Weekend Portfolio Analysis (June 3, 2017)

Market Analysis

The market got off to a slow start after the Memorial Day holiday, but by Thursday, things started to heat up after the release of the employment report and bullish EIA inventory report. On Friday, a disappointing nonfarm payroll report (138,000 actual vs. 185,000 consensus) was unable to deter investors as all three major indices set new record highs.

President Trump also announced this week that the U.S. would pull out of the Paris climate deal claiming that it puts U.S. businesses at a disadvantage.

Earnings season is coming to a close with 492 of the S&P 500 companies having reported for the first quarter. Earnings have increased 15.4% versus the same quarter a year ago.

The fed funds futures imply that traders now see an 89% chance that interest rates will be raised at the Federal Open Market Committee (FOMC) policy meeting on June 14th, up from last week’s 83.1%.

The S&P 500 (SPX) opened Tuesday at 2411.67 and closed Friday at 2439.07 up 27.4 points, or 1.14%.

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Once again, the SPX exceeded the expected move for the week (shown in magenta lines) by nearly 5 points. The expected move for the coming week is still quite muted, with the SPX options implying a range of only +/-20.56 points. With the market breaking above the 2435 level, our next target to the upside is the 2460 to 2480 range.

The chart below displays the percentage of stocks that are trading above their 50-day moving average. The current reading is that only about 56% of stocks are trading above their 50-day MA, which is an indication of lackluster market breadth. Market tops often follow extremely high levels of market breadth as investor euphoria results in everyone becoming bullish on the majority of stocks. This chart does not indicate that level of investor complacency. At least, not yet.

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The CBOE Volatility Index (VIX) continues to remain near historic lows, another bullish signal. The VIX closed Friday at 9.75.

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Crude oil traded at the lowest level in three weeks as traders digested the U.S. withdrawal from the Paris climate agreement which raised fears of more unbridled drilling. Despite bullish Energy Information Administration (EIA) inventory data this week and a weakening dollar, oil prices traded lower each and every day of this past week. The EIA reported a surprisingly strong drawdown in crude oil inventories, a drop of 6.43 million barrels. However, weekly U.S. oil production continues to climb. Also, Libyan oil production broke new highs for the year. OPEC saw its collective output jump in May because of the rising supply from Libya and also from Nigeria, two countries that are exempt from the production cut deal. The uptick in output was the first monthly increase in production for OPEC this year. Both of these countries have already stated their objective is to dramatically ramp up production during the second half of this year. U.S. drillers added oil rigs for a 20th straight period last week by 11 to 733, the biggest jump in seven weeks according to Baker Hughes’ weekly report. Crude oil futures for June delivery opened on Tuesday at $49.93 per barrel and closed Friday at $47.74, down $2.19 or 4.39%.

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Trade Activity

This week we opened three new positions.

/ZC September 500/330 Strangle
On Wednesday there was an increase in volatility on corn options, so we took advantage of this and sold a strangle. Corn prices are trading close to their 10-year lows, so I felt comfortable positioning the puts just outside of the one standard deviation move. On the call side, I allowed plenty of room for prices to run, while still collecting a decent premium. The trade is just barely registering a profit right now.

Trade Details:
SELL 2 /ZC Sep 500 Call @ 1.875
SELL 2 /ZC Sep 330 Put @ 1.375
Credit: 3.25 ($162.50 per contract)
Max Risk: Unlimited (Breakeven Prices: 326.75 / 503.25)
/ZC Current Price: $380.50
Margin Required: $280.00
Days to Expiration: 86
Probability of Profit: 84.33%

/CL September 59/37 Strangle
In anticipation of the release of the crude oil inventory numbers on Wednesday (a day later than normal due to the Memorial Day holiday), volatility spiked momentarily offering us an opportunity to increase our /CL position with some good premium. This trade is already showing a nice profit and is currently at 13% of maximum profit.

