Weekend Portfolio Analysis (June 10, 2017)

Market Analysis

The market was relatively quiet during the early part of the week in anticipation of testimony from the former FBI Director James Comey, policy announcements from the European Central Bank, and the general election in the United Kingdom. Investors were able to breathe a sigh of relief, not only in reaction to Mr. Comey’s testimony, but also in reaction to the ECB’s decision to leave interest rates unchanged. With two of the week’s three major events in the rearview mirror, the financial sector led the S&P 500 to another all-time high. However, gains were held in check as investors awaited the results of the UK general election. Thursday evening, Prime Minister Theresa May’s Conservative Party lost its parliamentary majority which caused the British pound to drop. With political risk off the table, U.S. Markets rose at the start of trading Friday with all three major market indices hitting new all-time highs.

The fed funds futures market still points to the June FOMC meeting as the most likely time for the next rate-hike announcement with an implied probability of 95.8%,

The S&P 500 (SPX) opened Monday at 2437.83 and closed Friday at 2431.77 down 6.06 points, or 0.25%.

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We are at an interesting inflection point in the market right now. The SPX closed well within the expected move for the week, which was +/- 20.56 points. This coming week the expected move has expanded over a third to +/- 28.10 points. This means that traders believe that the SPX will close Friday somewhere between 2403.67 and 2459.87. This is determined from the prices of the at-the-money straddle on SPX options that expire next Friday.

There does seem to be some inconsistencies or cracks forming in the market and this week I would like to explore some of those.

The diminishing focus on political events on Friday was evidenced by the decline of the Chicago Board of Exchange’s Volatility Index (VIX), or so-called fear index, to a 24-year low of 9.37 during early trading. However, during the afternoon session, the VIX climbed to 12.11, an increase of nearly 30%, before settling at 10.70. This 5-day 5-minute chart shows a very interesting change in mood during the Friday afternoon session.

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The next chart is a comparison of the SPY (cyan line), QQQ (green line) and IWM (magenta line). Friday brought about an abrupt change in market dynamics, as market-leading tech stocks sold off, while a rally early in the day helped the smaller-cap benchmarks outperform and manage to join the other indexes in record territory.

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Finally, let’s take a look at the financial sector which was off to the races on Friday. This sector was crucial in supporting the S&P 500 as the high-flying, mega-cap names like Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Alphabet (GOOGL), and Facebook (FB) came under some notable profit-taking pressure. Previously I have mentioned that the 24 price level on the XLF is an inflection point, which, as of Friday, was clearly blown through.

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Crude oil prices got crushed mid-week after the Energy Information Administration (EIA) reported a surprising increase of 3.3 million barrels, a sign that points to ongoing problems with oversupply. WTI dropped by 5 percent sinking back into the mid-$40s. The OPEC cuts put a floor beneath prices, with few analysts predicting substantial price losses from current levels, but there is also not a lot of confidence that a rally is imminent unless data is released that shows the latest inventory build to be an anomaly.

The oil-rig count also rose by 8 to 741, the highest level since April 10, 2015, data from Baker Hughes showed. This is the 21st straight week that the rig count has risen, the longest streak in at least three decades, which underscores that robust shale production continues to keep global oil supplies higher than demand.

Crude oil futures for July delivery opened Monday at $47.71 per barrel and closed Friday at $45.90, down $1.81 or 3.79%.

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Trade Activity

This week we had four closing trades and one new trade.

/ZW July 515/525/425/415 Iron Condor
On Tuesday, we had the opportunity to pull off this iron condor for nearly 50% of maximum profit. We originally sold two contracts of this iron condor for $4.00 each on May 8th. We bought them back for $2.25 which net us a profit $110.04 after commissions, or a 31.44% return on capital in 29 days. That was not too bad considering this trade was entered in error. However, while holding this position, wheat prices moved outside of our breakeven prices. As a result, we hedged it with another wheat trade which is currently being challenged as well. It is likely that most, if not all, of the gains from this trade will be offset by the loss from the remaining iron condor, which brings us to our next trade.

