Weekend Portfolio Analysis (May 21, 2016)

Market Conditions

The S&P 500 barely ended the week higher, underscoring how the prospect of higher interest rates has unsettled investors. Federal Reserve officials and upbeat economic data in recent days have raised the possibility of a rate increase as soon as June. Last Friday, the probability of a rate hike at the June meeting was just eight percent, which increased to a thirty percent probability by the end of this week. The fed funds futures market is now pricing in a fifty-five percent likelihood of a rate hike in July, as well. Zero-percent interest rates have persisted for 90 months helping to propel the stock market higher. However, corporate earnings reports this quarter have been dismal. Companies in the S&P 500 are on track to report a fourth consecutive quarter of declines from the previous year. This coupled with potentially higher interest rates is leading investors to question what will continue to drive stocks higher.

The S&P 500 opened Monday at 2046.53 and closed on Friday at 2052.32, up 5.79 or 0.28% for the week.


Today marks exactly one year since the S&P 500 closed at a new all-time high of 2130.82. Over the past year, the index has been unable to regain these levels. The chart clearly shows that the SPX is in a gradual downtrend having declined nearly 60 points from the highs just one month ago. However, despite several brief excursions this week below the 2040 level, it has failed to close below this critical level of support.

Oil prices edged higher this week posting a second straight weekly gain, as traders continue to focus on supply disruptions in Canada, Nigeria and Libya. Crude gained positive ground despite the surprise increase in U.S. oil inventories by 1.3 million barrels to 541.3 million barrels according to the Energy Information Administration (EIA). This was in stark contract to the American Petroleum Institute’s (API) projection earlier in the week that crude oil stockpiles would fall by 1.1 million barrels.

Baker Hughes reported on Friday that the U.S. crude oil rig count remained unchanged this week at 318 operating rigs, breaking an eight week streak of declines.

Crude oil opened the week at $46.28 per barrel and closed Friday at $48.48 per barrel, up $2.20 or 4.75%. This marks the highest weekly close since October 9, 2015.


The volatility in /CL options dropped to its lowest point in the past twelve months, which makes selling options in crude less desirable.

Gold has gained 18% since the start of the year, buoyed by dollar softness and demand for safe-haven assets. However, on Wednesday, gold sold off hard following the release of unexpectedly hawkish FOMC meeting minutes. Higher interest rates would presumably lift dollar demand, dampening buyer interest in dollar-priced precious metals. Rate hikes can also weigh on gold as the precious metal doesn’t pay interest. That tends to push investors toward higher-yielding alternatives when rates are on the rise.

Gold futures for June delivery opened Monday at 1273.10 and closed Friday at 1252.90, down 20.20 or 1.59%.


Soybean prices rose this week, although they did not break above the highs set last week as buying by speculators petered out. Last week, prices were pushed substantially higher amid expectations that inclement weather in South America would curb global output of the crop, boosting demand for domestic supplies. The projected elevated export demand comes even as some weather forecasters are predicting hot, dry weather for the end of the U.S. growing season, which could trim domestic harvests this fall. Soybean futures for July delivery opened Monday at 1063 and closed Friday at 1075.5, up 12.50 or 1.18%.


Note the expansion of the Average True Range over the past several weeks. /ZS has had daily price excursions averaging 24 points from high to low. Of course, implied volatility has been elevated as well. Unfortunately, soybean futures options do not have reliable closing prices which impacts the ability to accurately calculate IV Rank or IV Percentile.

Trade Activity This Week

TradeHistory_052016This week I closed four positions as well as opening and closing one new position. I also had one trade close due to options expiration. Clicking the thumbnail on the left will display the actual trade history for this past week.

On Tuesday, I closed the SLV Jun 16 straddle that was opened on April 20th. I originally sold the straddle for 1.43 when IV Percentile was 92.86%. I typically close straddles at 25% of maximum profit. This past Tuesday, IV Percentile had dropped to 61.11% which permitted me to buy back the position for 1.07. This resulted in a small profit of $30.00 (or 6.44% return on capital) over 27 days.

Late Tuesday evening, the price of soybeans spiked which also drove up the implied volatility. I decided to fade the move by selling a far out-of-the-money call option. The trade details shown below.


ZS_5_17_2016_at_10_27_02_PM/ZS Nov 1460 Call
Trade Details:

SELL 1 /ZS Nov 16 1460 Call @ 10.875

Credit: 10.875 ($543.75 per contract)
Max Risk: Unlimited (Breakeven Price: 1470.875)
/ZS Current Price: 1072.50
Margin Required: $941.00
Days to Expiration: 157
Probability of Profit: 97.19%

The next morning, soybeans had dropped to 1056.50 enabling a quick exit from the trade. I bought back the short call for 8.75 which net a profit of $98.13 (or 10.11% return on capital) in one day.

Volatility in /GC options continued to decline as well. On Thursday, I closed out both contracts of the /GC Aug 1550/1025 strangle that I had sold on April 25th for 2.70. At the time that the trade was originated, IV Percentile was 65.48%. With a slight drop in volatility and the passage of time (theta), I purchased the strangle back for 1.30, which was just over 50% of the maximum profit. The two contracts net a profit of $251.52 (or 19.42% return on capital) in 24 days.

On Friday, implied volatility dropped significantly in gold which allowed me to close out two more trades. First, I closed out the /GC Aug 1600/1075 strangle that I originally sold on April 28th for 3.00. IV Percentile was 66.27% when the trade was opened and on Friday morning it was a mere 46.03%. I purchased back the position for 1.50 (50% of maximum profit) which resulted in a profit of $135.76 (17.43% return on capital) in 22 days.

I then closed out both contracts of the /GC Aug 1575/1000 strangle for 1.00. This trade was originally opened on April 28th as well for 2.10. The profit was $191.52 (14.93% return on capital) in 22 days.

Finally, the /ES May 1780 Put that I purchased as portfolio protection on April 12th expired worthless. I paid 2.95 for the put and booked a loss of $150.16 after commissions.

Plan For Next Week

The challenge is to locate situations where implied volatility is elevated. That is one of the reasons that I have added soybeans to my list of trading products. I suspect that volatility may expand in /ZB with the looming threat of an interest rate hike in three weeks. Due to the bad experience I had with /ZB earlier this year, I will make sure that any potential trade conforms exactly to my trading plan before executing it.

The portfolio is now down only 1.74% for the year versus up 0.69% for the S&P 500 (see Trading Results).   The portfolio is currently 85% in cash. This is the highest level of cash that I have held in the account for quite some time.