Weekend Portfolio Review (December 12, 2015)

Market Conditions

The U.S. stock market indexes came unhinged this week as hopes for a Santa Claus rally faded just as quickly as prices in crude oil declined. Volatility escalated quickly on Friday with the VIX increasing by 63% this week to as high as 25.27 before closing at 24.39. The nervousness in the markets is returning just days before the Federal Reserve is expected to raise benchmark interest rates for the first time in nearly a decade. But the real story is not interest rates, but rather crude oil. With crude oil in an apparent free-fall, there is concern about the possibility of another credit crisis. The high-yield (junk bond) debt market is heavily exposed to energy. Of the $5 trillion in junk bonds, it is estimated that over $2 trillion is financing the energy sector. If energy companies begin to default due to the low crude oil prices, it could make the 2008 housing crisis look like child’s play. In fact, this week the high-yield mutual fund Third Avenue Focused Credit Fund announced that they are blocking investors from withdrawing their money! The SPX is now back in negative territory for 2015 having opened Monday at 2,090.42 and closing Friday at 2,012.37, down 78.05 or 3.73% for the week.

Chart_121315_SPX

The SPX chart offers some support at the 1995 level. Should we break below that level, it is possible that we may be on our way to retesting the August lows again.

Earlier in the week, the Energy Information Administration (EIA) announced that U.S. commercial crude inventories had unexpectedly dropped by 3.6 million barrels to a total of 485.9 million barrels. Analysts had expected an increase of 252,000 barrels. This provided some short-term relief to the decline in WTI crude. However, it was just too little too late. Data from Baker Hughes on Friday showed that the number of active U.S. oil-drilling rigs fell by 21 to 524. Compared to last year, the total rig count has fallen by 1,022. /CL futures opened the week at $40.10 per barrel and closed Friday at $35.36, down $4.74 or 11.82%. This marks the largest weekly drop this year.

Chart_121315_CL

Trade Activity This Week

Natural Gas futures have continued to plummet, although not as sharply as crude oil. On Monday, I bought back the nearly worthless /NG Jan 3.4 call for a $62.88 profit (9.5% return on capital) after commissions. I then sold the /NG Jan 2.4 call for $0.017 ($170 premium received). The trade is only two weeks away from expiration (12/29). The probabilities are indicating that I still have a 70% chance that the 1.85 put will expire out-of-the-money. I will be watching this closely.

On Monday, I also sold 2 /CL Feb 55 calls for $.06 ($120 premium received) to help neutralize the delta with the two Feb 28 puts that I currently have. This effectively turns the position into a strangle.

With the drop in the equity markets on Tuesday, I took advantage of increased premiums in /ES and sold the Jan4 1650 put for $1.50 ($75 credit received). In retrospect, I should have waited to place this position as the premiums got much richer towards the end of trading on Friday. However, hindsight is 20/20.

On Wednesday, I had an opportunity to close the /ES Mar 2250/2300/1725/1675 iron condor that I had placed four weeks prior. I closed the trade for slightly less than my target of 50% of premium collected, however, after commissions (which were quite hefty for this trade), I net a profit of $78.72 (52.1% return on capital).

On Friday, I closed one of my two /CL Feb 28 puts for a small loss of $157.12. Why? As the volatility really accelerated on Friday, the margin requirements for my positions increased significantly. And, although none of my positions are in any real danger at the moment, the cash available in my account is disappearing quickly. Rather than receive a margin call, I chose to take this small loss and free up a lot of buying power.

Plan For Next Week

Weeks like this make me wish that I had a lot of cash sitting on the sidelines so that I could take advantage of the huge increases in premiums. However, with the increase in margin requirements, I was not really in a position to open any new positions on Friday as the volatility escalated. As a result of this, I will be making some changes to my trading plan to determine how much capital is actually invested based on the current level of the VIX. That way I will always have capital available to take advantage of high implied volatility.

The portfolio is up 25.93% for the year versus down 2.26% for the S&P 500 (see Trading Results). The portfolio is currently 8% in cash.

  • It is gonna be a wild week. Everyone thinks something big is about to happen. Personally, I love it when VIX is up over 20 as it means I can sell spreads even further away than during more normal times. I am putting my money to use and will sell more if we have another big down week. I will buy some puts to protect my credit put spreads in case the market reacts too much to the downside.

    • Aram Basmadjian

      Agreed!

  • The Lazy Trader

    Good wrap up Aram.
    I think it is going to be quiet on Monday, Tuesday and the first half of Wednesday. I think the market will just be in waiting mode during the first half of the week.

    Then,…..I think we rally like mad 🙂
    I don’t invest based on my hunches, but man, we have seen this several times.
    I still remember in 2012, during elections, boy it was all gloominess and pessimism, and on Dec 16, one of the most spectacular rallies ever witnessed by the human kind started to take place.

    Debt Ceiling conversations, another good example.

    December just tends to be so bullish in the second half,……

    Lately, it has looked like, whatever the outcome, the fact that “uncertainty” is removed, is enough to unleash the beast to the upside.

    We’ll see.
    Here’s to a good week of trading.
    LT

    • Aram Basmadjian

      I agree with you, LT. This week is options expiration and also the last full trading week of the year and before the holidays. Are “they” really going to let 2015 be a “bust” for the market?

  • Aram Basmadjian

    Thanks, Glenn. I use /ES simply because it is more efficient from a margin perspective. I do not have the ability to trade SPX naked options in an account my size. With /ES, I am able to hold these positions.