/ZW July 445/455/400/390 Iron Condor
We did not close out this iron condor. However, we did buy back the short 400 puts. The puts were originally sold for 1.375 and we bought them back on Tuesday for 0.25. This net us a profit of $96.26. However, we still have the 445/455 call credit spread remaining and it is under water right now. If we see a small drop in wheat prices early next week, we should be able to exit rest of this iron condor and between all of the profits already captured, hopefully break even on the whole position.

FXE June 109.5/113/109.5/105.5 Iron Butterfly
This trade was originally placed as a hedge when the price of FXE breached our breakeven point on the original FXE 107 iron butterfly. Friday morning, FXE moved sharply lower so we exited this trade for a small loss by buying back just the short call and short put. The remaining value on the long call and put were miniscule and not worth paying commissions to sell them. However, we have them as free “lottery tickets” in case FXE does something crazy over the next week before expiration. After commissions, we took a $26.21 loss on this iron butterfly. However, this was more than offset by the gains on the original FXE iron butterfly, which is our next trade.

FXE June 107/112/107/102 Iron Butterfly
Shortly after closing the FXE 109.5 iron butterfly, we also exited the FXE 107 iron butterfly by again only buying back the short put and call. On this trade we net a profit of $43.79 after commissions. Our total profit on the combined FXE trade was only $17.58. That small of a profit is hardly worth tying up nearly $1,000 of capital for a month, but nonetheless, it is better than a loss and it helped keep the portfolio diversified.

/ZW September 600/400 Strangle
On Friday, after having unwound part of the wheat iron condor trade, I decided to put on a new strangle for the next expiration period. Unlike the original wheat trade which was placed in error (dumb thumbs), this trade was intentional and takes advantage of the higher premium that we have seen in the /ZW options lately.

Trade Details:
SELL 2 /ZW Sep 600 Call @ 2.125
SELL 2 /ZW Sep 400 Put @ 1.375
Credit: 3.50 ($175.00 per contract)
Max Risk: Unlimited (Breakeven Prices: 396.50 / 603.50)
/ZW Current Price: $464.25
Margin Required: $621.00
Days to Expiration: 77
Probability of Profit: 85.20%

Current Portfolio

/CL September 59/37 Strangle
$310.00 Credit. 68 days to expiration. 5 deltas on the puts and 4 deltas on the calls. Currently at 13% of maximum profit. Despite the strong move down, this trade still looks to be in real good shape.

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/CL September 39 Put
$220.00 Credit. 68 days to expiration. 10 deltas on the puts. Currently has a loss of $130.00. Oil prices have moved against us on this put, but I think oil prices will not trade too much lower. Should this be tested, we will just roll the put down and out to the next expiration cycle.

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/ZC September 500/330 Strangle
$325.00 Credit. 76 days to expiration. 5 deltas on the puts and 9 deltas on the calls. Currently has a loss of $37.50. Corn prices have moved up a bit since placing this trade due to weather issues that are impacting the crops right now. However, as you can see in the chart below, we have a lot of cushion on the upside.

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/ZS August 1110/810 Strangle
$175.00 Credit. 41 days to expiration. 2 deltas on the puts and 7 deltas on the calls. Currently at breakeven. Soybean prices have been recovering this past week. Again, we have plenty of room on this trade.

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/ZS September 1160/840 Strangle
$450.00 Credit. 76 days to expiration. 8 deltas on the puts and 9 deltas on the calls. Currently at 8% of maximum profit. This trade looks good at this point.

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/ZW July 445/455/400/390 Iron Condor
$262.50 Credit. 13 days to expiration. 52 deltas on the calls. As mentioned earlier, we closed out the put portion of this iron condor and have only the call side remaining. We will be looking for an opportunity to exit this for a small loss.

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Plan For Next Week

We are still looking for an opportunity to finish unwinding the July /ZW iron condor. We also will be looking for additional opportunities to deploy capital, as we have a large component of cash right now. The portfolio is currently up 18.1% year-to-date versus 8.0% for the S&P 500 (see Trading Results). The portfolio is currently 74% in cash.

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Happy Trading!