Weekend Portfolio Analysis (May 27, 2017)

Market Analysis

Upbeat corporate earnings and positive economic data helped support the continued rally in U.S. equities this week. The problems plaguing Washington which helped to fuel the one-day selloff last week were quickly dismissed as the S&P 500 Index and the Nasdaq Composite Index hit fresh all-time highs on Thursday. With 477 of the S&P 500 companies having reported for the first quarter, earnings are expected to increase 15.3% compared with Q1 2016. Revenue growth is also up 7.3% versus a year ago.

Neither the stock nor the bond market reacted strongly to Wednesday’s release of the minutes from the Federal Reserve’s May meeting, which seemed to change few minds about the likely path of further interest rate hikes. The fed funds futures market still points to the June Federal Open Market Committee (FOMC) meeting as the most likely time for the next rate-hike announcement with an implied probability of 83.1%, up from last week’s 78.5%.

The S&P 500 (SPX) opened Monday at 2387.21 and closed Friday at 2415.82 up 28.61 points, or 1.2%.

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This week we saw an unusual excursion as the SPX exceeded the expected move for the week by five points. The expected move (shown above by the magenta lines) for next week, as determined by the SPX options, is only +/-18.87 points. That is the smallest 1-week expected move for the SPX since the introduction of weekly SPX options! The fact that we exceeded the expected move this past week, coupled with the very small expected move for this coming week, is indeed interesting. This may be due, in part, to the shortened trading week as a result of the Memorial Day holiday.  Also of interest is the upper range of the expected move. The implied volatility of the SPX options indicates that traders expect the SPX to remain between 2435 and 2397 next week. The 2435 level also corresponds with the 161.8% fibonacci extension (as seen below).  Of course this does not mean that we can’t go higher, but it does become a significant inflection point.

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The CBOE Volatility Index (VIX) is, once again, very low. As a general rule, if the VIX is not trending higher, then stocks can continue to rally. Recently we have had two instances where the VIX has attempted to break out. The more lasting move was prior to the France presidential vote. The other excursion higher was only momentary in response to the large one-day market decline last week. Those two events have created a resistance area at the 16 level. Until the VIX moves above 16, the chart is bullish for stocks. The VIX closed Friday at 9.81, just slightly above its all-time low.

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Crude oil was back in the news this week as oil prices suffered a drop of nearly 5% Thursday, marking their lowest finish in a more than a week, as traders displayed disappointment over the Organization of the Petroleum Exporting Countries (OPEC) decision to extend production cuts by only nine months. An extension was widely expected, but traders had started to speculate that the cartel would make deeper reductions to output or extend the deal by 12 months. A day before OPEC’s meeting in Vienna, the Energy Information Administration (EIA) reported a healthy draw in crude oil inventories. Data from the EIA on Wednesday showed that domestic crude supplies fell by 4.4 million barrels to a total 516.3 million barrels. The update came a day after the American Petroleum Institute reported a 1.5-million-barrel draw in commercial inventories, falling short of analyst expectations for a decline of 2.3 million barrels. This was the second week when analysts expected an over two-million-barrel draw. U.S. energy firms added oil rigs for a record 19 weeks in a row but the pace of additions has slowed with only two added this week (722 total oil rigs), and the monthly total added was the lowest since October, according to Baker Hughes data. Crude oil futures for June delivery opened the week on Monday at $50.93 per barrel and closed Friday at $49.87, down 1.06 or 2.08%.

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Trade Activity

We closed several trades this week and opened one new position.

/CL August 59/40 Strangle
Most of our trades this we week revolved around our large crude oil position. We essentially had three of the August 59/40 Strangles in the portfolio, although the puts were sold at different times and for different premiums. We closed two of the 40 puts on Tuesday for .10 each. We had sold these originally for .32 and .23. On Thursday, we closed the last put for .09 which was originally sold for .16. We also closed all three calls on Thursday for .09. We had sold the calls initially for .11 each to delta hedge our position as the price of oil declined. Overall, we generated a nice profit of $436.68 on the entire position after commissions. This resulted in a 14.7% return on capital in just over a month.

/ZC July 395/405/340/330 Iron Condor
On Wednesday we closed out our corn position at our target of 50% of maximum profit. We sold the two iron condors for 2.50 each and bought them back for 1.25 each. As I have lamented in the past, the commissions for iron condors on grain futures are very high. However, this is offset by the very small capital requirements for these trades. Despite the fact that half our profits were consumed by commissions, we still did very well on the trade overall. Our profit after commissions was $60.04, but due to the minimal margin requirement for the trade, our return on capital was 35% in 30 days!

/ZS August 1110/810 Strangle
On Friday, we opened another position in soybeans to take advantage of the volatility and drop in price. We currently have a position for the September expiration, but we opened this trade for the shorter August expiration due to the favorable pricing and very high probability of success.

Trade Details:
SELL 1 /ZS Aug 1110 Call @ 2.25
SELL 1 /ZS Aug 810 Put @ 1.25
Credit: 3.50 ($175.00 per contract)
Max Risk: Unlimited (Breakeven Prices: 806.50 / 1113.50)
/ZS Current Price: $933.00
Margin Required: $427.00
Days to Expiration: 56
Probability of Profit: 95.99%

Current Portfolio

/CL September 65/39 Strangle
$320.00 Credit. 82 days to expiration. 5 deltas on the puts and 2 deltas on the calls. Currently at 28% of max profit. This trade looks good. Next week we may consider rolling down the 65 calls to collect a bit more premium, as the risk on the call side seems to be subsiding.

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/ZS September 1160/840 Strangle
$450.00 Credit. 90 days to expiration. 12 deltas on the puts and 7 deltas on the calls. Currently has a loss of $6.25. This trade looks good, although price has moved down a bit since putting on the position. The outlook for soybeans is bearish, so we may consider rolling down the calls next week. However, the calls do still have a fair amount of premium left in them.

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/ZW July 515/525/425/415 Iron Condor
$400 Credit. 27 days to expiration. 29 deltas on the puts and 5 deltas on the calls. Currently at 25% of max profit. This is the original wheat position that was entered erroneously. Although, the price is currently close to our breakeven point on the put side, this trade is actually looking okay.

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/ZW July 445/455/400/390 Iron Condor
$262.50 Credit. 27 days to expiration. 6 deltas on the puts and 42 deltas on the calls. Currently has a loss of $37.50. Interestingly, this was the hedge that was put on to protect our other wheat iron condor. However, this is now the position that is worse shape.

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The risk graph below shows the complete picture when we combine both of these iron condors together. As you can see, the breakeven prices for the combined position are 418.375 on the put side and 451.625 on the call side. The price of wheat for July delivery is currently at 438, right in the middle of the profit zone. With only 27 days to expiration, the theta decay should be fairly significant over the next week if wheat prices remain rangebound.

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FXE June 107/112/107/102 Iron Butterfly
$190.00 Credit. 20 days to expiration. 28 deltas on the puts and 71 deltas on the calls. Currently at 1.3% of max profit. Volatility is starting to contract and the price has started moving back down away from our upper breakeven. We will be looking for an opportunity to exit this trade towards the end of next week.

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Plan For Next Week

Closing the three crude oil strangles this week has freed up a lot of cash. We will be looking for good opportunities to add new positions to portfolio.

The portfolio is currently up 15.23% year-to-date versus 7.3% for the S&P 500 (see Trading Results). The portfolio is currently 76% in cash. We have done very well during the first half of the year. The challenge now is to preserve our profits and not get greedy.

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Please remember our veterans this Memorial Day Weekend. Happy Trading!