Trade Details:
SELL 1 /CL Sep 59 Call @ 0.14
SELL 1 /CL Sep 37 Put @ 0.17
Credit: 0.31 ($310.00 per contract)
Max Risk: Unlimited (Breakeven Prices: 36.69 / 59.31)
/CL Current Price: $48.40
Margin Required: $660.00
Days to Expiration: 78
Probability of Profit: 87.03%

FXE June 109.5/113/109.5/105.5 Iron Butterfly
The breakeven on the call side of our existing FXE iron butterfly was breached on Friday. We entered another position for the June expiration to raise our breakeven point above current price levels.

Trade Details:
SELL 1 FXE Jun 109.5 Call @ 0.58
BUY 1 FXE Jun 113 Call @ 0.01
SELL 1 FXE Jun 109.5 Put @ 0.82
BUY 1 FXE Jun 105.5 Put @ 0.05
Credit: 1.34 ($134.00 per contract)
Max Risk: $266.00 (Breakeven Prices: 108.16 / 110.84)
FXE Current Price: $109.16
Margin Required: $400.00
Days to Expiration: 14
Probability of Profit: 56.24%

Current Portfolio

/CL September 39 Put
$220.00 Credit. 75 days to expiration. 8 deltas on the puts. Currently has a loss of $60.00. This trade initially started out as the /CL September 65/39 Strangle. On Friday the price of crude oil moved sharply lower early on in the trading session which allowed us to exit the call side of this strangle for a nice profit. The calls were originally sold for 0.10 and we bought them back for 0.03 which net us a profit of $62.78 per contract after commissions (or 19.02% return on capital) in two weeks. Crude oil prices recovered in the afternoon, but not to the point that we were able to get the desired premium on the September 60 calls. We would like to collect at least 0.13 for these calls which would result in an additional $100.00 of total credit on the trade. Although the puts have a loss right now, we are really at breakeven when we consider the profit from closing the call side.

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/ZS August 1110/810 Strangle
$175.00 Credit. 48 days to expiration. 4 deltas on the puts and 5 deltas on the calls. Currently at 4% of maximum profit. Soybean prices had moved lower earlier in the week, but recovered much of their losses during Friday’s trading session. As shown below, the current price is positioned right at the most profitable part of the curve.

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/ZS September 1160/840 Strangle
$450.00 Credit. 83 days to expiration. 12 deltas on the puts and 7 deltas on the calls. Currently at 4% of maximum profit. This trade looks good at this point. When soybean prices were trending lower, we had considered rolling down the call side, but there was too much theta remaining in the calls, so it did not make sense.

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/ZW July 515/525/425/415 Iron Condor
$400 Credit. 20 days to expiration. 41 deltas on the puts and 2 deltas on the calls. Currently at breakeven. This is the original wheat position that was entered erroneously.

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/ZW July 445/455/400/390 Iron Condor
$262.50 Credit. 20 days to expiration. 7 deltas on the puts and 29 deltas on the calls. Currently at 19% of max profit. Since putting on this hedge or adjustment trade, these two positions keep swapping back in forth with one being profitable while the other is at breakeven or a slight loss.

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The risk graph below shows the complete picture when we combine both of these iron condors together. The price of wheat remains rangebound. Our plan is to exit this trade within the next week.

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FXE June 107/112/107/102 Iron Butterfly
$190.00 Credit. 13 days to expiration. 11 deltas on the puts and 89 deltas on the calls. Currently has a $46.50 loss. On Friday, the price of FXE increased solidly beyond our breakeven point, which triggered the sale of another iron butterfly centered around the 109.50 price point (as discussed above).

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When this trade is combined with the existing FXE iron butterfly, we end up with a risk graph that looks like an iron condor. Overall, our breakeven prices on the combined position are 106.63 and 109.87 with a probability of profit of nearly 60%. The risk graph below illustrates the combined position. With only 13 days to expiration, we are exposing ourselves to a bit of gamma risk. If FXE continues to move higher early in the week, we will likely just exit the trade and take the small loss.

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Plan For Next Week

We will be looking for opportunities to exit our FXE and /ZW positions which are two and three weeks, respectively, from expiration.

The portfolio is currently up 15.86% year-to-date versus 8.3% for the S&P 500 (see Trading Results). The portfolio is currently 68% in cash. May was a very profitable month for the portfolio with a monthly return of 4.98% after commissions.

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Happy Trading!