline that continued steadily with heavy volume until the conclusion of the trading week. The SPX opened on Monday at 1,963.06 and closed Friday at 1,958.03, down 5.03 or 0.26%.

Chart_091815_SPX

Volatility in /CL options picked up this week as the price of crude oil ticked up more than four percent to trade above $47/barrel on Wednesday as a report from the Energy Information Administration showed crude inventories fell by an unexpected 2.1 million barrels in the previous week. On Friday, crude oil futures saw their largest daily drop in almost three weeks as the Fed’s decision to keep interest rates unchanged raised worries about the U.S. economy and energy demand. Prices failed to find much support even after data released by Baker Hughes showed a third straight weekly decline in active U.S. oil-drilling rigs. November WTI crude opened Monday at $44.78/barrel and closed Friday at $45.32, up $0.54 or 1.21%.

Chart_091815_CL

Trade Activity This Week

It was a fairly busy trading week as I tried to position myself ahead of Thursday’s FOMC policy announcement. I closed five trades during the week and opened two new positions.

On Monday I closed the /CL Nov 63/25 strangle for a $35.76 profit (4.2% return on capital) after commissions. I also was able to exit the /ES Oct 1920 straddle with the long 1840 protective put for an $84.04 profit (2.32% return on capital) after fees. I had much higher hopes for this trade, but by purchasing the protective put (which eliminated ALL downside risk), it made the trade a lot harder to manage. The trade would have been significantly more profitable had I not added the put protection to the trade. However, hindsight is always 20/20. I was able to exit the trade for a small profit and that is all that matters. Had I held the position until Friday, I would have had a much larger profit, but I would not have had the strength to hold the trade as the market ripped higher immediately following the Fed announcement. The /ES Dec 1000 put was also bought back on Monday for a $37.18 profit (18.14% return on capital).

With the high implied volatility and a high cash balance, I was eager to re-deploy some capital. However, I did not want to have any risk exposure in equities until after the Fed announcement on Thursday. I chose to deploy capital in another crude oil position, as volatility is elevated there as well, but I figured it would be less susceptible to huge movements as a result of the a Fed policy change. I decided to try a straddle (instead of the usual strangle) in /CL. Here are the trade details:

Trade Details:

SELL 1 /CL Dec 15 45 Call @ 3.32
SELL 1 /CL Dec 15 45 Put @ 3.34

Credit: 6.66 ($6,660 per contract)
Max Risk: Unlimited (Breakeven Prices: 38.34 / 51.66)
Margin Required: $2,500
Days to Expiration: 64

On Wednesday after the EIA numbers came out, crude oil had a huge spike up which also increased implied volatility even more. To take advantage of the increased volatility, I placed a second /CL position:

Trade Details:

SELL 1 /CL Dec 15 65 Call @ 0.25
SELL 1 /CL Dec 15 30 Put @ 0.10

Credit: 0.35 ($350 per contract)
Max Risk: Unlimited (Breakeven Prices: 29.66 / 65.33)
Margin Required: $990
Days to Expiration: 62

This is one of my bread and butter trades which have proven to be extremely profitable this year. Below is the resulting risk graph for the combined /CL position as of the close on Friday.

Analyze_091815_CL

As you can see, the positions are already quite profitable. Click on the risk graph to enlarge it.

On Thursday I closed the /CL Nov 70/30 strangle for a $45.76 profit (8.46% return on capital) and on Friday I exited the Transocean (RIG) Oct 14 straddle for a $53 profit (18.53% return on capital) after commissions.

Plan For Next Week

I will likely close the /CL strangle next week as it is very close to 50% of maximum profit. I will close the /CL straddle when it reaches 10-15% of maximum profit. Depending on how the market trades on Monday, I may try adding another /ES at-the-money straddle to the portfolio. I still think there is considerable downside risk and that we will likely re-test the 1830 level, so any new positions will need to take that into consideration.

The portfolio is up 26.38% for the year versus down 4.9% for the S&P 500 (see Trading Results).  The portfolio is currently 72% in cash.

  • Jonathan

    Excellent weekend report. Your writing is as smooth as silk. Keep up the great work in your trading. It looks like you are on track for a banner year. I noticed you haven’t sold any credit spreads in a long time. Is it because risk/reward is not as attractive as your other strategies?

    • Aram Basmadjian

      Thanks, Jonathan! I haven’t sold any put credit spreads recently simply because I have not had the right setup come along. With the extreme downward pressure in the market right now, I am looking at other strategies where I can get in/out fairly quickly.

  • What you said about managing your /ES strangle is interesting. I know this might sound counterintuitive, but have you looked into broken wing butterflies at all?

    I’ve been doing some research on a strategy using them in the SPX. Specifically take a look at a 70 point x 60 point BWB positioned 20 points below the money with 35-45 DTE. Obviously the longs will keep you in the trade longer than a straddle, but the directional risk is significantly less. I like to keep my T+Zero as flat as possible with some room to run on the downside. The 70×60 BWB would need to be adjusted if/when price moves, but I think it’s an interesting starting point for a trade.

    Anyway, good stuff.

    • Aram Basmadjian

      Dan, thanks for your comments. I have never considered broken wing butterflies. I must admit that I have not studied the strategy, and cannot speak with any authority regarding it. I am always looking for new strategies to add to my arsenal, so I will definitely spend some time researching this.

      I have been enjoying your site as well. It is very informative and based on recommendations from several other trusted readers/bloggers, I have added your site to the list of TWA approved sites. 🙂

      • Awesome, thanks so much for including me in your list of sites!

        I’ll be interested to hear what you think if you do explore Butterflies more. I wandered down that path a little over a year ago and I haven’t come back. Some of their trading characteristics are really unique like the T+Zero line showing profit outside of the expiration break evens prior to expiration. At any rate, thanks again.

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