Weekend Portfolio Analysis (December 5, 2015)

Market Conditions

Volatility returned to the stock market briefly this past week as the VIX rallied to 19.35 on Thursday. Economic data was released all through the week, but the main drivers of the market activity were… you guessed it… economic stimulus and interest rates. Thursday morning, Mario Draghi announced that the ECB would expand its stimulus program. However, the amount of stimulus was disappointing causing European and U.S. markets to react negatively. Thursday’s drop in the SPX was the biggest single-day decline since the October rally began. On Friday, the Non-Farm Payrolls report was released indicating that the U.S. economy added 211,000 new jobs in November (200,000 expected) with the unemployment rate remaining unchanged at 5%. The strong report all but ensured the first interest rate increase in nearly a decade. Throughout the rest of the day, the markets rallied erasing all of the previous day’s losses. The SPX opened Monday at 2,090.95 and closed Friday at 2,091.69, up 0.74 or 0.04% for the week.

Chart_120415_SPX

The SPX chart now has heavy resistance in the 2080-2100 area, where it spent most of the previous two weeks. The 2020-2040 range is acting as support. It will be interesting to see whether the market will move outside of this range before the the end of the year.

U.S. crude stockpiles unexpectedly increased in the week ending November 27th according to data released Wednesday by the U.S. Energy Information Administration. Crude oil stockpiles rose by 1.2 million barrels to 489.4 million barrels (analysts were expecting a drop of 300,000 barrels). This marks the 10th straight week of increases in stockpiles. On Friday, crude oil prices took another tumble when OPEC announced it would be keeping production at 31.5 million barrels per day. WTI crude opened on Monday at $41.77 per barrel and closed Friday at $40.14, down 1.63 or 3.9%.

Chart_120415_CL

As seen on the chart above, crude oil appears to have very strong support at the 78.6% fib retracement level. Despite this weeks decline and increase in volatility, oil has not yet ventured below this level.

Trade Activity This Week

This weeks increase in volatility in both stocks and commodities offered some great trading opportunities. On Monday, the price of the iShares MSCI Brazil Capped ETF (EWZ) dropped to its lowest point in eight weeks resulting in an increase in volatility. I decided to take a small non-directional position by selling a strangle. The trade is outlined below.

Trade Details:

SELL 2 EWZ Jan 16 26 Call @ 0.25
SELL 2 EWZ Jan 16 19 Put @ 0.29

Credit: 0.54 ($54.00 per contract / $108.00 total credit)
Max Risk: Unlimited (Breakeven Prices: 18.46 / 26.54)
Margin Required: $564.00
Days to Expiration: 46
Probability of Profit: 73.96%

Analyze_120515_EWZ

This trade offers a bit of diversification to the portfolio and is one of the reasons that placed it. As usual, I plan to close the trade when it reaches 50% of maximum potential profit. In the event that the trade does not work out, I have also set an exit point of $1.12 per contract to contain the loss since it is an undefined-risk trade.

This past week there was a lot of oil-related news scheduled which had the potential (and did) move oil prices – stockpiles and rig counts on Wednesday and the OPEC meeting on Friday. This helped drive up the implied volatility in the /CL options early in the week. With IV Percentile pushing upwards of 75% and the looming binary events of the week, I decided to sell a straddle on Tuesday.

Trade Details:

SELL 1 /CL Mar 16 44 Call @ 3.22
SELL 1 /CL Mar 16 44 Put @ 3.49

Credit: 6.71 ($6,710.00 per contract)
Max Risk: Unlimited (Breakeven Prices: 37.29 / 50.71)
Margin Required: $2,560.00
Days to Expiration: 78
Probability of Profit: 53.6%

I have had mixed results with these big-boy straddles when trading them using /ES options. However, I have had good success when trading them using /CL options provided that I follow my rules carefully (selling only in very high implied volatility). To further protect myself from the large drawdowns that can occur when trading these large straddles (which I have firsthand experience with), I used the Kelly formula to determine an exit point should the trade move against me. In this trade, the exit point was set at $7.11. If the straddle had traded at or above $7.11, I would have exited and taken the small $400 loss. However, that was not necessary. On Friday, I was able to exit the straddle profitably. IV Percentile dropped from 75% to 55% shortly after OPEC announced their plans to not cut production resulting in a significant drop in the option prices. I was able to buy back the straddle for $6.36 locking in a profit of $335.76 (13.1% return on capital) after commissions in just 3 days.

On Thursday, as the markets were making a strong move down, the VIX expanded sharply and I took advantage of the opportunity to sell some more premium. In this scenario, I sold a credit put spread using January /ES options. Since this is a defined-risk trade, I felt more comfortable placing the short put strike a bit higher than I would if it was undefined-risk. The short put was placed at the 84% probability of expiring out-of-the-money (approximately 16 delta).

Trade Details:

SELL 1 /ES Jan 16 1915 Put @ 12.50
BUY 1 /ES Jan 16 1895 Put @ 10.50

Credit: 2.00 ($100.00 per contract)
Max Risk: $900.00 (Breakeven Price: 1913)
Margin Required: $246.00
Days to Expiration: 43
Probability of Profit: 87.95%

Again, I will close the trade at approximately 50% of maximum profit. If the market starts to threaten the position, I have several options. Either I can exit at my predetermined point (when the spread is trading at or above $4.70) and just take the $270 loss, or, I can attempt to manage the position. Puts and put spreads are easier to manage than calls, however my experience is that when I attempt to manage a position it is often just delaying the inevitable (loss).

On Friday, in addition to closing the /CL straddle, I also closed out two contracts of /CL calls that I had sold two weeks prior. On November 20th I sold 2 contracts of the /CL Feb 63 calls for $0.07. On Friday I closed them out for $0.03. This resulted in a $65.76 profit (8.5% return on capital) in just two weeks.

Plan For Next Week

This ended up being a very profitable week with virtually all of the open positions in the portfolio now showing a profit. I will continue to monitor these positions and close them as they reach their target profit (or loss) levels.

The portfolio is now up 26.11% for the year versus 1.59% for the S&P 500 (see Trading Results).  If I am able to maintain this profit through the end of the year, I will have met my goal of generating 2% per month on my capital. The portfolio is currently 36% in cash.

  • You are having an awesome return this year. I know you had some rough times but you pulled through. It has been a pleasure reading your weekend analysis.

    • Aram Basmadjian

      Thanks, Jonathan!