Weekend Portfolio Analysis (November 7, 2015)

Market Conditions

Liftoff! A surprisingly strong non-farm payrolls report (271,000 actual vs. 180,000 expected) on Friday pushed stocks down slightly, while boosting the U.S. dollar and hammering precious metals and bonds. The unemployment rate fell to 5.0%, the lowest since April 2008. Average hourly earnings rose by 0.4% from September and were 2.5% higher than a year earlier. It was the highest year-over-year wage increase since 2008. After the robust payrolls report and comments by U.S. Federal Reserve Chair Janet Yellen earlier in the week, the likelihood of a quarter-point fed funds rate hike at the December policy meeting has increased from 58.1% to 69.8%. Equities advanced for the sixth week in a row, and the S&P 500 is now less than 2% below its all-time high. The SPX opened Monday at 2,080.76 and closed Friday at 2,099.2, up 18.44 or 0.89% for the week, but traded as high as 2,116.48 on Tuesday.

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U.S. crude oil inventories remain near levels not seen for this time of year in at least the last 80 years, according to a EIA report this week. In its Weekly Petroleum Status Report released on Wednesday, the Energy Information Administration reported an increase of 2.8 million barrels in crude oil inventories for the week ended October 30, 2015. Analysts were expecting inventories to rise by a slightly smaller 2.5 million barrels. In addition to the inventory increase, the rally of the U.S. Dollar put further downward pressure on crude prices. Baker Hughes reported the number of oil rigs operating in U.S. fields fell by 6 in the previous week to a total of 572, compared with 1,568 at the same time last year. West Texas Intermediate crude oil logged its third weekly decline out of the previous four weeks opening on Monday at $46.43 per barrel and closing Friday at $44.52, down 1.91 or 4.11%.

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Gold also struggled this week due to the increased anticipation of an interest rate hike at the end of the year. Gold loses value as interest rates climb because it doesn’t pay interest and costs money to store, making it less appealing than Treasury bonds in an environment of rising rates. The monetary-policy shift is also expected to boost the dollar, which also negatively impacts commodities futures that are priced in U.S. Dollars, such as gold and crude oil. After this week’s jobs report, gold futures dropped over 1.5% ending the week at $1,088.90 per ounce.

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Trade Activity This Week

This week was a fairly busy week for trading as I began to unwind the /ES straddle positions for the November expiration cycle.

The /ES Nov 1950 straddle has been a problematic position as I have continued to make a number of adjustments to the original trade in an effort to reduce risk and overall losses. As previously discussed in the Weekend Portfolio Analysis for the week of October 24, I had rolled up the nearly worthless 1950 put to 2065 to bring in more premium. This resulted in an inverted strangle bounded by the 1950 call and 2065 put. As the market has continued to march higher without looking back, I decided that I could no longer take the pain of the deep in-the-money 1950 call. I had actually tried to close this out the previous week when it was trading around 139, but was never filled. I finally was able to buy back the call on Tuesday for an unprecedented $4,717.82 loss. Of course, as soon as I exited the call, the market started to pull back (which it did for the rest of the week). But I never claimed to have good timing! I immediately sold the /ES Nov 2160 call for $2.00 ($100 credit received). At this point, it is important to take in any additional premium that can help offset the loss. Adding the new out-of-the-money call results in the more traditional 2160/2065 strangle where both the call and put are both out-of-the-money. As the market declined mid-week and with the potential of a sell-off on Friday due to the non-farm payrolls report, I decided that I would roll down the 2065 put to 2040. I exited the Nov 2065 put for a $619.68 profit after commissions and sold the Nov 2040 put for $8.75 ($437.50 credit received). My plan is to allow the new 2160/2040 strangle to expire in two weeks, unless the market continues to move down. Should this trade expire worthless, the total loss on the 1950 straddle will have been $975 after taking into consideration all of the adjustments. Below is the current risk profile of the trade.

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Also on Thursday, I closed the /ES Nov 1985 put for a $1,697.18 profit. This was the last remaining option as part of the /ES Nov 1875 straddle. The previous adjustments were detailed in Managing an /ES Straddle. I had originally planned to let the option expire, but with the risk of a market decline on Friday, I just decided to take the money and run since I had collected nearly all of the available premium. With all the adjustments and commissions, my net loss on the /ES Nov 1875 straddle was only $225.96, which is quite remarkable considering how far the S&P 500 has moved since this trade was originally placed.

In the early part of October, I placed an earnings trade in YUM! Brands (YUM) which moved against me significantly. The details of that trade can be reviewed in the Weekend Portfolio Analysis for the week ending October 10th. I was assigned the stock and wrote the Nov 72.5 covered call against it. For a period of time, YUM was trading above 72.5 and I was hopeful that the stock would be called away. That did not happen and the stock is now beginning to struggle again. On Friday I bought back the Nov 72.5 call for a $98 profit after commissions and sold the Nov 71 call for $1.63. If the stock is not called away at expiration, I will likely write one more weekly covered call and then close out the position for a scratch (or slightly better).

With the huge selloff in gold on Friday and the increase in volatility, I opened a new trade:

Trade Details:

SELL 1 /GC Jan 16 1250 Call @ 0.70
SELL 1 /GC Jan 16 930 Put @ 1.30

Credit: 2.00 ($200.00 per contract)
Max Risk: Unlimited (Breakeven Prices: 928 / 1252)
Margin Required: $741.00
Days to Expiration: 52

This is a high probability trade with a 94% probability of profit. I will exit the trade at 50% of max profit ($100 profit/contract). I will exit the trade at a loss if the strangle trades at $5.78, capping my maximum loss at $378 per contract. Below is the risk analysis for the trade.

Analyze_110615_GC

Note that I have stated an exit plan for this trade regardless of whether it is profitable or not. Historically, I have always had fairly clear rules for exiting a profitable trade in my trading plan. However, knowing when to exit a losing trade has, unfortunately, been more of an emotional decision and not clearly defined in my trading plan. I now have clearly defined rules for exiting a losing trade and with all new trades that I make, I will establish the exit points when the trade is placed. This should be a game changer for my trading. Within the next few weeks, I plan to publish an article detailing the rules that I am using for establishing my exit points.

Plan For Next Week

I will continue to watch and manage the /ES Nov 2160/2040 strangle as well as the Dec 2025 straddle. Once these two positions are closed out, I can get back to business “as usual”. With the huge market melt-up right as I began trading the strategy has proven to be a costly mistake in a small account. Although, I will not exit these trades unscathed, I am confident that by returning to my core strategies (strangles, put spreads, etc), I can recover quickly.

Despite this month’s drawdown, the portfolio is still up 23.65% for the year versus 1.96% for the S&P 500 (see Trading Results).   The portfolio is currently 15% in cash.

  • “Within the next few weeks, I plan to publish an article detailing the rules that I am using for establishing my exit points.”

    I am looking forward to this article. The large unexpected move is always a possibility in the market. We have to use risk management to ensure that it does not blow up our entire account. To be successful in the long term, one must have a well-defined and robust system of rules to manage the risk. I have never seen any consistently profitable trader who trades based on emotions and gut instincts.

  • Tony

    Thanks for the update Aram. I’m looking forward to your exit rules as well as I haven’t really been disciplined in that area.